Browse Profiles > Germany > Core Principles for Effective Banking Supervision
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Germany

Core Principles for Effective Banking Supervision

Summary
Germany's banking supervision practices were assessed against the 1997 Basel Core Principles (BCPs) by the International Monetary Fund (IMF) in its 2003 Financial System Stability Assessment. The report concluded that Germany has a strong banking supervision framework, legal and institutional, in place, and implementation of the respective laws is appropriate. Furthermore, the legal framework is comprehensive and up to date, and the judicial system is efficient. In a 2005 report on BCP implementation in selected countries, the Austrian Central Bank cited an IMF assertion that Germany had a generally high level of BCP compliance. The 2003 IMF report noted, however, that shortcomings remain regarding consolidated supervision, connected lending, loan evaluation, and guidelines on risky acquisitions and investments. Furthermore, market discipline could benefit from increased transparency and disclosure. The IMF added that banking supervision relies heavily on the use of external auditors for on-site supervision. The legal framework for banking supervision in Germany is mainly based on the 1998 Banking Act, which was last amended in 2002. The Financial Supervisory Authority (BaFin) was established within the Ministry of Finance on May 1, 2002, as an integrated financial supervisory authority for the banking, securities, and insurance sector. The 2003 IMF report noted that the BaFin cooperated closely with the German central bank in conducting banking supervision.

    General Overview

    In 2003, the International Monetary Fund (IMF), in a report based on an assessment of Germany's compliance with the 1997 Basel Core Principles (BCPs), concluded that, overall, Germany had a strong banking supervision framework. It stated that the supervision of banks was "based on a comprehensive system of laws, regulations, and other documentation, and implemented with appropriate institutional capacity" (p. 29). Citing the IMF, the Oesterreichische Nationalbank (Austrian central bank) reported in 2005 that compliance with the BCPs was generally high. Moreover, the well-developed legal framework ensured the independence of the supervisory authority and fostered close cooperation with other supervisory authorities. Improvements were still needed in the areas of consolidated supervision, connected lending, loan evaluation, risk management, and transparency and disclosure, according to the IMF's 2003 assessment. Furthermore, market discipline could benefit from increased transparency and disclosure. The IMF report also noted that banking supervision relied heavily on the use of external auditors for on-site supervision.
    Germany's legal framework for banking supervision is mainly based on the 1998 Banking Act (Kreditwesengesetz, or KWG), which was last amended in 2002. According to the IMF's 2003 assessment, the legal framework for the banking sector in Germany was "comprehensive and regularly updated" (p. 29) and the judicial system was efficient. Furthermore, as noted in the 2007 U.S. Department of Commerce (DoC) Doing Business report, the legal, regulatory, and accounting systems are generally transparent and consistent with international banking norms. In its 2006 Annual Report, the Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht, or BaFin) noted that the European Union (EU) Banking Directive and redefined EU Capital Adequacy Directive were transposed into German legislation at the end of 2006. The new EU legislation is mainly reflected in the KWG, the new Solvency Regulation (Solvabilitätsverordnung, or SolvV), and the Large Exposures Regulation (Großkredit- und Millionenkreditverordnung, or GroMiKV).
    The BaFin was established within the Federal Ministry of Finance (Bundesministerium der Finanzen, or MoF) on May 1, 2002, as an integrated financial supervisory authority, consolidating the supervisory agencies for banking (Bundesaufsichtsamt für das Kreditwesen, or BAKred), insurance (Bundesaufsichtsamt für das Versicherungswesen, or BAV), and securities (Bundesaufsichtsamt für den Wertpapierhandel, or BAWe). According to the IMF's 2003 assessment, the BaFin and Germany's central bank, the Bundesbank, cooperated closely in banking supervision. The BaFin is responsible for licensing of credit institutions, whereas the Bundesbank provides prudential reports and performs audits. The IMF added that, while both authorities conducted on-site and off-site supervision, legal responsibilities were solely assigned to the BaFin. Furthermore, although the BaFin was under the legal and supervisory control of the MoF, its functions and organization were independent.
    As noted in the IMF's 2003 assessment, the German banking sector is composed of three pillars: private commercial banks, public sector savings banks and Landesbanken, and the cooperative banking network. The German financial system is very bank-centered, the country's banks are a the heart of the German financial system, as can be seen by the banking sector accounting for almost 80 percent of the financial system's gross total assets, according to the 2003 IMF report. As of 2004, per the 2007 U.S. DoC report, total assets of banks amounted to EUR 6.63 trillion. The four largest commercial banks -- Deutsche Bank, Commerzbank, Hypovereinsbank, and Dresdner Bank -- accounted for about 58% of Germany's total commercial bank assets.


    The Principles

    1. (1) Clear responsibilities and objectives for each supervisory agency.

    The BaFin was established within the MoF on May 1, 2002, as an integrated financial supervisory authority for the banking, securities, and insurance sector. According to the IMF's 2003 assessment, the BaFin and the Bundesbank cooperate closely in banking supervision. The BaFin is responsible for licensing of credit institutions, whereas the Bundesbank provides prudential reports, and performs audits. Per the same report, while both authorities conduct on-site and off-site supervision, legal responsibility is solely assigned to the BaFin. Moreover, although the BaFin is under the legal and supervisory control of the MoF, its functions and organization are independent. Despite the above descriptive information, there is little information publicly available addressing Germany's actual compliance with this principle.

    1.(2) Operational independence and adequate resources.

    In its 2003 assessment, the IMF recommended increasing the staffing and expertise of the supervisory authority to improve risk-based supervision. Furthermore, although BaFin's functions and organization were independent from the MoF, the IMF report suggested clarifying the scope of the role of the MoF. Citing the IMF, the Oesterreichische Nationalbank reported in 2005 that although the German supervisory authorities suffered from staff shortages, the quality of their on-site inspections remained high. Furthermore, Germany's well-developed legal framework ensured the independence of the supervisory authority and fostered close cooperation with other supervisory authorities. Nonetheless, overall, the information does not directly address Germany's compliance with this principle.

    1.(3) A suitable legal framework for authorization and ongoing supervision.

    Banking Supervision is mainly based on the 1998 KWG, which was last amended in 2002. According to the IMF's 2003 assessment, Germany's banking-sector legal framework was "comprehensive and regularly updated" (p. 29), and the judicial system was efficient. The IMF report recommended extending BaFin's mandate to issue secondary regulations. It further advised clarifying the relations between the MoF and the BaFin. As noted in the Oesterreichische Nationalbank's 2005 report, Germany's well-developed legal framework ensured the independence of the supervisory authority and fostered close cooperation with other supervisory authorities. Furthermore, according to the 2007 U.S. DoC report, the legal, regulatory, and accounting systems are generally transparent and consistent with international banking norms. In its 2006 Annual Report, the BaFin noted that the EU Banking Directive and redefined EU Capital Adequacy Directive were transposed into German legislation at the end of 2006. The new EU legislation is mainly reflected in the KWG, the SolvV, and the GroMiKV. Nonetheless, there is insufficient information publicly available as to Germany's compliance with this principle.

    1.(4) A suitable legal framework to address compliance with laws as well as safety and soundness concerns.

    Refer to Principle 1.(3)

    1.(5) Legal protection for supervisors.

    There is insufficient information publicly available addressing Germany's compliance with this principle.

    1.(6) Arrangement for sharing of information between supervisors and protection of confidentiality of shared information.

    As noted in the Oesterreichische Nationalbank's 2005 report, Germany's well-developed legal framework ensures close cooperation between the BaFin and other supervisory authorities. However, there is insufficient information publicly available regarding Germany's compliance with this principle.

    2. Clearly defined permissible activities for banks and control of the use of the word 'bank'.

    According to the IMF's 2003 assessment, definitions for banks, and the permissible activities for banks are clearly defined in the legislation. Furthermore, all credit institutions are required to be licensed and supervised. Despite the above information, however, there is little information publicly available as to Germany's compliance with this principle.

    3. Criteria for structure, directors, operating plan, controls, financial condition and capital base.

    The conditions for licensing banks are comprehensive and must be fulfilled during ongoing supervision, as noted in the IMF's 2003 assessment. However, there is insufficient information publicly available regarding Germany's compliance with this principle.

    4. Authority to review and reject transfer of ownership.

    As stated in the IMF's 2003 assessment "the rules for notifying the authorities of intended acquisitions of qualifying participating interests in credit institutions follow international best practices, and the authorities have different measures available if they disapprove of a change in ownership status" (p. 30). However, there is insufficient information publicly available regarding Germany's compliance with this principle.

    5. Authority to review major acquisitions and investments.

    As stated in the IMF's 2003 assessment, compliance with the pre-notification of acquisitions and investments was, at the time of the assessment, inadequate. The IMF report recommended strengthening provisions regarding the pre-notification of major or risky acquisitions by banks. Nonetheless, there is insufficient information publicly available as to Germany's compliance with this principle.

    6. Minimum capital adequacy requirements (meet Basle Capital Accord for internationally active banks).

    According to the IMF's 2003 assessment, Germany complies with international standards on minimum capital adequacy requirements. In its 2006 Annual Report, the BaFin noted that the EU Banking Directive and redefined EU Capital Adequacy Directive were transposed into German legislation at the end of 2006. The new EU legislation is mainly reflected in the KWG, the SolvV, and the GroMiKV. However, there is insufficient information publicly available regarding Germany's compliance with this principle subsequent to these changes.

    7. A method exists for the evaluation of procedures related to loans, investments and portfolio management.

    As noted in the IMF's 2003 assessment, Germany complies with the international standards on credit policies. However, there is insufficient information publicly available regarding Germany's compliance with this principle.

    8. Policies, practices and procedures for evaluating the quality of assets and the adequacy of loan loss provisions and reserves.

    In its 2003 assessment, the IMF recommended strengthening "regulations for the classification of restructured loans to permit more timely monitoring of nonperforming loans" (p. 7). It further advised establishing minimum objective criteria for the classification of assets (e.g. 90-day past-due rule). The Oesterreichische Nationalbank, in its 2005 report, cited the IMF as recommending that Germany "define and report both bad loans and those to be restructured more precisely" (p. 163). Nonetheless, there is little information publicly available addressing Germany's compliance with this principle.

    9. Prudential limits and management information system on concentration of exposure.

    According to the IMF's 2003 assessment, Germany complies with international standards on large exposures. The new EU legislation is mainly reflected in the KWG, the SolvV, and the GroMiKV. However, there is insufficient information publicly available regarding Germany's compliance with this principle subsequent to these changes.

    10. Arm's length rule and monitoring for connected lending.

    In its 2003 assessment, the IMF advised implementing additional measures to avoid abuse of banks by connected or related parties. It further recommended clarifying the guidelines on the extension and management of loans to related parties. However, there is insufficient information publicly available regarding Germany's compliance with this principle.

    11. Policies and procedures for country risk and transfer risk.

    The revised Regulation (Country Risk Regulation) governing information on loans to foreign borrowers pursuant to the Banking Act entered into force on August 15, 2003, establishing more detailed and frequent reporting of banks positions, as stated in the IMF's 2003 assessment. Nonetheless, there is little information publicly available addressing Germany's compliance with this principle.

    12. Measuring and monitoring market risk. Limit and/or specific capital charge on market risk exposure.

    According to the IMF's 2003 assessment, regulations and supervisory implementation related to market risks are in line with international best practices. However, there is insufficient information publicly available regarding Germany's compliance with this principle.

    13. Comprehensive risk management processes.

    In its 2003 assessment, the IMF recommended establishing clearer guidelines on the proper management of liquidity risk, interest rate risk, and operational risk. However, there is insufficient information publicly available regarding Germany's compliance with this principle.

    14. Adequate internal controls.

    The IMF, in its 2003 assessment advised requiring the internal audit function to report directly to the advisory board instead of the managing board. However, there is insufficient information publicly available regarding Germany's compliance with this principle.

    15. Strict "know-your-customer" rules and high ethical and professional standards.

    According to a 2004 Report on the Observance of Standards and Codes by the IMF, which is based on the Financial Action Task Force (FATF) Recommendations, Germany has adopted very comprehensive legislation and enforcement measures that meet the general obligations of the FATF's 40 Recommendations with regards to fighting money laundering. Furthermore, Germany has taken steps towards meeting the FATF Eight Special Recommendations on combating the financing of terrorism. According to a 2007 U.S. Department of State International Narcotics Control Strategy report, the Money Laundering Act, as amended by the 2002 Act on the Improvement of the Suppression of Money Laundering and Combating the Financing of Terrorism (Geldwäschegesetz), criminalizes activities related to money laundering. Furthermore, banks are required to report money laundering to the Central Office for Suspicious Transaction Reports (Zentralstelle für Verdachtsanzeigen) within the Federal Criminal Police Office (Bundeskriminalamt), as well as to the State Attorney. Despite the above information, there is little information publicly available addressing Germany's actual compliance with this principle.

    16. Effective supervisory system consisting of on-site and off-site supervision.

    As stated in the IMF's 2003 assessment, the on-site and off-site supervisory system in Germany is broadly satisfactory. However, per the same report, banking supervision "relies heavily on the use of external auditors for on-site supervision and the related identification and validation of supervisory information" (p. 29). Therefore, the IMF report encouraged the BaFin and Bundesbank to be more active in conducting on-site supervision to ensure direct contact with supervised entities and a better understanding of banks' activities. According to the IMF's 2003 report, these recommendations were to be implemented by German authorities following an increase in their supervisory staff. However, little subsequent information is publicly available as to whether implementation has occurred. The IMF report further recommended implementing measures "to ensure proactive identification and treatment of weaknesses in institutions" (p. 32).

    17. Regular contact with bank management and understanding of bank's operations.

    In its 2003 assessment, the IMF recommended increasing the roles of the BaFin and Bundesbank in conducting on-site supervision to ensure direct contact with supervised entities and a better understanding of banks' activities. Per the same report, these recommendations were to be implemented by German authorities following an increase in their supervisory staff. However, there is insufficient information publicly available as to whether implementation has occurred.

    18. Analytical reports and statistical returns on solo and consolidated basis.

    The 2003 IMF assessment recommended implementing "a structured framework for peer review, early warning indicators or similar analyses of prudential and other bank data, including qualitative information" (p. 31). As a follow-up to the IMF's 2003 recommendations, the BaFin and the Bundesbank have been developing an early warning system, as noted in the 2004 IMF Consultation report. However, there is insufficient information publicly available regarding Germany's compliance with this principle subsequent to these changes.

    19. Independent validation of supervisory information through on-site examination or external auditors.

    As noted in the IMF's 2003 assessment, German banking supervision "relies heavily on the use of external auditors for on-site supervision and the related identification and validation of supervisory information" (p. 29). The IMF report encouraged the BaFin and Bundesbank to be more active in conducting on-site supervision to ensure direct contact with supervised entities and a better understanding of banks' activities. According to the same report, these recommendations were expected to be implemented by German authorities following an increase in their supervisory staff. However, there is insufficient information publicly available as to whether implementation has occurred.

    20. Ability to supervise on a consolidated basis.

    In its 2003 assessment, the IMF suggested extending consolidated supervision to both non-consolidated entities and holding companies. However, there is insufficient information publicly available addressing Germany's compliance with this principle.

    21. Consistent accounting policies and practices that provide a true and fair view of the financial condition of the bank.

    There is little information publicly available addressing Germany's actual compliance with this principle. However, according to the IMF's 2003 assessment, the "auditing and accounting rules applicable to banks generally comply with international standards" (p. 29). Per the same report, the German Commercial Code (Handelsgesetzbuch, or HGB) accounting rules ("German GAAP") complied with the relevant EU Directive. There were however discrepancies between the HGB accounting rules and the international accounting standards (IAS). Following the IMF's 2003 report, Germany improved its regulatory framework in 2005 by requiring all listed companies to prepare their consolidated accounts in accordance with International Financial Reporting Standards, formerly the IASs, as noted in the 2006 European Commission report on the implementation of the Regulation No. 1606/2002.

    22. Adequate supervisory measures to ensure timely corrective action.

    According to the IMF's 2003 assessment, supervisory authorities in Germany had "a broad range of remedial measures at their disposal to counter weaknesses in banks, and they use these measures frequently" (p. 31). The IMF report recommended introducing more explicit rules to ensure timely corrective action. Nonetheless, there is little information publicly available addressing Germany's compliance with this principle.

    23. Banking supervisors must practice global consolidated supervision over their internationally-active banking organizations.

    There is insufficient information publicly available addressing Germany's compliance with this principle.

    24. International exchange of information with other supervisors.

    In its 2003 assessment, the IMF recommended prohibiting the licensing of foreign branches where cooperation with relevant home country supervisory authorities was not guaranteed. As noted in the Oesterreichische Nationalbank's 2005 report, Germany has signed Memoranda of Understanding (MoUs) on cooperation between supervisory authorities with Austria, the Czech Republic, Hungary, Slovakia, and Slovenia. Furthermore in 2006, the BaFin, as noted in its 2006 Annual Report, signed a new MoU with Banco Central do Brasil and the Central Bank of the Russian Federation. Nevertheless, there is insufficient information publicly available addressing Germany's compliance with this principle.

    25. Supervision of local operation of foreign banks and information sharing with home country supervisors.

    There is insufficient information publicly available addressing Germany's compliance with this principle.

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    Sources of Assessment

    International Monetary Fund, "Germany: Financial System Stability Assessment, including Reports on the Observance of Standards and Codes on the following topics: Banking Supervision, Securities Regulation, Insurance Regulation, Monetary and Financial Policy Transparency, Payment Systems, and Security Settlements," Country Report No.03/343, Washington, D.C.: IMF, November 2003. Available from International Monetary Fund website. Accessed on January 10, 2008. (IMF 2003)

    Oesterreichische Nationalbank, "The Implementation of the Basel Core Principles in Selected Countries from the Perspective of the International Monetary Fund," Focus 2/05, OeNB, February 2005. Available from Oesterreichische Nationalbank website. Accessed on January 10, 2008. (OeNB 2005)

    Relevant Organizations

    Central Office for Suspicious Transaction Reports, Federal Criminal Police Office -- Zentralstelle für Verdachtsanzeigen, Bundeskriminalamt (FIU)

    Deutsche Bundesbank

    Federal Agency for Financial Services Supervision -- Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin)

    Federal Criminal Police Office -- Bundeskriminalamt (BKA)

    Federal Ministry of Finance -- Bundesministerium der Finanzen (MoF) (in German only)



    Relevant Legislation/Regulation

    Banking Act, 1998 -- Kreditwesengesetz, 1998 (last amended 2007, in German only)

    Law on Federal Institution for Supervision on Financial Services, 2002 -- Finanzdienstleistungsaufsichtsgesetz, 2002 (last amended 2007, in German only)

    Act Concerning the Deutsche Bundesbank, 1992 -- Gesetz über die Deutsche Bundesbank, 1992 (last amended 2007).

    Solvency Regulation, 2006 -- Solvabilitätsverordnung, 2006 (in German only)

    Country Risk Regulation, 2003 --Länderrisikoverordnung, 2003 (in German only)

    Large Exposures Regulation, 2006 - Großkredit-und Millionenkreditverordnung, 2006 (in German only)

    Liquidity Regulation, 2006 -- Liquiditätsverordnung, 2006 (in German only)

    German Commercial Code, 1897 -- Handelsgesetzbuch, 1897 (last amended December 2007, in German only)

    Money Laundering Act as Amended by the 2002 Act on the Improvement of the Suppression of Money Laundering and Combating the Financing of Terrorism, 2002 -- Geldwäschegesetz, 2002

    European Banking Directive No. 2000/12/EC, 2000

    European Capital Adequacy Directive, 2006

    European Commission Regulation No 1606/2002 on the Application of International Accounting Standards, 2002



    Supplementary Sources

    European Commission, "Planned Implementation of the IAS Regulation (1606/2002) in the EU and EEA," May 15, 2006. Available from European Union website. Accessed on January 24, 2008. (EC 2006)

    Federal Agency for Financial Services Supervision, "The new Federal Financial Supervisory Authority (BaFin)," June 2003. Available from Zurich Financial Services website. Accessed on January 18, 2008. (BaFin 2003)

    Federal Agency for Financial Services Supervision, "Annual Report 2006," 2007. Available from Federal Agency for Financial Services Supervision website. Accessed on January 16, 2008. (BaFin 2007)

    Federal Criminal Police Office, "2006 Annual Report: Financial Intelligence Unit (FIU) Germany," Wiesbaden: BKA, 2007. Available from Federal Office of Criminal Investigation website. Accessed on January 18, 2008. (BKA 2007)

    International Monetary Fund, "Germany: Report on the Observance of Standards and Codes -- FATF Recommendations for Anti-Money Laundering and Combating the Financing of Terrorism," Country Report No. 04/213, Washington, D.C.: IMF, July 2004. Available from International Monetary Fund website. Accessed on January 10, 2008. (IMF 2004a)

    International Monetary Fund, "Germany: 2004 Article IV Consultation -- Staff Report; Staff Supplement; and Public Information Notice on the Executive Board Discussion," Country Report No.04/341, Washington, D.C.: IMF, November 2004. Available from International Monetary Fund website. Accessed on January 10, 2008. (IMF 2004b)

    U.S. Department of Commerce, "Doing Business in Germany: A Country Commercial Guide for U.S. Companies," U.S. & Foreign Commercial Service and U.S. Department of State, May 2007. Available from U.S. Department of Commerce website. Accessed on January 11, 2008. (U.S. DoC 2007)

    U.S. Department of State, Bureau for International Narcotics and Law Enforcement Affairs, "International Narcotics Control Strategy Report 2007," March 2007. Available from U.S. Department of State website. Accessed on January 10, 2008. (U.S. DoS 2007)
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