Blog Post

Banking regulation in the Euro Area: Germany is different

Despite progress in recent years towards a single banking policy framework in the euro area – a banking union – much of the German banking system has remained partly sheltered from uniform rules and disciplines that now apply to nearly all the area’s other banks. The resulting differences in regulatory regimes could generate vulnerabilities in the still-incomplete banking union, which is being tested in the context of the COVID-19 pandemic.

By: Date: May 7, 2020 Topic: European Macroeconomics & Governance

Two reports published in early 2020 shed new light on this challenge. The European Central Bank’s risk report on less-significant institutions is the first of what is intended to be an annual series. The impact assessment study on the most important differences between accounting standards used by banks in the banking union was prepared by legal consultants for the European Commission’s Directorate-General for Financial Stability, Financial Services and Capital Markets Union (DG FISMA). The reports provide comparative quantitative information that was not previously available in the public domain.

The new data highlights differences in rules and oversight in different countries that matter in the context of efforts to achieve an EU single market and banking union. From a single-market perspective, the fact that many German banks are subject to a different supervisory, state-aid and accounting framework raises the possibility of competitive distortions, even though a subset of these banks only have local activity and don’t compete outside of Germany. German stakeholders might misjudge and underestimate the extent of EU-imposed discipline in the banking sectors of other member states, by wrongly assuming that national discretions and exceptions in those countries are similar to those in Germany. Conversely, in euro-area countries other than Germany, a politically corrosive perception of unfairness can arise from differences in regulatory and/or supervisory treatment. From a banking-union perspective, the exceptions could, at least in certain scenarios, contribute to fragmentation of the euro-area financial space and thus to the risk that bank-sovereign vicious circles become worse, and potentially unmanageable.

The history that led to this situation is too long to summarize here. In a nutshell, the banking systems of a number of euro-area countries previously displayed significant idiosyncrasies, memorably expressed by former prime minister Giuliano Amato’s description of Italy’s banking system in 1988 as a petrified forest.” But in Italy as in other euro-area countries, such idiosyncrasies have been eroded by successive waves of reform. Germany has reformed less than most others, largely because it has not been compelled to by circumstances. It also has unique leverage over EU legislation, which could have played a role in the creation or persistence of legislative loopholes. Furthermore, Germany’s public bank community is uniquely intertwined with its political community.

Supervisory authority

The ECB risk report gives, for the first time, a national breakdown of the assets of significant versus less-significant institutions in the euro area. This distinction matters for the assigning of supervisory authority within the banking union. Significant institutions (SIs) are all euro-area banks with more than €30 billion in total assets, plus a few more on the basis of criteria that include cross-border activity and prominence within a single country. Less-significant institutions (LSIs) are all the other banks. Only a small number of banks are deemed SIs by the ECB for reasons other than total assets above €30 billion (31 in the ECB’s latest listing, compared to more than 2,600 LSIs), so that the boundary between SIs and LSIs is primarily, though not exactly, determined by the asset-size criterion. The ECB directly supervises SIs, while most supervisory tasks related to LSIs are carried out by national supervisory authorities (though the ECB has authority over banking licences and other infrequent procedures). The ECB also exercises oversight over the national supervision of LSIs.

A fact that jumps out from the report is that LSIs are found disproportionately in Germany (Figure 1). At end-2018, German LSIs represented 55%  of total LSI assets in the euro area, whereas Germany accounted for 25%  of total banking assets (LSIs and Sis).

Figure 1: Aggregate assets of SIs (ECB supervision) and LSIs (national supervision), end-2018 (€ bns)

Source: ECB risk report on LSIs, Table 1; IPS (institutional protection schemes, see below) assets based on The Banker database, Deutsche Bundesbank (page 110) for Germany, and Grunewald 2017 (Figure 1, page 8) for Austria and Spain.

The vast majority of German LSIs, however, are not fully on their own, even though they are managed on a decentralised basis. They benefit from mutual support arrangements known in EU prudential law as institutional protection schemes (IPSs), labelled virtual groups by the ECB’s then second-most-senior supervisor at the start of her tenure in 2014. LSIs within an IPS support each other: if and when one becomes unviable, it is generally rescued by its peers. As a consequence, the group as a whole, rather than its individual member banks, is the relevant level of observation for financial-stability purposes. As Figure 1 shows, not all LSIs belong to an IPS. Conversely, all existing IPSs include at least one SI.

There are two IPSs in Germany: the Savings Banks Financial Group (Sparkassen-Finanzgruppe) and the Volksbanken Raiffeisenbanken Cooperative Financial Network (Genossenschaftliche Finanzgruppe Volksbanken Raiffeisenbanken, hereafter ‘Cooperative Group’). Entities in the Sparkassen-Finanzgruppe belong to the public sector and are controlled by different sub-federal levels of government under various legal forms and ownership patterns. Such entities include local savings banks (Sparkassen) and regional wholesale banks (Landesbanken). Entities in the Cooperative Group are ultimately owned by the individual cooperative members.

As of end-2018, based on data from the German Central Bank, LSIs in the Sparkassen-Finanzgruppe represented 45%  of total German LSI assets. Those in the Cooperative Group, including buildings and loan associations, represented another 39%. In recent years, both groups have published group-level financial statements (using the accounting methods, respectively, of aggregation and consolidation), which indicate that, taken together including their SI members, they are among the largest banking players in the euro area. Indeed, in 2018 the Sparkassen-Finanzgruppe in aggregate had more assets than any euro-area bank (Figure 2).

Figure 2: Total end-2018 assets of the largest euro area banking groups (€ bns)

In black: Group-level assets of German institutional protection schemes; in red: other German banks; in yellow: other banks with total assets above €1 trillion. Source: The Banker database, Savings Banks Group website, and Cooperative Group website.

On the basis of publicly available information, it is difficult to assess the specific differences, if any, between the supervisory regimes of the ECB (applicable to SIs, including those in IPSs) and of national authorities (applicable to LSIs, including those in IPSs). The applicable prudential rulebook is substantially harmonised by the EU capital requirements directives and regulations. Thus, differences which may remain despite the above-mentioned supervisory oversight by the ECB, are mostly in supervisory enforcement and discretion. There are indications that at least some banks have a preference for being labelled LSIs. For example, L-Bank (full name Landeskreditbank Baden-Württenberg Förderbank), a public bank in southern Germany, unsuccessfully sued the ECB over its SI determination. It was later removed by new legislation from the scope of application of EU banking law altogether (together with two other former German public SIs, NRW.Bank and Landwirtschaftliche Rentenbank), and is thus no longer under direct ECB supervision.

State-aid control

European banks are subject to state-aid control conditions, enforced by the European Commission. The application of these disciplines, however, takes a distinctive form for unlisted public banks, for which the boundary between an arm’s-length recapitalisation (with the government providing funds as a shareholder) and state aid (the government transferring funds in a non-market transaction) is less well-defined than in cases when there are shareholders other than public entities. The leeway that results from full government ownership was put under the spotlight in the recent case of Norddeutsche Landesbank (or NordLB), a public bank in Northern Germany, which was recapitalised by its public shareholders in a transaction that the European Commission deemed market conform in December 2019 but was widely viewed as distortionary by external observers. The NordLB decision itself had precedents, particularly in the cases of Portugal’s Caixa Geral de Depositos in 2017, and Romania’s CEC Bank in October 2019. The upshot is that the state-aid regime appears to be different for unlisted public banks than for other banks, in practice if not in theory.

Possibly for the first time, the ECB’s report on LSIs, combined with data on assets of individual SIs and a few no-nonsense assumptions, permits a tentative mapping of such banks in the euro area. Figure 3 shows the results of these calculations. They suggest that, as with LSIs, unlisted public banks in the euro area are predominantly located in Germany. Namely, the Sparkassen-Finanzgruppe includes all of Germany’s unlisted public SIs, and most if not all of its unlisted public LSIs. (Note: the differences compared to Figure 1 and Figure 4 in total amounts by country result from differences in accounting methodologies and in the scope of observation, eg SIs that are part of non-euro-area banking groups are not included in Figure 3, and some cross-border operations are assigned to the home country in Figure 3 vs host country in Figures 1 and 4).

Figure 3: Unlisted public banks in the euro area, end-2018 assets (€ bns)

Source: ECB risk report on LSIs; Deutsche Bundesbank; The Banker database; corporate websites; author’s assumptions and calculations.

Accounting standards

In landmark legislation adopted in 2002, the EU mandated the use of International Financial Reporting Standards (IFRS) for all its listed companies, starting in 2005. For unlisted companies, however, including unlisted banks, the choice of accounting standards was left to the discretion of individual member-state authorities. This stands in contrast to most of the world’s jurisdictions outside of the European Union, where all (listed and unlisted) banks generally have to comply with IFRS or, in the case of the United States, Generally Accepted Accounting Principles (US GAAP).

The DG FISMA report on banks’ accounting practices includes an overview of which banks (aggregated by country and by assets) use which set of accounting standards,  – IFRS or national standards. Germany stands out with 52.1%  of banking assets reported under national standards. The next-highest ratio is much lower, in Austria (22.7%), followed by the Netherlands (5%), and under 2.5%  in all other member states. Figure 4 illustrates these findings.

Figure 4: Use of accounting standards by banks in the euro area, end-2018 assets (€ bns)

Source: European Commission impact assessment study, Table 1 (page iv) for percentages; ECB risk report on LSIs for total assets per country.

Figure 4 implies that there remain only two systems of accounting standards in wide use in the euro-area banking system: IFRS and German national standards. Whether one is more demanding than the other depends on the issue; the DG FISMA report gives a wealth of detail on the differentiated outcomes. For example, for credit loss accounting, IFRS require expected loss provisioning as mandated by the Group of Twenty (G20), while German standards preserve more flexibility to maintain the prior practice of incurred loss provisioning.

Conclusion

It is too early to assess the extent to which the COVID-19 pandemic may influence future debates and decisions on the still-unfinished banking union. By providing additional data on structural quirks of the euro-area banking system, the two reports analysed in this post contribute to a trend of greater supervisory transparency. Further efforts in that direction will hopefully contribute to better-informed policymaking when dealing with the difficult challenges ahead.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

Read about event More on this topic
 

Upcoming Event

May
26
15:00

Prospects for improving securities and financial reporting oversight in the EU

This members-only event welcomes Eva Wim­mer, Head of the Directorate-General for Financial Market Policy at the German Federal Ministry of Finance, for a conversation with an invited audience.

Speakers: Nicolas Véron and Eva Wimmer Topic: Finance & Financial Regulation Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article More on this topic More by this author
 

Blog Post

Confronting the risks: corporate debt in the wake of the pandemic

As European economies emerge from lockdowns, it is becoming clearer that corporate debt has reached critical levels. A new French scheme, in which the state guarantees portfolios of subordinated debt, shows how financial support could be targeted better.

By: Alexander Lehmann Topic: Finance & Financial Regulation Date: April 28, 2021
Read article More on this topic
 

Opinion

The ECB needs political guidance on secondary objectives

While EU Treaties clearly stipulate that the ECB “shall support the general objectives of the European Union”, it is not appropriate to simply stand by, wishing that the ECB will use its discretionary power to act on them. Political institutions of the EU should prioritise the secondary goals to legitimise the ECB’s action.

By: Pervenche Béres, Grégory Claeys, Nik de Boer, Panicos O. Demetriades, Sebastian Diessner, Stanislas Jourdan, Jens van ‘t Klooster and Vivien Schmidt Topic: European Macroeconomics & Governance Date: April 22, 2021
Read article
 

Blog Post

Urgent reform of the EU resolution framework is needed

In this blog, the authors argue that two aspects of the European resolution framework are particularly in need of reform – the bail-in regime and the resolution mechanism for cross-border banks – and propose a reform of both.

By: Mathias Dewatripont, Lucrezia Reichlin and André Sapir Topic: European Macroeconomics & Governance, Finance & Financial Regulation Date: April 16, 2021
Read about event More on this topic
 

Past Event

Past Event

An alpine divide? Comparing economic cultures in Germany and Italy

A discussion of Italian and German macro-economic cultures and performances.

Speakers: Thomas Mayer, Patricia Mosser, Marianne Nessén, Hiroshi Nakaso, Francesco Papadia, André Sapir and Jean-Claude Trichet Topic: European Macroeconomics & Governance Date: April 13, 2021
Read about event More on this topic
 

Past Event

Past Event

Presentation of the Euro Yearbook 2021

Join us for the launch of the eighth edition of the 'Euro Yearbook'

Speakers: Maria Demertzis, Fernando Fernández, Fiona Maharg-Bravo, Antonio Roldán and Jorge Yzaguirre Topic: European Macroeconomics & Governance Date: March 12, 2021
Read article Download PDF More on this topic More by this author
 

External Publication

When and how to unwind COVID support measures to the banking system?

Study of regulatory measures and supervisory practices that have supported public guarantee schemes and moratoria in euro-area countries prepared for the ECON committee of the European Parliament.

By: Alexander Lehmann Topic: European Macroeconomics & Governance Date: March 9, 2021
Read article Download PDF More on this topic
 

Working Paper

COVID-19 credit-support programmes in Europe’s five largest economies

This paper assesses COVID-19 credit-support programmes in five of the largest European economies, and examines how countries have dealt with trade-offs raised by the programmes.

By: Julia Anderson, Francesco Papadia and Nicolas Véron Topic: European Macroeconomics & Governance Date: February 24, 2021
Read article More on this topic More by this author
 

Opinion

Asset bubbles won’t help our post-pandemic recovery

An unintended consequence of the virus has been ‘one of the wildest bull markets in recent economic history’ but a worsening of income distribution will have a negative impact further down the line.

By: Alicia García-Herrero Topic: Finance & Financial Regulation Date: February 23, 2021
Read about event More on this topic
 

Past Event

Past Event

How could regulators address financial firms’ dependency on cloud and other critical IT services providers?

At this closed-door event Dirk Clausmeier, Head of IT security at the German Ministry of Finance will discuss financial institutions use of cloud service providers.

Speakers: Dirk Clausmeier and Nicolas Véron Topic: Finance & Financial Regulation Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: January 28, 2021
Read article More on this topic More by this author
 

Blog Post

Has the European Union squandered its coronavirus vaccination opportunity?

The European Union’s purchases of frontrunner coronavirus vaccines are insufficient for the population’s near-term needs. The shortfall could have healthcare consequences and might delay economic reopening. Lessons should be learned for future pandemics.

By: J. Scott Marcus Topic: Innovation & Competition Policy Date: January 6, 2021
Read article Download PDF More by this author
 

Parliamentary Testimony

European Parliament

Euro area accession countries in the context of the pandemic

Testimony before the European Parliament on the subject of euro area accession.

By: Zsolt Darvas Topic: European Macroeconomics & Governance, European Parliament, Testimonies Date: November 19, 2020
Load more posts