Cablegate: New German Government Plans for Reform of Financial

Published: Fri 20 Nov 2009 12:54 PM
DE RUEHFT #3012/01 3241254
P 201254Z NOV 09
E.O. 12958: N/A
SUBJECT: New German Government Plans for Reform of Financial
Supervision Raise Questions and Criticism
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1. (SBU) Summary: As one of its first decisions, the new coalition
government in Germany agreed to concentrate banking supervision,
which has previously been shared by Germany's financial supervisor,
BaFin, and the German central bank, Bundesbank, in the hands of the
central bank.
Proponents of the reform claim that the current supervisory
structure has exacerbated the financial crisis.
Critics deny that re-designing the institutional structure would
improve financial supervision and claim that the move is primarily
political as the current dual system was introduced under
Schroeder's Social Democratic Party (SPD) government. Additionally,
some believe that the intended reforms may create a conflict of
interest between monetary policy geared towards price stability and
supervisory responsibility for financial stability. This tension
may ultimately damage the central bank's reputation. End Summary.
Early Harvest
2. (U) The Christian Democratic Union (CDU), its Bavarian sister
party the Christian Social Union (CSU) and the pro-business Free
Democratic Party (FDP), all campaigned on platforms promising to
concentrate banking supervision in the hands of the German central
bank (Bundesbank). Just ten days after the September 27 elections
this was the first issue on which the new coalition agreed.
However, in the new government's written coalition agreement many of
the more difficult details on the merger were not addressed.
3. (U) Current proponents of the reforms argue that regulatory
failures, in particular, insufficient coordination and cooperation
between BaFin and the Bundesbank, have aggravated the financial
crisis in Germany. The German Council of Economic Experts argues
that a merger of banking and insurance supervision under the
Bundesbank would ensure more effective macro-prudential supervision.
However, the Council is silent on how the duties would be legally
Current Financial Supervisory Arrangement
4. (U) BaFin and the Bundesbank currently share responsibility for
banking supervision. The Bundesbank monitors the operations of
banks on an ongoing basis, analyzing bank reports and assessing
whether their capital and their risk management procedures are
adequate. It reports its findings to the Federal Financial
Supervision Agency, BaFin, which has regulatory decision-making
powers. BaFin is responsible for managing and licensing banks, and
acting against banks that do not meet regulatory requirements. BaFin
is also (exclusively) in charge of insurance and securities trading
5. (U) BaFin was established in 2002 as a single financial regulator
(replacing three separate agencies that individually supervised
banking, insurance, and securities) with the objective of creating
integrated financial supervision, a move which reflected an
international trend at the time. BaFin was headquartered in Bonn due
to the available government office space there after the capital
moved to Berlin, even though Frankfurt is Germany's financial
capital. BaFin officials told the Embassy that its distance from
Frankfurt enabled it to be more objective.
Contentious Political History
6. (SBU) Banking supervision has remained a hotly debated topic due
to the political circumstances that brought BaFin to life. BaFin
was born by "precipitate delivery," according to Peter Abrahams,
BaFin's insurance sector spokesman. The Act establishing BaFin
easily passed with the votes of Schroeder's governing Social
Democratic Party (SPD)/Green coalition government, because,
according to sources at BaFin, the Christian Democratic Union (CDU)
faction had left en bloc in protest during a prior vote and did not
return in time to vote on BaFin. The CDU thus was dealt a political
defeat that it has never fully digested, according to Bernhard
Speyer, Head of Banking, Financial Markets and Regulation at
Deutsche Bank Research.
Seizing the Opportunity: The Bundesbank's Plan
--------------------------------------------- -
7. (U) Although the new German government presented few details on
the BaFin-Bundesbank reorganization, the Bundesbank quickly seized
the moment to present its own version. Only three days after the
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federal election, Bundesbank President Axel Weber declared the
Bundesbank ready to take on more responsibilities. On October 2,
the six-member executive board unanimously approved a six-point plan
for concentrating financial oversight at the Bundesbank. Under this
plan, the bank would not only take over banking, but also insurance
supervision leaving only the securities supervision to BaFin.
(Comment: the insurance sector subsequently protested the plan and
it appears unlikely that insurance supervision will be transferred
to the Bundesbank. End Comment.) The proposal gives the Ministry of
Finance veto power over all decisions. "Administrative acts of high
intensity" such as bank closures would also be left to the
BaFin's Response
8. (SBU) The president of BaFin, Jochen Sanio, considers the planned
reforms political. The reorganization, he predicted in a discussion
with Consulates Duesseldorf and Frankfurt, "would allow the new
coalition government to score an early political success." The
Bundesbank has been in search of a new mission ever since it has
lost its core competence, monetary policy making, with the creation
of the European Central Bank, he opined. In addition, Weber is
trying to enhance his personal powers after his chances to succeed
ECB president Jean-Claude Trichet have waned, with Mario Draghi, the
Chairman of the Financial Stability Board (FSB), entering the race.
Draghi has been the "undisputed number one of international finance"
since Timothy Geithner bestowed the FSB the "highest honors" by
declaring it the "fourth pillar" of the financial system.
9. (SBU) According to Sanio, the current division of labor between
Bafin and Bundesbank has been a success and has strengthened
Germany's position in international fora. Sanio argued that to
dissolve the current arrangement would weaken Germany, especially
now after the crisis has shown the need for strong cross-sectoral
supervision. Further, concentrating exclusively on national reforms
while the new EU regulatory structure is being set up is ill-timed.
Banking Sector Response: It's Political
10. (SBU) The new government's reform plan has provoked negative
reactions from the banking industry. Norbert Walter, Chief
Economist of Deutsche Bank Group, called the plan "an archaic reflex
of politicians that do not trust anybody but the Bundesbank." DB
Research's Bernhard Speyer noted there is no evidence available that
the current supervisory structure aggravated the impact of the
financial crisis in Germany. Other countries' experience does not
suggest that allocating the task of banking supervision to the
central bank yields superior results. Many, like Dr. Ulrich Kater,
Chief Economist of Deka-Bank, have cautioned that much of the blame
for regulatory failures during this crisis was deflected from the
Bundesbank and fell on BaFin. Otto Steinmetz, former head of risk
management at Dresdner Bank pointed out that BaFin was at times
constrained from taking decisive action by political considerations
in Berlin.
Potential Conflict of Interest
11. (SBU) The key concern of the banking sector, however, is the
potential conflict of interest between monetary policy geared at
price stability and the supervisory responsibility for financial
stability. The execution of sovereign powers, such as closing banks
or removing senior management from office, Norbert Walter argued, is
not compatible with central bank autonomy in the conduct of monetary
policy. The Bundesbank might be forced to make monetary decisions
in the ECB Governing Council that burden the financial institutions
that it supervises to the point where they could even become a
systemic risk. Installing "Chinese Walls" as the Bundesbank plan
suggests, "is a fiction as we all know," Otto Steinmetz, former head
of risk management of Dresdner Bank, said. The reputation of the
Bundesbank is at stake fears Ulrich Kater, Chief Economist of
12. (SBU) This conflict could, Walter contended, be carried through
the Bundesbank into the European Central Bank, making it more likely
to be soft on inflation. Some would call this hyperbole. Fabio
Recine, senior expert on Financial Supervision of the ECB, argues
instead that, "monetary policy is decided by the entire Governing
Council; any reputational damage therefore does not apply to the
ECB." However, Racine does believe that a central bank should
remain independent from the Ministry of Finance. If the Bundesbank
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jurisdiction were to be extended to the insurance sector, there
could be a legal conflict with Article 105 (6) of the EU Treaty that
explicitly excludes insurance supervision from the ECB's powers.
Compensation for Regulators
13. (U) Some believe that the real problem with financial
supervision in Germany is the insufficient resources and competences
of the regulators. Uncompetitive remuneration makes it difficult to
attract and keep highly qualified staff. As a result, "even
Bundesbank staff is less qualified than those working at the
institutions they oversee," said Otto Steinmetz. The lack of a
waiting period before a regulator can move over to the private
sector is also part of the problem. Joerg-Matthias Butzlaff, Head of
Communications of Metzler Bank, compared the relationship between
the regulators and the regulated to a race of "a Golf against a
14. (SBU) The planned reorganization of German banking supervision
appears to be motivated at least in part by politics. Many in the
banking community believe that the move will not improve the
performance of the country's financial supervisors. The current
restructuring discussion comes at the same time as the
implementation of new European supervisory regulations. Given its
focus on the BaFin-Bundesbank debate, it is not clear that Germany
is putting its best foot forward in discussions at the European
15. (U) This cable has been coordinated by Embassy Berlin and
Consulate Dusseldorf.
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