Consultation by the High-level Expert Group on reforming
the structure of the EU banking sector
Participant:
Sparkasse Freiburg – Nördlicher Breisgau
Kaiser-Joseph-Straße 186-190
79098 Freiburg
Germany
Detailed information on the business model and key financials for Sparkasse Freiburg are enclosed as an annex.
Questions to banks
To what extent are the current and ongoing regulatory reforms sufficient to ensure a stable and efficient banking system and avoid systemic crises?
The financial crisis has revealed the inadequacies of the current regulatory framework for the banking sector, and it is therefore right and proper that regulatory conclusions should be drawn from this.
However, in particular from the perspective of a savings bank, it should not be forgotten that regulatory measures in the banking sector affect all institutions, irrespective of the size and particular business model involved. This can lead to undesirable imbalances. For example, measures aimed at stabilising the interbank market may make sense for large banks but at the same time may represent a disproportionate burden for smaller institutions operating on a regional basis.
The German banking sector with its three-pillar banking structure (savings banks, cooperative banks and the large private banks), is characterised by its different business models. The focus of the major banking houses is on international transactions and business with large-scale customers. Regional institutions such as the savings banks and cooperative banks, by contrast, only operate within their region and function as universal credit institutes offering classic banking services to private customers and small and medium-sized enterprises. This division of labour proved valuable during the financial crisis and helped maintain stability. It is therefore important that the stabilising effect of this tripartite structure should not be weakened.
Where we do see an urgent need for action is with regard to international financial stability. The crucial problem during the financial crisis was – and still is – the existence of financial institutions that were “too big to fail”. Mergers and takeovers have, in fact, accelerated this process of consolidation since the financial crisis. Because of their sheer size the large institutions can, if they become imbalanced, drag entire states and their taxpayers down with them – as we saw in the case of Ireland and Iceland. In our view this is the area where there is a need for regulation.
In addition, major international banks tend to distort regional competition because they can refinance at more favourable rates than the regionally operating banks. The crucial elements here are the implicit credit guarantees offered by governments to many major banks nowadays. In the capital markets the assumption is that such banks will ultimately be bailed out by taxpayers if it comes to the crunch. Taking into account the fact that German savings banks were specifically denied access to the former system of guarantor's liability on the grounds that this represented an impermissible state credit guarantee, we are of the opinion that there is a need for regulatory action to be taken. We do not regard a possible addition of 1% to 2.5% to a bank's core tier 1 capital as sufficient to neutralise the distortion of competition in the banks' classic business with retail and corporate customers.
A further important point is the current inequality of treatment of traditional banks and so-called “shadow banks”. In contrast to the strictly regulated banking sector, the shadow banking system is subject to many fewer regulatory requirements, even though their business is in many cases identical. The principle of “same business, same risk, same rules“ should be applied here.
Which structural reforms would improve the safety and efficiency of the banking system in the EU in the near term? In the long term?
The main task of the banks is to meet the financial requirements of their customers. They are service providers for the real economy. Adequate competition ensures that this happens efficiently and to the benefit of customers.
The German financial market is probably the most competitive in the whole of Europe, as can be seen from the sheer number of market players. In Germany, more than 1,000 cooperative banks, over 400 savings banks and upwards of 200 private banks provide services. In the area covered by Sparkasse Freiburg alone, a total of 7 cooperative banks and 17 private banks operate at more than a hundred different locations. This diversity means that even in rural areas, in which the major banks no longer operate, there is still competition for customers. It offers people choice - which is all the more important as about half of the 420,000 inhabitants in the region we cover live in rural areas.
The purpose of Sparkasse Freiburg is defined in the Baden-Württemberg law on savings banks in terms of its public service obligation. In addition to strengthening competition, our task is to supply financial and credit services to all sections of the population, industry, in particular SMEs and the public sector. Corporate social responsibility is also an important part of our philosophy. Interbank transactions and proprietary trading are kept to a minimum. The business model of Sparkasse Freiburg has changed little since it was first established back in 1826.
In terms of our bank's business figures this means that two thirds of the bank’s liabilities consist of the deposits we hold on behalf of retail and corporate customers. Lending to these groups of customers also accounts for two thirds of our assets. The bank thus refinances mainly from its own customers' deposits and is therefore largely independent of any interbank transactions. In terms of profit and loss, 90% of the bank’s earnings are derived from business with these customers. The bank’s annual net profits are sufficient to enable it to continuously top up its equity and prudential reserves. The bank’s economic capital was generated by itself. A cost-income-ratio of around 60% demonstrates that our structures are efficient. Further information on our key financials is contained in the annex.
Strong local competition ensures fair conditions for customers and encourages the market players to develop efficient structures. It is the basis for a stable, reliable supply of financial services to all groups of customers.
The marked diversity of organisational forms in the German banking sector proved invaluable during the financial crisis, as it helped to reduce risk. That is why it is important to preserve and protect the balance of private, profit-oriented banks and decentralised groups such as the savings banks and cooperative banks – and possibly also to further develop these internationally in the context of regulation agreements.
In our opinion any structural reforms that led to large-scale mergers and oligopolistic structures would create a major obstacle to competition in the single market. In addition to the danger posed by institutions that are “too big to fail”, it would also have a distinctly negative impact on the cost and availability of banking services.
From our perspective, plurality in the banking sector is crucial if its efficiency and stability are to be further improved.
What are your views on the structural reform proposals to date (e.g. US Volcker Rule, UK ICB proposal)? What would be the implications of these proposals on your institution and the financial system as a whole?
We believe there is no patent remedy for solving the structural problems of the banking sector. It is not possible to implement such reforms using a sort of “copy and paste” approach around the world. Any reforms must always be adapted to the structure of the particular economic area involved.
The “Volcker Rule”, for example, is based on the established US policy of separation of banks. It is appropriate in terms of the structure of the US market as, for historical reasons, all-round banks are not so common in that country. The existing structure of the US banking sector, with various major banking houses primarily focused on investment banking and a large number of smaller regional banks, is not fundamentally undermined by the Volcker Rule.
On the other hand, – unlike the USA – all-round banks are relatively widespread in Europe, and transferring the Volcker Rule to the EU would therefore entail fundamental structural change. Nor would a system of separate banks remove the source of instability in the current crisis – as became clear in the case of Lehmann Brothers, which was a pure investment bank and yet still found itself at the heart of the crisis. Furthermore we are convinced that breaking up the all-round banks would have a negative impact on the services offered to customers. Services provided from a single source would no longer be possible and this would be to the detriment of customers. In particular the SME sector in Germany requires services from a single source, as companies are often not big enough to be able to make use of services from separate providers.
Irrespective of this, Basel III is already going to have a tangible impact on Sparkasse Freiburg. The significant increase in equity ratios is going to drive up the cost of equity, and this is likely to have an effect on borrowing conditions for our customers. The Liquidity Coverage Ratio (LCR) also represents a challenge. Under current requirements we have to hold a significant volume of sovereign bonds which, given the 60% limit, are also the basis of assessment for Level II assets such as mortgage bonds. These requirements will have a significant impact on the structure of the asset side of our balance sheet.
We also take a critical view of adherence to a long-term net stable funding ratio (NSFR), as this is likely to have a massive impact on the possibility of granting long-term fixed interest loans. But offering the long-term security of fixed levels of interest benefits customers and is an important element in the services we offer. To move away from this would merely mean passing on the interest rate risks to the borrowers, but we see managing interest rate risks as an essential task for the banks. In Germany in particular, the culture of long-term financing has proved its value over many decades. The US sub-prime crisis in particular is a cautionary example.
What are the main challenges of your financial institution as regards resolvability? Are you implementing structural changes to your institution in the framework of your recovery and resolution planning?
One of the special strengths of the Savings Bank Finance Group is its joint liability scheme, which offers comprehensive protection to customers and investors alike. The scheme ensures that savings banks maintain their operations and fulfil all their obligations, and goes well beyond statutory requirements by offering full security for customer deposits. This “institution protection scheme” is underwritten by the Savings Bank Finance Group with its own assets. A risk monitoring system for all banks in the group obliges institutions to provide comprehensive quarterly data on their solvency, liquidity and profitability. An internal scoring system translates this data into a traffic light system. If institutions are put on amber or red alert, the protection scheme has increasing rights of consultation and intervention in order to improve the risk situation. Sparkasse Freiburg’s current status under the traffic light system is “green”.
Ever since the Savings Bank Finance Group’s mutual liability scheme was first set up in 1973, all liabilities have been fully met. This is one of the main reasons for the high degree of trust enjoyed by savings banks in Germany.
Sparkasse Freiburg currently has an overall capital ratio of more than 14% (in % RWA). Even if one only takes the retained earnings of the bank, the ratio is 13%. Given these capital ratios and the low risk profile of our business model, we regard the danger of suffering major losses as being very slight. If, however, there was to be a significant reduction in equity, we would first of all try to sell core tier 1 capital instruments in line with the new Basel III regulations (e.g. silent participations). The next step would be to reduce assets in order to bring us back into line with the minimal capital requirements again. And the final step would be to request assistance from the mutual liability scheme.
In order to avoid imbalances and losses we have made considerable efforts to improve our risk management in recent years. For several years we have been analysing virtually our entire lending portfolio on the basis of rating or scoring systems. Building on this, we have introduced the application CPV for managing the lending portfolio, and for managing interest rate risks we use the application S-Treasury on the basis of present value. In doing so, we have adopted a risk-averse approach and operate on a rolling ten-year benchmark. Given our deposit structure, the issue of liquidity is of less significance, but we nevertheless hold an appropriate volume of securities in the security deposit (ECB) to cover any short-term refinancing with the ECB.
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