German banking system’s

German Bank

The Bundesbank’s annual Financial Stability Review was presented to the media on 10 November 2011. It identifies the European sovereign debt crisis as the greatest current risk to the German financial system. Besides Greece, Ireland and Portugal, serious doubts are now beginning to arise as to whether Italy and Spain, too, will be able to service and repay their high levels of government debt.

It follows that overcoming the crisis requires tackling unsustainable public finances in several euro-area countries. Financial assistance is no substitute for such corrections. The objective must be to work towards permanently sound fiscal policies in the euro-area countries through closer supervision, stronger institutions and deeper economic union. The strict separation between monetary and fiscal policy must be respected.

According to the Financial Stability Review, the European banking sector is confronted by a considerable loss of confidence as a result of the sovereign debt crisis. Countering this loss of confidence is possibly the greatest challenge facing the financial industry. The Deutsche Bundesbank therefore welcomes the recapitalization of the major banks that has been initiated at the European level. Nonetheless, improved resilience has enhanced the German banking system’s robustness in the past two years. Capital levels have risen appreciably, profitability has been fairly stable to date, and vulnerabilities in refinancing have been reduced.

Challenges are now emerging, however. These include haircuts on some claims against the Greek state, higher funding costs and the deterioration of the economic outlook. Moreover, the Bundesbank sees ongoing risks in persistently low interest rates and high global liquidity. Moreover, legacy problems at banks as a result of credit claims on commercial real estate and structured securities have not yet been fully dealt with.

To secure financial stability long term, the institutional and regulatory framework needs developing. Large financial institutions, too, must be able to exit the market without jeopardising the financial system. 

The European Banking Authority on Wednesday, 26 October 2011, disclosed preliminary data on the capital shortfall expected for the EU banking sector. According to these data, the preliminary and indicative capital shortfall at the EU level totals € 106.4 billion, of which € 5.2 billion is attributable to Germany. The EBA thus clarifies the decision by the European Council requiring a group of major international banks to build up a 9% Core Tier 1 ratio by the end of June 2012, which goes far beyond regulatory requirements. The basis used in this context is the EBA 2011 stress test definition. When calculating the ratio it is necessary to consider an additional buffer for market price losses in sovereign exposure to EEA states.

The preliminary figures stated by the EBA are based on a sample of 70 European credit institutions – of which 13 in Germany – conducted at the beginning of October jointly with the national supervisory authorities. These are all the banks that participated in the 2011 EU-wide stress test except for a subset of small non cross-border banks. In the sample, details on the composition of Core Tier 1 capital as at 30 June 2011 and the sovereign exposure to EEA states were submitted.

The EBA will update the capital shortfall data based on the credit institutions’ audited quarterly figures as at 30 September 2011. The capital requirement to be satisfied by 30 June 2012 will be determined on the basis of a valuation of EEA sovereign exposures reflecting current market prices as at 30 September 2011, so as not to give any incentive to withdraw from these commitments. The EBA expects to disclose the final capital shortfall in the middle of November.

Banks requiring capital will have to submit to their respective national authorities their plans detailing the actions they intend to take to meet the higher capital requirements. The objective will be to avoid excessive deleveraging so as to contain the potential impact on the real economy. Primarily, the banks are to raise fresh capital and/or withhold dividends and bonuses. In narrowly defined cases banks shall be permitted to use convertible bonds where these satisfy the EBA’s strict requirements with regard to their conversion conditions and their subsequent capacity to absorb potential losses. Banks shall be permitted to fall back on state aid only if sufficient recapitalisation cannot be achieved by any other means.

In addition to the press release, the EBA has also published on its website numerous questions & answers with further background information as well as a methodological note.