Imagine that you are a chief executive of a high-powered bank with
about E200bn in assets and you are late for a crucial board meeting.
Topping the meeting’s agenda is your bank’s still secret acquisition of
a foreign bank. Slightly embarrassed, you step into the room, apologise
to your colleagues and give a friendly nod to none other than the bank
police. The meeting can now begin. Sounds familiar? Then you must be a
CEO of a major bank in Germany, where officials from BaFin, the German
financial services watchdog, regularly sit in at meetings of banks’
supervisory boards.
For all other bank CEOs, such a scenario might seem unsettling, as
police presence normally means that something is wrong. Indeed, when a
foreign newspaper first heard of the practice last August, it suggested
that another crisis was looming for German banks, many of which have
been bouncing back this year after a disastrous 2002.
But a repeat of last year’s German bank crisis is a remote possibility.
Apart from several Landesbanken (state-owned regional banks), major
German banks are making money again and have streamlined their
structures to at least get by in these difficult economic times. Should
the economy and markets pick up again, the likes of Dresdner Bank,
Commerzbank and HypoVereinsbank (HVB) – all big listed banks that had
huge losses in 2002 – could even thrive as they did in the late 1990s.
BaFin’s attendance at board meetings of the major banks is not an
indication that something is amiss but is part of the way the sector is
regulated in Germany. Manfred Weber, managing director of the German
Banking Association (BdB) in Berlin, says: “It has nothing to do with
crisis management but rather serves to improve the flow of information,
which in turn facilitates optimum supervision.”
Mr Weber says he was completely taken aback by the newspaper report.
“The article’s suggestion of problems at German banks is
incomprehensible. It invites the conclusion that, despite knowing
better, people are putting down the German financial centre.”
Peculiar practice
Regardless of whether that was the case, the fact is that BaFin’s
attendance at the board meetings is a practice peculiar to Germany.
Banking regulators worldwide have many effective means of supervision,
such as tough questionnaires, special investigations and, if necessary,
revocation of a bank’s licence. Only in Germany, however, do regulators
have the additional right to turn up at board meetings where key
strategic decisions are made.
As outsiders, BaFin regulators do not vote on issues before a
supervisory board but they do have the right to ask questions of the
management team and voice their opinion on any issue. They can even
suggest to a supervisory board that a particular bank director be
replaced, although there is no obligation to follow their advice.
If all this still seems a bit too close for comfort for bank executives
outside Germany, consider the cultural reasons for the practice. There
are essentially two: the way corporate governance is set up and the
country’s traditionally high tolerance for government intervention.
Corporate governance
Like all big German companies, major banks have a two-tier system
of corporate governance: a management board, which comprises the bank
executives and runs the bank; and a supervisory board, which typically
includes the bank’s CEO, former bank directors, employee or union
representatives and people from outside the bank. As the latter’s
function is to “supervise”, German bankers view the presence of a
regulator as fairly logical.
Such simple logic alone does not explain BaFin’s presence, however.
Banks outside Germany are equally as well – if not better – supervised
without the need of the regulator showing up at board meetings. This is
where the second and more crucial factor comes in. At least since the
days of the German Empire under Otto von Bismarck, Germans, including
those in the increasingly international banking sector, have been
accustomed to a high level of government bureaucracy and intervention.
Many still welcome it. Thus, even if bank executives are less than
delighted to see BaFin at supervisory board meetings, they have little
trouble accepting its presence. It is difficult to imagine US bank
executives, who have a different attitude towards government
intervention, feeling the same way.
While the German regulator has had the legal right to participate in
board meetings for decades, it has only actively exercised this right
in the past three years. The reason, says Helmut Bauer, chief director
of banking supervision at BaFin, is that as the major German banks
expanded in size and became more complex in the 1990s, a more
innovative and hands-on approach was needed for their regulation.
“BaFin’s current approach has come a long way from what a decade ago
was a very legalistic one,” Mr Bauer tells The Banker in his Bonn
office.
Helmut Bauer: supervisors must leave their desks
“Nowadays, supervision requires a wide range of skills and expertise;
it is not enough to be an expert on banking law and then just apply the
law. As a supervisor, you need to be more proactive and investigative
in order to respond to control deficits and risks as they arise and not
once they have materialised. Proper desk-top analysis is essential but
for supervisors it is important to get up from their desks and go visit
the banks regularly.”
In many respects and for many of its supervisory processes, the German
regulator looked to the UK’s Financial Services Authority (FSA) as the
model, says Mr Bauer. Before rejoining BaFin at the beginning of this
year, he worked for two years at the FSA as a senior securities
regulator.
Investigative approach
Mr Bauer credits BaFin president Jochen Sanio with moving the
regulator toward an investigative approach when the latter took over
BAKred, BaFin’s forerunner, in July 2000. Almost two years later,
BAKred was merged with the German insurance regulator BAV and the
German securities regulator BAW to form BaFin.
Generally speaking, the banks that BaFin visits regularly are those
with more than E100bn in assets. These include Dresdner, Commerzbank,
HVB and Deutsche Bank, plus the Landesbanken WestLB, NordLB, BayernLB
and Bankgesellschaft Berlin (BGB). DZ Bank, the central bank for
Germany’s co-operative banks, is also part of the group.
Mr Bauer emphasises, though, that the regulator has not drawn up a list
of specific banks to target. “We may attend meetings of the supervisory
bodies of any of Germany’s 2500 banks but with just over 350
supervisors, it stands to reason that we generally focus on the major
ones,” he says.
Beyond the high-profile visits, BaFin’s bank police have plenty of
other means of watching the German banking sector. According to the
regulator, these include demands for full disclosure of information,
special investigations, requests to replace bank directors and the
ability to shut a bank down.
Although it ceded many of its supervisory powers to BaFin when the
super-regulator was formed in May 2002, the Bundesbank, Germany’s
central bank, still plays an important role. Along with handling flows
of euros between itself and German banks, the Bundesbank operates a
state-of-the-art database listing all loans of more than E3m, which
under law must be reported. BaFin is free to access the database.
Banking fiascos
Between BaFin and the Bundesbank, there is no doubt that the German
banking sector, like the country, is well-regulated. However, that does
not mean that German financial regulators have necessarily been more
effective than their peers elsewhere. Despite embracing a more
investigative approach, BaFin has failed to prevent numerous fiascos
from occurring in the past three years – a period marked by bearish
equity markets and an anaemic economy.
Trouble began in mid-2001, when BGB almost went under due to a whopping
E2.5bn in bad real estate loans, many of which were politically
motivated. Luckily for BaFin, this posed no risk to the system because
by law the public shareholders of Landesbanken must bail out their
banks – albeit to the cost of German taxpayers.
In early 2002, it emerged that many of the banks that BaFin routinely
visits had lent billions of euros to such colossal corporate failures
as the media empire of Leo Kirch, the construction group Holzmann and
the aircraft maker Dornier. And, beyond having the greatest exposure to
Kirch (E1.9bn), BayernLB was one of the many creditors of Enron, the
failed US energy trader.
Another bank fiasco that is making headlines in Germany is that of
WestLB, a Landesbank that embarked on an aggressive international
expansion, particularly in the UK – a decision that has cost the bank
dearly. In 2002, WestLB posted a record loss of E1.7bn, much of which
was caused by the controversial financing of the UK television business
BoxClever. The fiasco led to the departure of two chief executives this
year alone and infighting among public shareholders.
International view
These events show that BaFin’s in-depth knowledge of where the
biggest bank loans are going and what strategy the country’s major
banks are pursuing is not always of great use. Citing the WestLB fiasco
as an example, a source at Commerzbank noted that BaFin’s greatest
weakness was that its brief did not extend beyond Germany: “They might
have been kept informed of WestLB’s international strategy in broad
strokes but they had no idea what was really going on in the UK. What
we need is a European BaFin.”
Mr Bauer agrees that watching the international activities of banks
poses a challenge for BaFin. But he dismisses the notion that it did
not fully know what was going on at WestLB. “Regarding WestLB, all I
can say is that we have been monitoring the bank and its branches and
legal entities abroad,” he says.
Newspapers have reported that the WestLB CEOs were forced out partly
because BaFin held them responsible for the bank’s woes and made it
clear that it wanted new leadership. New leadership has arrived in the
form of Thomas Fischer, a former Deutsche Bank CEO, who has been hailed
as the manager to deliver WestLB from its crisis.
BdB’s Mr Weber says: “The regulator cannot guard against all risks just
like the police cannot stop all crime. There have been bank failures
and there is the difficult economic situation. Yet wiping out risk
entirely is not even a desirable aim. An attempt to control risks 100%
would involve massive intervention, which no one can want and which is
not compatible with a market economy. Banks, after all, are in the
business of taking risks. In principle, German banking supervision is
both efficient and effective.”
