Jan Wagner reports from Frankfurt on the unique powers of the German financial regulator but finds that its approach has not prevented banking troubles.

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



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


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.”


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