bank talk

Regulator Warns of Race to the Bottom

  • Why it matters

    Why it matters

    If regulators cannot agree on rules for banks, there is a risk of a race to the bottom with lax regulations potentially failing to protect against possible crisis.

  • Facts


    • BaFin keeps watch over the state of German banks, insurance companies and securities trading.
    • From its headquarters in Bonn, the agency is also partly responsible for consumer protection.
    • Regulators at BaFin work closely with the European Central Bank, which now oversees the largest banks in the Eurozone.
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Germany, Frankfurt: Raimund Roeseler, Executive Director Banking Supervision of the BaFin
BaFin's top banking regulator, Raimund Röseler, fears a "race to the bottom" if countries cannot agree on a global set of rules for regulation. Source: Picture Alliance

The headquarters of the German Federal Financial Supervisory Authority, known here as BaFin, in Bonn are as plain as you would expect for a government agency. This also goes for the offices of the watchdog’s top banking regulator, Raimund Röseler. There is no expensive art on the walls and no spectacular views from the window. Frankfurt’s bank-dominated skyline is far away, and not just geographically.

But sometimes it isn’t such a bad idea to keep a healthy distance from the banks you are charged with regulating, said Mr. Röseler. He told Handelsblatt he fears for what will happen if countries cannot agree on banking regulations and said the outcome of talks remains completely up in the air.


Handelsblatt: Mr. Röseler, after the financial crisis politicians and regulators promised not to intervene in large failing banks and liquidate them instead. Will we see this promise fulfilled?

Raimund Röseler: Well, at least we are on the way to solving the problem. My impression is that the resolution authorities would liquidate banks today that we wouldn’t have dared approach in 2008. We would certainly liquidate an IKB today [the German government bailed out the bank to the tune of €1 billion] – and even banks that are quite a bit larger than that.

But no-one seems prepared to do this with Italy’s Banca Monte dei Paschi. Instead, in their first acid test, the new E.U. liquidity rules are being called into question.

These rules cannot be circumvented. I assume that the European Central Bank and the European Commission will firmly investigate and ensure that the Italian authorities comply with European Union rules …

… if these rules are interpreted very generously…

As I mentioned, the European institutions are responsible for the implementation of the rules. In exceptional cases, there are conditions which allow for a preventive government recapitalization of banks. The bank in question must be solvent. Government funds must not be used to cover foreseeable losses. And even then, owners and secondary creditors have to pay up first.

If we don't agree on regulations, we risk a race to the bottom, towards increasingly lax rules.

Would a liquidation of Monte dei Paschi really be such a big problem for Italian or even European banks?

On average, German banks have already significantly reduced their commitments in Italy. BaFin is not responsible for other banks.

It sometimes seems as if the European banking sector is simply not strong enough to handle tougher rules. Does this explain the firm European stance on international rules at the Basel Committee on Banking Supervision?

The newspapers sometimes create the impression that our role in the Basel negotiations is that of a lobbyist for German or European banks, which is simply not true. We would agree to a sensible compromise, one that would involve significant increases in capital requirements for some German banks.

What would significant mean?

The new rules wouldn’t greatly affect small banks, but they would impact larger institutions and banks with a lot of real estate business. We have calculated the effects on about 18 larger banks. In those cases, the increase amounted to 15 percent or, in some cases, more than 20 percent. But we would have accepted that, because we think that a capital increase is justified in those cases.

What is the problem in the talks?

What we are pushing for is that the capital rules continue to ensure that banks with higher risks get more capital than banks with lower risks. That wasn’t necessarily the case with the proposals, at least not for European banks. The Americans have completely different balance sheet structures, because real estate loans there don’t remain on the books but are resold instead. But we came very close to each other in Basel. We just need to cover those last few meters.

And how will the last few meters be covered?

I don’t know. I think the outcome is still completely up in the air. All that is left is the design and calibration of a lower limit for how much capital banks need to back their risks, which is known as the output floor. We feel that this floor is the key element, because it determines how much sensitivity to risk remains in the system.

Is it even possible to find uniform rules for so many different banking systems?

Perhaps this can be done by incorporating more leeway for individual nations into the rules. It would practically be a disaster for the Basel Committee if no agreement was reached, because it lays claim to being the global standard setter for banks. If we fail now, it will be a bitter setback. This is why everyone is motivated to find a compromise. But I do believe that the positions are pretty entrenched, and I don’t know whether an agreement will be reached.

Why is it so important to find an overall solution?

If we don’t agree on regulations, we risk a race to the bottom, towards increasingly lax rules. In the past, this meant that some countries developed a banking sector that was simply too big for their economies. We want to avoid that. This is why I think a global standard is important, but not at any cost.

Haven’t the policies of the new U.S. president, Donald Trump, already substantially increased the threat that this race to the bottom will occur?

I cannot evaluate what effect the presidential election will have on regulation in the United States. Apparently some people there believe in getting rid of stricter regulation. But whether and to what extent this influences the negotiations in Basel is not clear to me yet.

“I do believe, however, that the culture in banks – including their behavior – has changed drastically in recent years.”

Raimund Röseler, BaFin's head of banking regulation

The Bundesbank has just massively increased its risk provisions, because it fears the consequences of rising interest rates should the European Central Bank back away from its extremely relaxed monetary policy. At the same time, Bundesbank board member Andreas Dombret has told the banks to prepare for rising rates. What do you fear more at the moment, that interest rates will remain this low for some time to come, or a rapid increase in rates?

Both are bad, and in both cases some banks will run into problems. Rising interest rates, even a rapid rate increase, would be better for the banks in the long term. Then we will have to see how lenders cope if the increase hits them hard in the short term.

To what extent have interest risks accumulated among German banks?

We use the “Basel interest rate shock” to indicate the risks. This tests how much a bank’s cash value and therefore its equity capital declines when rates change by two percentage points. If the equity capital declines by more than 20 percent, this is considered an elevated interest risk. The situation mainly affects banks that take in a lot of customer deposits, which are invested in very short-term investments nowadays, but ones that also issue very long-term loans.

Why don’t the banks hedge against these risks?

Hedging against risks also costs money. Every bank weighs how much risk it can handle. We just believe that some banks are too optimistic in this regard. That is why we carry out stress tests, like we did two years ago, and we will take the results into account when we determine the individual capital surcharges for banks.

Will you also ban dividends?

The chances are very good that we will. But at BaFin we aren’t always required to act if the board of directors and owners are reasonable themselves. I know enough banks that haven’t planned any dividends at all for the coming years.

In your stress test, do you also look at the consequences of negative interest rates?

How many and which scenarios we test is still being discussed. But we will certainly have a scenario that includes even lower interest rates than today’s.

For a time, accounting for old scandals from the financial crisis was seen as a major risk for banks, and one that could jeopardize financial stability. Is that phase over?

I believe that most of that has been addressed. But this doesn’t mean that we no longer have any complaints about individual banks.

In the settlement with Deutsche Bank over bad mortgage deals, the U.S. Justice Department described some outrageous practices at the bank in the years prior to 2007. Have banks learned their lesson since then, or have they just become more skillful at deception?

I can’t say anything about an individual bank, of course. I do believe, however, that the culture in banks – including their behavior – has changed drastically in recent years.

And yet new allegations keep resurfacing, such as the business with offshore companies in Panama. What have BaFin’s investigations yielded on that subject so far?

We have requested original records from all the banks that were implicated in the allegations. We have already received terabytes of data. We are now in the process of analyzing the documents, but we need outside help because of the sheer volume. We haven’t come across anything dramatic yet, but as I said, the investigation is still not complete.

Have you made any headway with your investigation into the so-called “cum ex” trades, in which banks and investors claimed multiple rebates on capital gains taxes that were paid only once?

We have been working on this case for some time. As we now know, around a dozen banks were active in this area. Thanks to our close cooperation with the criminal prosecution and financial authorities, which has been allowed since 2015, we have gained access to some new information. Where necessary from a regulatory standpoint, we have also conducted some audits. The results have been remarkable at times, and in a few cases there may be personnel consequences.

In other words, you could force bank executive board members out of office, because they are no longer viewed as reliable and professionally qualified?

Exactly. However, the decisions of the public prosecutor’s offices also play a role here. If a public prosecutor reaches a financial settlement with a bank, which explicitly stipulates that the people in charge at the bank are not at fault, we have of course no basis to recall a manager for precisely that reason.


Yasmin Osman covers the financial sector for Handelsblatt. Michael Maisch is deputy lead of Handelsblatt’s financial coverage. To contact the authors:

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