VZCZCXRO4043
PP RUEHIK
DE RUEHFT #3012/01 3241254
ZNR UUUUU ZZH
P 201254Z NOV 09
FM AMCONSUL FRANKFURT
TO RUEHC/SECSTATE WASHDC PRIORITY 2462
RUEHRL/AMEMBASSY BERLIN 1189
INFO RUEATRS/DEPT OF TREASURY WASHDC
RUCNMEM/EU MEMBER STATES COLLECTIVE
RUCNFRG/FRG COLLECTIVE

UNCLAS SECTION 01 OF 03 FRANKFURT 003012 
 
SENSITIVE 
 
STATE FOR EEB (NELSON, HASTINGS), EEB/IFD/OMA (WHITTINGTON), 
TREASURY FOR ICN (MEYER), IMB (MURDEN, MONROE, BEASLEY) AND OASIA 
 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: EFIN ECON PREL GM
 
SUBJECT: New German Government Plans for Reform of Financial 
Supervision Raise Questions and Criticism 
 
FRANKFURT 00003012  001.2 OF 003 
 
 
¶1. (SBU) Summary: As one of its first decisions, the new coalition 
government in Germany agreed to concentrate banking supervision, 
which has previously been shared by Germany's financial supervisor, 
BaFin, and the German central bank, Bundesbank, in the hands of the 
central bank. 
Proponents of the reform claim that the current supervisory 
structure has exacerbated the financial crisis. 
Critics deny that re-designing the institutional structure would 
improve financial supervision and claim that the move is primarily 
political as the current dual system was introduced under 
Schroeder's Social Democratic Party (SPD) government.  Additionally, 
some believe that the intended reforms may create a conflict of 
interest between monetary policy geared towards price stability and 
supervisory responsibility for financial stability.  This tension 
may ultimately damage the central bank's reputation.  End Summary. 
 
 
Early Harvest 
------------- 
¶2. (U) The Christian Democratic Union (CDU), its Bavarian sister 
party the Christian Social Union (CSU) and the pro-business Free 
Democratic Party (FDP), all campaigned on platforms promising to 
concentrate banking supervision in the hands of the German central 
bank (Bundesbank).  Just ten days after the September 27 elections 
this was the first issue on which the new coalition agreed. 
However, in the new government's written coalition agreement many of 
the more difficult details on the merger were not addressed. 
 
¶3. (U) Current proponents of the reforms argue that regulatory 
failures, in particular, insufficient coordination and cooperation 
between BaFin and the Bundesbank, have aggravated the financial 
crisis in Germany.  The German Council of Economic Experts argues 
that a merger of banking and insurance supervision under the 
Bundesbank would ensure more effective macro-prudential supervision. 
 However, the Council is silent on how the duties would be legally 
divided. 
 
 
Current Financial Supervisory Arrangement 
----------------------------------------- 
¶4. (U) BaFin and the Bundesbank currently share responsibility for 
banking supervision.  The Bundesbank monitors the operations of 
banks on an ongoing basis, analyzing bank reports and assessing 
whether their capital and their risk management procedures are 
adequate.  It reports its findings to the Federal Financial 
Supervision Agency, BaFin, which has regulatory decision-making 
powers.  BaFin is responsible for managing and licensing banks, and 
acting against banks that do not meet regulatory requirements. BaFin 
is also (exclusively) in charge of insurance and securities trading 
supervision. 
 
¶5. (U) BaFin was established in 2002 as a single financial regulator 
(replacing three separate agencies that individually supervised 
banking, insurance, and securities) with the objective of creating 
integrated financial supervision, a move which reflected an 
international trend at the time. BaFin was headquartered in Bonn due 
to the available government office space there after the capital 
moved to Berlin, even though Frankfurt is Germany's financial 
capital. BaFin officials told the Embassy that its distance from 
Frankfurt enabled it to be more objective. 
 
 
Contentious Political History 
----------------------------- 
¶6. (SBU) Banking supervision has remained a hotly debated topic due 
to the political circumstances that brought BaFin to life.  BaFin 
was born by "precipitate delivery," according to Peter Abrahams, 
BaFin's insurance sector spokesman.  The Act establishing BaFin 
easily passed with the votes of Schroeder's governing Social 
Democratic Party (SPD)/Green coalition government, because, 
according to sources at BaFin, the Christian Democratic Union (CDU) 
faction had left en bloc in protest during a prior vote and did not 
return in time to vote on BaFin.  The CDU thus was dealt a political 
defeat that it has never fully digested, according to Bernhard 
Speyer, Head of Banking, Financial Markets and Regulation at 
Deutsche Bank Research. 
 
 
Seizing the Opportunity: The Bundesbank's Plan 
--------------------------------------------- - 
¶7. (U) Although the new German government presented few details on 
the BaFin-Bundesbank reorganization, the Bundesbank quickly seized 
the moment to present its own version. Only three days after the 
 
FRANKFURT 00003012  002.2 OF 003 
 
 
federal election, Bundesbank President Axel Weber declared the 
Bundesbank ready to take on more responsibilities.  On October 2, 
the six-member executive board unanimously approved a six-point plan 
for concentrating financial oversight at the Bundesbank.  Under this 
plan, the bank would not only take over banking, but also insurance 
supervision leaving only the securities supervision to BaFin. 
(Comment: the insurance sector subsequently protested the plan and 
it appears unlikely that insurance supervision will be transferred 
to the Bundesbank. End Comment.) The proposal gives the Ministry of 
Finance veto power over all decisions. "Administrative acts of high 
intensity" such as bank closures would also be left to the 
Ministry. 
 
 
BaFin's Response 
---------------- 
¶8. (SBU) The president of BaFin, Jochen Sanio, considers the planned 
reforms political.  The reorganization, he predicted in a discussion 
with Consulates Duesseldorf and Frankfurt, "would allow the new 
coalition government to score an early political success."  The 
Bundesbank has been in search of a new mission ever since it has 
lost its core competence, monetary policy making, with the creation 
of the European Central Bank, he opined.  In addition, Weber is 
trying to enhance his personal powers after his chances to succeed 
ECB president Jean-Claude Trichet have waned, with Mario Draghi, the 
Chairman of the Financial Stability Board (FSB), entering the race. 
Draghi has been the "undisputed number one of international finance" 
since Timothy Geithner bestowed the FSB the "highest honors" by 
declaring it the "fourth pillar" of the financial system. 
 
¶9. (SBU) According to Sanio, the current division of labor between 
Bafin and Bundesbank has been a success and has strengthened 
Germany's position in international fora. Sanio argued that to 
dissolve the current arrangement would weaken Germany, especially 
now after the crisis has shown the need for strong cross-sectoral 
supervision. Further, concentrating exclusively on national reforms 
while the new EU regulatory structure is being set up is ill-timed. 
 
 
Banking Sector Response: It's Political 
---------------------------------------- 
¶10. (SBU) The new government's reform plan has provoked negative 
reactions from the banking industry.  Norbert Walter, Chief 
Economist of Deutsche Bank Group, called the plan "an archaic reflex 
of politicians that do not trust anybody but the Bundesbank."  DB 
Research's Bernhard Speyer noted there is no evidence available that 
the current supervisory structure aggravated the impact of the 
financial crisis in Germany.  Other countries' experience does not 
suggest that allocating the task of banking supervision to the 
central bank yields superior results. Many, like Dr. Ulrich Kater, 
Chief Economist of Deka-Bank, have cautioned that much of the blame 
for regulatory failures during this crisis was deflected from the 
Bundesbank and fell on BaFin.  Otto Steinmetz, former head of risk 
management at Dresdner Bank pointed out that BaFin was at times 
constrained from taking decisive action by political considerations 
in Berlin. 
 
 
Potential Conflict of Interest 
------------------------------ 
¶11. (SBU) The key concern of the banking sector, however, is the 
potential conflict of interest between monetary policy geared at 
price stability and the supervisory responsibility for financial 
stability.  The execution of sovereign powers, such as closing banks 
or removing senior management from office, Norbert Walter argued, is 
not compatible with central bank autonomy in the conduct of monetary 
policy.  The Bundesbank might be forced to make monetary decisions 
in the ECB Governing Council that burden the financial institutions 
that it supervises to the point where they could even become a 
systemic risk.  Installing "Chinese Walls" as the Bundesbank plan 
suggests, "is a fiction as we all know," Otto Steinmetz, former head 
of risk management of Dresdner Bank, said.  The reputation of the 
Bundesbank is at stake fears Ulrich Kater, Chief Economist of 
Deka-Bank. 
 
¶12. (SBU) This conflict could, Walter contended, be carried through 
the Bundesbank into the European Central Bank, making it more likely 
to be soft on inflation.  Some would call this hyperbole.  Fabio 
Recine, senior expert on Financial Supervision of the ECB, argues 
instead that, "monetary policy is decided by the entire Governing 
Council; any reputational damage therefore does not apply to the 
ECB."  However, Racine does believe that a central bank should 
remain independent from the Ministry of Finance.  If the Bundesbank 
 
FRANKFURT 00003012  003.2 OF 003 
 
 
jurisdiction were to be extended to the insurance sector, there 
could be a legal conflict with Article 105 (6) of the EU Treaty that 
explicitly excludes insurance supervision from the ECB's powers. 
 
 
Compensation for Regulators 
--------------------------- 
¶13. (U) Some believe that the real problem with financial 
supervision in Germany is the insufficient resources and competences 
of the regulators.  Uncompetitive remuneration makes it difficult to 
attract and keep highly qualified staff.  As a result, "even 
Bundesbank staff is less qualified than those working at the 
institutions they oversee," said Otto Steinmetz.  The lack of a 
waiting period before a regulator can move over to the private 
sector is also part of the problem. Joerg-Matthias Butzlaff, Head of 
Communications of Metzler Bank, compared the relationship between 
the regulators and the regulated to a race of "a Golf against a 
Ferrari". 
 
Comment 
------- 
¶14. (SBU) The planned reorganization of German banking supervision 
appears to be motivated at least in part by politics.  Many in the 
banking community believe that the move will not improve the 
performance of the country's financial supervisors.  The current 
restructuring discussion comes at the same time as the 
implementation of new European supervisory regulations.  Given its 
focus on the BaFin-Bundesbank debate, it is not clear that Germany 
is putting its best foot forward in discussions at the European 
level. END COMMENT 
 
¶15. (U) This cable has been coordinated by Embassy Berlin and 
Consulate Dusseldorf. 
 
 
ALFORD