That is now ten years ago. BaFin was at that time created as an integrated financial supervisory authority out of the former Federal Banking Supervisory Office (Bundesaufsichtsamt für das Kreditwesen – BAKred), Federal Insurance Supervisory Office (Bundesaufsichtsamt für das Versicherungswesen – BAV) and Federal Securities Supervisory Office (Bundesaufsichtsamt für den Wertpapierhandel – BAWe). Since then it has gone through sometimes stormy times and has, as predicted by Jochen Sanio, undergone a process of constant change. “The integrated financial supervisory authority has stood its test in all respects,” said Dr. Thomas Mirow, State Secretary at the Federal Finance Ministry at the time, back in 2008. BaFin had shown itself equal to all challenges even in times of crisis, he added.

Surprisingly rapid establishment

BaFin saw the light of the world surprising quickly. When the Bill on Integrated Financial Services Supervision came to the Bundesrat (the German Federal Council) in March 2002, scarcely anyone expected that the new integrated financial supervisory authority would complete the legislative process within the space of only six weeks. It was the unusual path taken by the Bundesrat session that resulted in the Act coming into force unexpectedly rapidly, without taking the circuitous route of the Mediation Committee: since some Länder had left the Chamber early because of a dispute over the passage of the Immigration Act (Zuwanderungsgesetz) – subsequently declared to be unconstitutional by the Constitutional Court – the then Federal government's Bill on Integrated Financial Services Supervision passed the Bundesrat without further discussion.

BaFin officially commenced operations on 4 May 2002 with 1,050 employees under the leadership of President Jochen Sanio, who had previously been President of BAKred. At the very beginning, the new integrated supervisory authority had a mammoth task to deal with: three independent offices had to be merged into one single authority. BAKred brought 620 employees, BAV 300 and BAWe 130, who from then on were supposed to supervise the German financial market together as one. It was a question of unifying not only the three large supervisory areas but also three different organisational and staff structures that were even at that time split between two cities: Bonn and Frankfurt am Main.

It was agreed, though, that the establishment of an integrated financial supervisory authority made sense. The division of responsibilities practiced up to that date had fallen behind the times. Banks, financial service providers and insurers were increasingly competing for the same customers with similar products, financial conglomerates had arisen. For that reason a single, cross-sectoral financial supervisory authority had to be created – not only as a central contact but also in order to be able to exploit knowledge synergies and to keep pace with the rapid innovation process on the financial markets. In addition, the amalgamation of the three branches of supervision enabled better cooperation with foreign supervisory authorities and made it easier for supervisor representatives to assert German interests in international negotiations on regulation proposals.

Dotcom bubble and 9/11

BaFin was born into an extremely difficult market environment. The signs of a global recession had already begun to emerge in early 2001. The speculative bubble of the “new economy”, frequently also known as the dotcom bubble, had burst. Then, on 11 September 2001, the terrorist attacks in New York and Washington caused slumps on markets worldwide the likes of which had not been seen since the global economic crisis of 1930. Financial stocks were among the hardest hit. There were also dramatic falls in the German equity index DAX (Deutscher Aktienindex).

While risk model forecasts nonetheless continued to see German banks relatively robust, the German insurance sector found itself faced with hitherto unknown problems. Individual life insurers who had invested fairly heavily in equities were also affected. For the first time ever a life insurer went into a financial tailspin: Mannheimer Lebensversicherung AG. In mid-2003 its insurance portfolio was acquired by Protektor Lebensversicherung AG, a newly created bailout solution that was funded by the industry. With the terrorist attacks, re-insurers recorded the biggest losses that the insurance industry had ever had to absorb. Including other large losses, the gross loss ratio of German re-insurers rose from 66.3% to 81.6% in 2001.

The repercussions of the terrorist attacks revealed weaknesses in the international financial system, the elimination of which was in the following months the subject of intensive discussions, in which BaFin played its part. In response to the closing of Wall Street by the Securities Exchange Commission (SEC) following the terrorist attacks in September 2001, the International Organization of Securities Commissions (IOSCO) published a report on suspensions of trading in cross-border listed securities. The aim was to establish a standard practice and appropriate communication mechanisms in order to be able to deal with such exceptional situations better. In addition, there was much racking of brains internationally on the question of how the short selling of securities should be dealt with.

Phoenix compensation case

While ongoing supervision by BaFin also attracted increasing attention from the public in subsequent years, it was two unfortunate events in particular that created a stir: the Phoenix fraud and compensation case and the corruption case involving a BaFin employee.

Phoenix Kapitaldienst GmbH offered its customers a collective investment in derivatives that it managed itself. In March 2005 BaFin banned the company from carrying on this business after being informed of irregularities in the management of trust account funds to the amount of 680 million euros. Since the company was unable to cover the loss, BaFin petitioned for the opening of insolvency proceedings and declared the matter a case for compensation. This was the prerequisite for the Compensatory Fund of Securities Trading Companies (Entschädigungseinrichtung der Wertpapierhandelsunternehmen – EdW) being able to act. While the former Managing Director and Chief Operating Officer had already been sentenced to terms of imprisonment in the summer of 2006, the compensation process kept those involved on tenterhooks for years. When it came to examining investors’ claims for the insolvency proceedings, to start with, establishing the actual performance of their investments proved difficult. There then ensued legal disputes about segregation claims and the insolvency plan submitted. It was not until 2011 that the EdW could finally compensate the victims.

In 2006 irregularities at BaFin came to the attention of the Federal Audit Office (Bundesrechnungshof). BaFin's Internal Audit Department subsequently established that for several years a high official had been diverting funds into his own pocket. His activities cost BaFin, which funds itself via fees and levies paid by the financial industry, several million euros. The official was suspended and, after BaFin had reported the offence to the criminal prosecution authorities, was sentenced to six years' imprisonment for corruption and misappropriation of funds. In response to the case, BaFin re-designed its internal control system.

Financial crisis

In 2007 the financial markets worldwide were hit by such extreme turbulence that there was a serious threat to financial stability. The bursting of the real estate bubble in the USA and other countries manifested itself worldwide in losses and insolvencies of financial sector companies, including the major US investment bank Lehman Brothers Inc. in September 2008. Other collapses could be prevented only by government intervention.

While German direct insurers and re-insurers had to absorb sometimes high write-downs on their investments but, all told, got off quite lightly from the crisis, some banks fell into serious difficulties in Germany as well. As far back as 2007 a lifeboat worth several billion euros had to be launched for IKB Deutsche Industriebank AG (IKB); the bailout fund was increased on a number of occasions before KfW transferred its 90 % shareholding to the Lone Star Group, which had been charged with re-organising the bank. Landesbank Sachsen, too, was soon adversely affected by the crisis, as a result of which the supervisory authority feared a liquidity squeeze. It was eventually absorbed into the Landesbank Baden-Württemberg group.

SoFFin guarantees

In 2008 the Financial Market Stabilisation Fund (Sonderfonds Finanzmarktstabilisierung – SoFFin) received applications for guarantees from WestLB AG, BayernLB and HSH Nordbank AG as well as IKB. BaFin imposed a moratorium on Lehman Brothers Bankhaus AG, the German subsidiary of the US Lehman group, before a compensation case was declared and insolvency proceedings had to be opened.

In addition, two Pfandbrief issuers, Düsseldorfer Hypothekenbank AG and Hypo Real Estate Holding (HRE), fell into serious financial difficulties in 2008. While Düsseldorfer Hypothekenbank was taken over by the private banking industry in April 2008 and so saved from collapse, the much larger HRE could be stabilised only with the aid of the private financial industry and substantial state support. In 2009 the Act supplementing the Financial Market Stabilisation Act (Finanzmarktstabilisierungsergänzungsgesetz) also brought into effect the Rescue Takeover Act (Rettungsübernahmegesetz), which had been largely designed with HRE in mind. For a limited period of time this Act gave the Federal government the power to nationalise systemically important banks. HRE was eventually taken over by SoFFin and comprehensively restructured.

International efforts

The financial sector suffered from the effects of the crisis on a global scale. With a shortage of market liquidity, uncertainty regarding the actual risk-content in bank balance sheets and the proper valuation of structured products caused a global dwindling of confidence between credit institutions. Funding became more difficult; banks began to hoard liquidity. As a result, there were massive disruptions on the interbank market. The leading central banks therefore gave the market large doses of liquidity injections in several, sometimes concerted actions.

“We were very well aware that in some areas of the international financial system risk volumes had built up that were too high in comparison with the risk buffers that the banks held in the form of capital,” said then BaFin President Jochen Sanio in May 2009. But BaFin could not step in: “We supervisors are only as good as the rules we work by.” The crisis had shown in dramatic fashion, he said, what dangerous loopholes and shortcomings lurked in the international regulatory system. But as part of the international community of supervisors, he had to admit that the regulatory loopholes had been accepted for far too long, on the – unfortunately false – assumption that they were not particularly dangerous.

Extensive efforts were made at the global level to eliminate the regulatory loopholes; BaFin played its part in these. One of the most significant outcomes were the capital and liquidity rules of Basel III. Other topics included the lack of transparency regarding the actual risks of individual institutions, how to deal with concentration risk and the work of rating agencies.

New legislation in Germany

It became also clear in Germany that an improvement in BaFin's powers of intervention in times of crisis and better prevention were needed. As part of the package of measures to stabilise the financial markets, the Act on the Strengthening of the Supervision of Financial Markets and Insurance (Gesetz zur Stärkung der Finanzmarkt- und Versicherungsaufsicht) was enacted in July 2009. Among other things, it contains provisions for the vetting of Supervisory Board members, provides for a restriction on the number of executive directorships and prohibits direct insurance undertakings from conducting non-insurance business. In addition to the foregoing, it also prescribes special disclosure requirements for insurance groups and a reporting requirement for securitisations.

With the Restructuring Act (Restrukturierungsgesetz) of 9 December 2010 German lawmakers also drew the consequences of the financial failure of a number of systemically important credit institutions and the unavoidable need to bail out such institutions. The Act created procedures whereby institutions whose continued existence is threatened can be re-organised and restructured at an early stage. One realistic alternative that can be considered here is an orderly winding-up. The financial costs must be borne in the first instance by the institution concerned, its creditors and the financial sector as a whole. As a last resort for stabilising the financial market, state aid payments are limited to the absolute minimum necessary and give the state far-reaching opportunities to influence the institution. The Restructuring Act was therefore an important step towards disciplining the financial industry and solving the so-called “too big to fail” problem.

Re-organisation of BaFin

BaFin itself also underwent a significant change: in April 2008 its senior management was restructured. Whereas up to then President Jochen Sanio had headed up BaFin on his own, he was now given four Chief Executive Directors to work beside: Sabine Lautenschläger as Chief Executive Director for banking supervision, Karl-Burkhard Caspari for securities supervision, Dr. Thomas Steffen for insurance supervision and Michael Sell for “Cross-sectoral issues/Internal Administration”. Since then the President and Chief Executive Directors have constituted BaFin's Executive Board.

In late 2010 the coalition parliamentary parties agreed to reform national financial supervision in order to adapt it to the changed requirements since the financial crisis. But the division of labour between the Deutsche Bundesbank and BaFin was also to be maintained in the future. The parliamentary parties agreed ten key points. The Bill drawn up by the Federal Finance Ministry (Bundesministerium der Finanzen – BMF) on this basis is currently in the final reconciliation stage within the Federal government. A key element is the establishment of a Financial Stability Committee. Its members will include representatives of the Deutsche Bundesbank, the BMF and BaFin, together with a non-voting representative of the Financial Market Stabilisation Agency (Bundesanstalt für Finanzmarktstabilisierung – FMSA). Because of its macroeconomic and financial market expertise the Deutsche Bundesbank is being given the task of contributing to the preservation of financial stability. It is to continually analyse matters that could materially affect financial stability and to identify possible threats to financial stability. On the basis of this information, the Financial Stability Committee discusses financial stability in detail and can for its part issue warnings and recommendations for counter-measures. As the integrated financial supervisory authority, BaFin still remains responsible for the supervision of individual institutions. In its work it will in future be able to draw on the macroprudential knowledge acquired by the Deutsche Bundesbank and the Financial Stability Committee.

European supervisory system

On 1 January 2011 three European Supervisory Authorities (known for short as ESAs) began their work. Shortly after, the European Systemic Risk Board (ESRB), which is to monitor macroeconomic developments and, if need be, warn of systemic risks to the financial stability of the European Union, was launched. Together with the ESAs, it forms the new European System of Financial Supervision (ESFS).

While the national level – in Germany, BaFin therefore – remains responsible for the ongoing supervision of undertakings, it is the function of the ESAs to seek to achieve greater harmonisation and more consistent application of rules in the EU. To that end, it can in particular draft technical regulation and implementation standards, which the EU Commission can accept or amend and then puts into effect, and issue guidelines and recommendations. Although these are in principle not binding, for reasons of political pressure they are generally transposed into national law by Member States. The European Supervisory Authorities can exercise specific supervisory powers in cases of breaches of Union law, in crises and where there are differences of opinion between national supervisory authorities in cross-border cases. The European Securities and Markets Authority (ESMA), one of the ESAs, is also responsible for the oversight of rating agencies in the EU.

The decisions of the ESAs therefore have a considerable impact on the work of national supervisory authorities. BaFin is involved in these decisions through its membership of the various committees and working groups and through the secondment of BaFin employees to the European Authorities. The respective competent BaFin Chief Executive Directors are also voting members of the Boards of Supervisors of the individual ESAs which take the operational and administrative decisions there.

BaFin today

Jochen Sanio, who as President had been the head of BaFin since its establishment, retired at the end of 2011. Since then the President has been Dr. Elke König. Up to then she had been a member of the International Accounting Standards Board (IASB). Prior to that, she had worked as Chief Financial Officer at large companies in the insurance sector.

In addition to König, the BaFin Executive Board currently consists of Chief Executive Directors Raimund Röseler (banking supervision), Gabriele Hahn (insurance and pension fund supervision) and Karl-Burkhard Caspari (securities supervision/asset management). In addition to these three divisions, BaFin also has a fourth directorate, which deals with cross-sectoral issues concerning all areas of supervision. These include risk and financial markets analysis, the prosecution of unauthorised business, risk modelling, consumer complaints and investor protection issues. There is also a separate department for international supervisory issues, which reports directly to the President.

BaFin currently oversees around 1,880 banks, 680 financial services institutions, some 600 insurance undertakings and 30 pension funds as well as some 5,900 investment funds and 77 investment companies. Today it employs around 2,300 people. With an average age of 38, BaFin is a relatively young authority.