Financial Regulation

Strong But Not Invulnerable

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Financial regulator Felix Hufeld is keeping a close eye on new risks. Picture source: Reuters

The comic-book hero Superman is not only super-strong, he is invulnerable. Bullets bounce off, buildings crumble in his path, blazing heat or icy cold don’t faze him. He is, after all, the Man of Steel.

Germany’s financial system, too, is strong, the country’s top financial regulator claims. Maybe not super-strong, but much stronger than it was 10 years ago when the financial crisis broke out. However, it is far from being invulnerable.

“The financial system is more stable,” Felix Hufeld, president of BaFin, said in an interview with Handelsblatt, “but naturally not invulnerable.”

BaFin and other financial regulators, including the central bank, the Bundesbank, work together to identify trends and risks, to play through scenarios, and to monitor new activities. Mr. Hufeld believes the regulatory authorities are well-prepared to counter risks as they emerge.

“We don’t know which corner the next crisis is coming from. But we try to spot trends and to see where problems could arise.”

Felix Hufeld, president, BaFin

“We don’t know, however, which corner the next crisis is coming from,” he said. “But we try of course to spot trends and to see where problems could arise.”

Among the chief vulnerabilities of the financial system are cyberattacks – and not just hacking from the outside, but inside jobs as well. Mr. Hufeld said there was recently an internal cyberattack at a bank in Germany that could have resulted in a loss of more than a billion euros, but fortunately the money was recovered.

“We are one of the first countries that have developed concrete supervisory requirements for the risk management of IT and cyber risks,” Mr. Hufeld said. The rules will go into effect for banks by the end of the year, and then will rolled out to insurance companies and fund managers.

BaFin is also keeping a close eye on the growth in crowdlending. The practice has gone beyond just peer to peer lending to the point that loans are being bundled together and placed with investors – a development disturbingly similar to the subprime securities that contributed to the financial crisis in the first place.

Mr. Hufeld sees increasing risk as well in the growth of exchange-traded funds. There could be a crisis if these index-based funds experienced a selling panic. Also, their popularity could eventually lead to individual stock prices being driven by fund buying rather than fundamentals in the stock.

Some developments have positive aspects as well as risks. The growth of robo-advisors in wealth management is an “exciting” trend in principle, Mr. Hufeld said. It hasn’t been crisis-tested yet and the number of people using robo-advisors is still limited.

“In my view, it’s legitimate to ask whether a self-learning system out of the world of artificial intelligence isn’t more qualified than the average bank adviser,” Mr. Hufeld said. “I’m firmly convinced that robo-advice will someday take a fixed place in the world of algorithm-based systems.”

If necessary for consumer and investment protection, some regulations might have to be adjusted. For that matter, artificial intelligence will come to play a greater role in financial regulation. Such “RegTech” could be particularly useful in data evaluation. Mr. Hufeld said he couldn’t speculate what AI would be doing for regulation by the year 2050. “But,” he added, “we will always need human intelligence and the knowledge of experienced auditors.”

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