EXECUTIVE SUMMARY
Germany’s financial sector plays a key role in the global economy. The country is home to two global systemically important financial institutions, Deutsche Bank AG and Allianz SE, as well as to one of the largest global central counterparties (CCP), Eurex Clearing AG.
The system is also very heterogeneous, with a range of business models and a large number of smaller banks and insurers. Its asset management industry is the third largest in the European Union (EU), while its sovereign bond market is a safe haven and benchmark for fixed income instruments globally. Consequently, Germany’s contribution to ensuring the success of the new European financial stability architecture is crucial for fostering its domestic financial stability and the success of the European reform agenda.
The resilience of the German financial sector is bolstered by major financial sector reforms, driven by EU-wide and global developments, which are now nearing completion. The regulatory landscape has changed profoundly with strengthened solvency and liquidity regulations for banks (the EU Capital Requirements Regulation (CRR) and Directive IV (CRD IV)), and the introduction of macroprudential tools. The establishment of the Single Supervisory Mechanism (SSM) has positively impacted the supervision of the banking system as a whole, while the bank resolution regime has been significantly strengthened following the implementation of the EU Bank Recovery and Resolution Directive (BRRD). Introduction of Solvency II enhanced the regulatory and supervisory regime for insurance, leading to a more risk-based approach. The framework for Financial Markets Infrastructure (FMIs) has been strengthened by the European Market Infrastructure Regulation (EMIR). Germany is making progress towards compliance with the new EU Directives on Undertakings for Collective Investment in Transferable Securities (UCITS) and Alternative Investment Fund Managers (AIFMD). Overall, there is welcome emphasis on quantitative analysis to augment the traditional qualitative and relationship-based supervision.
The key risks facing the financial system reflect euro area (EA) and global developments as well as characteristics unique to the domestic financial architecture:
The ongoing transition to the new supervisory and resolution architecture may give rise to decision-making and implementation frictions. The newly established European recovery and resolution framework entails a major cultural change. Its complex decision-making process still needs to be tested. The coordination of the European and domestic authorities to handle a systemic crisis is being set up. While the SSM supervisory practices are evolving quickly, the SRB—in charge of resolution measures for significant German banks—is still in a startup mode. This constitutes a transition risk until the EA level authority is fully operational.
Low profitability, rooted in banks’ and insurers’ business models, is exacerbated by the low interest rates. The low interest rates are helping to boost credit demand and stimulate growth. However, prevailing business models make banks and life insurers particularly vulnerable to the associated adverse side-effects of unconventional monetary policy. Banks faced with falling net interest margins may be tempted to adopt risky search-for-yield strategies, and bank equity prices have been dropping markedly. Low profitability of life insurers hampers their ability to pay guaranteed yields to policyholders. Real estate assets, while currently broadly in line with fundamentals, could become overvalued.
A global growth shock, sharp downturn in emerging markets (EMs), or renewed tensions in the EA could lead to a rapid hike in global risk premia and asset price volatility. This may give rise to domestic financial risks and second round adverse spillovers because of the globally interconnected financial sector and the importance of German G-SIFIs for shock transmission. The uncertainties associated with the possibility of British exit from the EU weigh on the outlook.
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