It’s been a rough year for banks big and small in Europe.
For large banks, barely a week goes by without news that international authorities have slapped yet more billion-dollar fines for wrongdoing. Germany’s two largest banks, Deutsche Bank and Commerzbank, have been among those facing hefty fines that are hurting their bottom line.
For all banks and insurers, record low interest rates in Europe, combined with a struggling European economy, have pushed down profits and forced many to consider drastically scaling back their balance sheets.
All this is starting to make regulators nervous. It prompted Germany’s top banking supervisor to announce a string of new steps Tuesday to make sure the problems of individual banks don’t threaten the stability of the financial system as a whole.
Among other things, the regulator will be subjecting smaller banks and insurers to a new round of tests to see whether they can truly weather the hard times.
“This has a stress test character to it,” said Raimund Röseler, executive director in charge of banking supervision at Germany’s Federal Financial Supervisory Authority, known as Bafin. “We want to know which bank has how much water under its keel — and when it would run aground.”
It couldn’t come soon enough. A growing chorus of studies and surveys have warned that Germany’s financial landscape is in dire need of change.
Should interest rates remain so low, we'll have to place more companies under one-on-one coverage. Felix Hufeld, Bafin President
“The current business models of established banks are no longer sustainable. ‘Carry on’ is not an option for German banks,” said Rüdiger Filbry, who leads banking research at consulting firm Boston Consulting Group.
Record low interest rates imposed on Europe to bring it out of an economic slump, have had a massive impact on the profitability of banks and insurers. A Boston Consulting Group study this week warned that, despite Germany’s healthy economy, retail banks’ earnings were likely to fall by 25 percent within the next five years as they struggle to make money off of loans or investments.
This is a major concern for Bafin. While the regulator is no longer responsible for the biggest banks in Germany – the European Central Bank since November supervises the 120 largest banks in Europe, including 20 in Germany – the regulator still monitors more banks than any other European country.
While the overall financial sector still looks healthy for the moment, this doesn’t apply to all companies, Bafin said. Germany has nearly 2,000 individual banks, more than any other European country, prompting many to call for some institutions to fail or be gobbled up by others.
Felix Hufeld, the president of Bafin, warned that any institution showing shortcomings might be subjected to a more invasive examination of its finances.
The regulator will begin by subjecting all German banks not under direct supervision by the ECB to a low-interest rate stress test. Unlike the ECB’s own stress test in October, the results will not be released to the public. But the test will inform which banks have to be taken under the microscope.
"Should rates remain so low, we'll have to place more companies under one-on-one coverage,” Mr. Hufeld, who took over as Bafin head in March, told reporters at a press conference in Frankfurt.
The major fines being handed down for wrongdoing are also worrying regulators.
The Financial Stability Board, which consists of finance ministers and banking supervisors of the world’s 20 leading economies, is considering whether to classify “market misconduct,” meaning criminal manipulation by bankers, as a new risk.
“The Financial Stability Board believes that misconduct in some banks has reached such dimensions that one may have to speak of a systemic risk,” said Felix Hufeld, the president of Germany’s Federal Financial Supervisory Authority, known as Bafin.
The board identified misconduct as a potential issue for examination, he said, adding that banks were now being fined “significant amounts,” he said.
A study by Boston Consulting Group supports that view. It said banks had to pay just over €170 billion, or $191 billion, in fines and settlements worldwide between 2009 and 2014. The sums in 2014 alone totaled almost €67 billion, a record.
“The banks should deal proactively with the peculiarities of this new era,” said Gerold Grasshoff, risk analyst at the consultancy, referring to the tougher fines being imposed. Institutions should push forward with plans to become more transparent, he added.
This year hasn’t started much better. Five of the world’s largest banks, Citigroup, JP Morgan, Barclays, Royal Bank of Scotland and Switzerland’s UBS are expected to be fined a total of more than $5 billion this week for manipulating the foreign exchange market.
And Deutsche Bank was fined a record $2.5 billion by authorities in the United States and Britain for its role in the Libor interest-rate fixing scandal.
It’s still unclear whether German authorities will separately punish Deutsche Bank in the Libor case. Bafin recently completed its own report into the bank’s wrongdoing, but has stayed quiet on what will happen next.
“Deutsche Bank now has the report and has been asked to comment,” said Mr. Röseler. Only then will Bafin decide what steps to take. “The consequences we take will depend on the content of the response,” he said.
Bafin’s probe is focusing less on fines than on ascertaining who was responsible for the misconduct. In addition to the Libor probe, Bafin is investigating what role the bank may have played in the rigging of foreign exchange rates and in fraud linked to trading of carbon certificates. Mr. Röseler said the carbon probe was finished but the forex investigation would still take a while.
Banking scandals aside, regulators are also taking a closer look at the insurance industry, which perhaps has faced more hurdles in the current low interest rate environment than any other financial sector. The European insurance regulator EIOPA in November warned as many as a quarter of insurance firms are under threat of collapse.
Bafin warned Tuesday that many German insurers may have trouble meeting tougher new minimum capital requirements, known as Solvency II, that are being imposed by the European Union and due to take effect on January 1, 2016.
Mr. Hufeld assumes that more than 10 insurers in Germany will fail to meet the requirements. A survey in 2014 had already revealed a high single-digit number of insurers unable to show sufficient capital. Market conditions had “significantly deteriorated” since then, he said.
Bafin has now given insurers a deadline of June 3 to let the regulator know whether they already fulfil the tougher standards, based on market conditions at the end of 2014.
"German insurers will successfully enter the world of Solvency II only with considerable efforts," Mr. Hufeld said.
Yasmin Osman is a senior correspondent covering banks and their supervisors for Handelsblatt in Frankfurt. Christopher Cermak of the Handelsblatt Global Edition also contributed to this story. To contact the author: [email protected] and [email protected]