VZCZCXRO4331
PP RUEHIK
DE RUEHFT #2800/01 3030755
ZNR UUUUU ZZH
P 300755Z OCT 09
FM AMCONSUL FRANKFURT
TO RUEHC/SECSTATE WASHDC PRIORITY 2129
INFO RUEATRS/DEPT OF TREASURY WASHDC
RUEHC/DEPT OF LABOR WASHDC
RUCNMEM/EU MEMBER STATES COLLECTIVE
RUCNFRG/FRG COLLECTIVE

UNCLAS SECTION 01 OF 03 FRANKFURT 002800 
 
SENSITIVE 
 
STATE FOR EEB (NELSON, HASTINGS), EEB/IFD/OMA (WHITTINGTON), 
DRL/ILCSR AND EUR/CE (HODGES, SCHROEDER) 
LABOR FOR ILAB (BRUMFIELD) 
TREASURY FOR ICN (KOHLER), IMB (MURDEN, MONROE, BEASLEY) AND OASIA 
 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: EFIN ECON GM
 
SUBJECT: German Financial Sector Reactions to Pittsburgh G-20 Summit 
 
FRANKFURT 00002800  001.2 OF 003 
 
 
 
SENSITIVE BUT UNCLASSIFIED, NOT FOR INTERNET DISTRIBUTION. 
 
¶1. (SBU) Summary: The consensus in German banking circles and the 
ECB is that the G-20 Summit in Pittsburgh set the stage for 
financial reforms and a new architecture that together will help 
reduce the dangers of another meltdown.  In recent meetings with 
Economic Minister Counselor Robert Pollard and Consulate 
representatives in Frankfurt, top bankers, including the Vice 
President of the European Central Bank and the President of the 
Federal Financial Supervisory Authority (BaFin), expressed 
satisfaction  with the results of the G-20 Summit, including the 
enhanced responsibilities of the Financial Stability Board (FSB). 
German bankers remain committed to the Basel II accords, but seek 
transatlantic agreement on what constitutes core capital and favor 
tighter regulation of rating agencies.  Most believe it is too early 
to implement exit strategies from fiscal measures intended to 
counteract the economic crisis.  End Summary. 
 
 
The New Financial Oversight Architecture 
---------------------------------------- 
¶2.  (U) All of our interlocutors uniformly saw the "successful" 
Pittsburgh G-20 meeting as proof that governments are now more 
willing to cooperate on financial issues.  It was a real "turning 
point" according to Thomas Mayor, Chair of the Management Board, JP 
Morgan Germany.  Many parties also remarked that the quality of the 
G-20 discussion has improved with more members in it, including 
India and China although a few, such as Karlheinz Walch, Head of the 
Banking Sector Analysis Division at the Bundesbank, wondered if the 
wider forum will make it harder to reach consensus. Professor 
Andreas Noelke from Goethe University thought that the non-G7 
countries will benefit because they will be able to enhance their 
negotiating positions through coalitions while others thought the G7 
countries would still wield disproportionate influence in guiding 
financial reform. 
 
¶3.  (SBU) Members of the European Central Bank (ECB) in particular 
hailed the enhanced role of the recreated Financial Stability Board 
(FSB, formerly the Financial Stability Forum.)  According to Lucas 
Papademos, Vice President of the ECB, the FSB's mandate is to 
prevent another financial crisis by coordinating between nations and 
reporting its findings to G-20 countries. Yet Papademos did note 
that in its new form, the FSB has more than 60 members, including 
institutions such as the Basel Committee and the IMF.  This has 
tripled the number of committee meetings that Papademos himself must 
attend, he noted, while multiplying the number of individual 
agendas.  Mauro Grande, Director of Financial Stability and 
Supervision at the ECB, also observed that "there is a bit of 
tension about who does what." Grande feels however that the FSB 
committees still play a crucial role in macroprudential supervision 
by implementing common standards. So far, he said, Chairman Mario 
Draghi is doing a good job. 
 
 
Core Capital 
------------ 
¶4. (SBU) Stronger core capital for banks is viewed among contacts as 
essential for financial stability.  But German bankers remain 
concerned about differing international standards on what 
constitutes "Tier 1" core capital. BaFin President Sanio and Stephen 
Kohns from the Bundesbank both asserted that "silent partnerships" 
that are widespread in German banking, i.e. equity capital from 
investors who do not take part in management, is Tier 1 capital. 
The US has not always agreed. Sanio said that "we feel badly treated 
by the US" on this issue and criticized what he called an attempt to 
create an "uneven playing field to the disadvantage of continental 
banks." For Sanio, silent partnerships fulfill the same function as 
common stock (without the voting rights) and meet the three key 
criteria for core capital (participation in the business losses, 
being honored last in insolvency cases, and longevity.) 
 
¶6. (SBU) While core capital is necessary, Karlheinz Walch from the 
Bundesbank warned that regulations that set capital percentages too 
high could affect the availability of credit in the German market. 
Walch said that German banks currently tend to keep their capital 
ratio around 4 percent points higher than the legal limit (at around 
8-9 percent instead of the legally required 4 percent.) If the legal 
requirement moves up to 8-10 percent, Walch fears that banks may 
shift their benchmark to a level so high that it will dry up the 
credit market and sharply reduce bank profitability.  Dr. Ralph 
Solveen, Senior Vice President of Commerzbank's Economic Research, 
 
FRANKFURT 00002800  002.2 OF 003 
 
 
posited that the federal German government would not let such a 
credit crunch take place. 
 
 
Leverage Ratios and Basel II 
---------------------------- 
 
¶7. (SBU) Everyone we met was confident the EU will stick with Basel 
II. Mauro Grande from the ECB affirmed that the EU will implement 
Basel II regulations by 2011, including Basel II's risk sensitive 
requirements. Both he and Walch and Kohns from the Bundesbank did 
think, however, that some Basel II elements (treatment of the 
trading book, the calibration of credit risks, and the need for 
anticyclical buffers) should be revised.  Sanio of BaFin urged the 
US to stick to its implicit commitment to Basel II (as evident in 
the "Framework for Strong, Sustainable, and Balanced Growth.") He 
added that if the US does not meet this commitment, its credibility 
in international negotiations will be undermined. 
 
¶8. (SBU) The consensus for the high core capital standards in Basel 
II was complemented by consensus against the introduction of a 
leverage ratio (Tier 1 capital divided by average total consolidated 
assets) as a further measurement tool in regulation.  Not only is it 
inconsistent with Basel II, Guenther Gebhardt, Professor of 
Accounting at Goethe University, pointed out, but there is, 
according to Bernhard Speyer, Head of Banking Research at Deutsche 
Bank, "no empirical evidence of a correlation between a bank failure 
and a bank's leverage ratio."  President Sanio of Bafin, in fact, 
considers it "totally insane" to first create Basel II with 
risk-weighted capital requirements and then put a risk-indifferent 
measure like the leverage ratio on top of it. To him this is 
combining "stone-age with modern financial regulation."  Another, 
more neutral observer pointed out that it is difficult to evaluate 
Basel II because it was just coming into effect when the global 
crisis hit, and Basel II should be given a chance to work before 
fiddling with it. 
 
 
Rating Agencies and Insurance Supervision 
----------------------------------------- 
 
¶9. (U) The quality of core capital would improve with better rating 
agency supervision, Mauro Grande of the ECB and Joachim Sanio of 
BaFin predicted, since the erroneous high ratings of "dirty core 
capital" greatly contributed to the crisis.  An April 2009 EU 
Commission proposal empowers the European Securities and Markets 
Authority (ESMA) to regulate rating agencies starting in 2010, 
Grande noted. The ESMA will examine whether registered agencies (and 
they must now register in each EU country where they operate) comply 
with the International Organization of Security Commissions (IOSCO) 
Code of Conduct. 
 
¶10. (SBU) President Sanio also argued that U.S. federal agencies 
need to monitor insurance companies (currently regulated at the 
state level), which would have helped in the crisis.  The lack of a 
federal insurance regulator forces BaFin to sign numerous 
Memorandums of Understanding (MoUs) with state insurance regulators 
that have proven incapable of supervising global firms like AIG. 
When BaFin examined the US subsidiary Allianz Life of the German 
insurer Allianz, they found the U.S. regulator (based in the 
Midwest) to be very "locally oriented." Sanio thought that limited 
know-how of this nature poses a "global systemic risk." 
 
Exit Strategies 
--------------- 
 
¶11.  (U) Central bankers think it is still too early to implement an 
exit strategy from recent financial rescue programs.  The timing of 
exit strategies is also tricky, ECB Vice-President Papademos pointed 
out, as even the IMF is uncertain whether greater risk comes with 
exiting too early or too late. Dealing with adjustments in monetary 
policy is particularly difficult, according to both Papademos and 
Walch from the Bundesbank, since transmission mechanisms are longer 
than in the past, around 1.5 years. In other words, central bankers 
must anticipate what will be happening 1-2 years from now since 
their adjustments take that much time to reach the real economy. 
Walch was concerned that government policy in the U.S. might 
interfere with appropriate monetary adjustment.  If the Fed, for 
example, waited to adjust monetary policy until unemployment rates 
went down, this would likely come too late to dampen demand. 
 
¶12. (SBU) For his part, Papademos expressed confidence in U.S. 
 
FRANKFURT 00002800  003.2 OF 003 
 
 
officials, praising the very good coordination between the Fed and 
the ECB in response to the financial crisis, particularly the Lehman 
Brothers collapse.  He said, however, that the ECB and Fed do not 
necessarily need to coordinate on future interest rate changes. 
"There will be an information exchange and informal consultations, 
but no formal cooperation."  Papademos expects that interest rate 
increases by the ECB and the Fed will not take place at the same 
time because the US is likely to come out of the recession earlier 
than the EU. 
 
¶13. (U) This cable has been coordinated with Embassy Berlin. 
 
ALFORD