IMF Publishes Report on the 2018 Article IV Consultation with Germany

The staff report highlights that completion of Basel III, as well as other recent regulatory changes, may have important implications for large German banks. After a long period of favorable economic conditions, banks’ internal risk models may underestimate risk-weights. The introduction of the 72.5% output floor is aimed to limit the effects of sharp re-assessments of risks on bank capital. As the use of internal models is more pervasive in large banks, this measure will affect mostly this group. In addition, the report highlighted that the Markets in Financial Instruments Directive (MiFiD II), which came into force in January 2018, aims to increase transparency and efficiency in financial trading, but may also add regulatory compliance costs in the larger banks. Furthermore, the 2017 minimum requirement for own funds and eligible liabilities (MREL) policy of EU sets targets that are binding only for larger/more complex banks in the Single Resolution Board remit, while smaller and medium-size institutions are not yet affected. Few banks are expected to face funding shortfalls to meet MREL target and subordination requirements are facilitated by recent changes to the German Banking Act.

In the banking sector, the regulatory capital ratio has increased, but the cost-to-income ratio and leverage remain high. Risk-weighted capital stood at comfortable levels, supported by favorable macroeconomic conditions and declining risk-weighted asset density, and is improving for all categories, except large banks. Non-performing loans (NPLs) continue to decline and provisioning for impaired shipping loans is leveling off. As noted in the 2016 Financial Sector Assessment Program (FSAP), international experience suggests that macro-prudential tools should be deployed early to be most effective. It is therefore important that the macro-prudential framework is sufficiently nimble such that instruments can be utilized preventively to avoid the build-up of vulnerabilities. The macro-prudential toolkit should be strengthened. New tools—loan to value (LTV) caps and amortization requirements—were legally created in 2017, a welcome development. However, income-based instruments, such as the debt-to-income ratio and the debt-service-to income ratio, are not included in the legislation. These tools, which can help prevent an excessive build-up of debt by households when house prices are rising rapidly, should be added.

Large German banks continue to underperform relative to the European peers. To keep up with cost-reduction targets, the German global systemically important bank (G-SIB) presented an updated restructuring strategy to refocus activities in Europe and reduce personnel costs by shrinking its investment banking business. Overall, the financial market stress is assessed to be low, capital buffers in the banking and life insurance sectors are deemed comfortable. Nevertheless, accelerating restructuring, restoring profitability, and reducing interest rate risk remain the key priorities in the banking and life insurance sectors. Continued supervisory attention to interest rate risk and implementation of restructuring plans, including through Pillar 2 measures, remains essential. The report also reveals that low interest rates and the introduction of Solvency II are forcing some restructuring in the life insurance sector. Solvency ratios, according to Solvency II, have improved overall, alongside the increase in long-term yields, since late 2016. However, a majority (nearly 70%) of life insurers rely on transitional measures to calculate their solvency capital requirement. As was noted in the Bundesbank’s 2017 Financial Stability Report, 14 life insurers would not meet the Solvency II minimum requirement as of end of 2016 without transition measures.

Related Link: Staff Report

Keywords: Europe, Germany, Banking, Insurance, Securities, Solvency II, Basel III, MiFID II, NPLs, Restructuring, IMF