Preventing a new crisis?

The German parliament's order of business this week was full of bewildering abbreviations: CRD IV, Basel III, AIFM, SSM-regulation. But behind the letters lies a new, stricter regulation of the financial markets, or what Christian Democratic Union (CDU) parliamentarian and finance policy specialist Hans Michelbach called a "new constitution for banks."

The debates and votes were spread over two days, at the end of which the parliament passed laws on stricter equity regulations, bank "testimonies" (a yearly report in which a bank lays out how it will act in the event of insolvency), penalties for bank executive boards, and the segregation of high-risk financial business from everyday banking activities.

The laws are based on European models, since they are designed not only to be implemented in Germany but the whole of Europe. Initially set to be introduced this year, the new rules now won't be introduced until January 1, 2014.

Less risk-taking

The banks are not exactly delighted at these new regulations. That's hardly surprising, since they'll have to accommodate completely new procedures, and, above all, do their business more cautiously. The laws are intended to prevent the taxpayer footing the bill when a financial institution gambles away its money.

Up until now, German banks were only obliged to keep two percent of their equity in reserve, but by 2019 it will be seven percent. Meanwhile, banks considered "system-relevant" - i.e. those whose collapse would threaten the worldwide financial system - could be obliged to keep 10.5 percent in reserve. In Germany, that would only apply to Deutsche Bank, while the country's second biggest bank, Commerzbank, has been classified nationally system-relevant, and will have to raise its equity ratio to nine percent.

The Social Democratic Party (SPD) backed the government bill, but argued that the higher equity ratio will not be enough to prevent future crises. During the debate, representatives of the center-left party pointed out that the US investment bank Lehman Brothers had an equity ratio of 10 percent when it went bankrupt. Meanwhile Barbara Höll, MP for the socialist Left party, quoted a calculation from the public interest association Finance Watch, saying the equity ratio would have to be 25 percent to be truly effective. "And we're miles away from that," said Höll.

From Basel III to CRD IV

In fact the law does stipulate that half of the increased equity ratio must be sufficiently liquid - easy to transform into cash - so that investors and creditors can be paid in an emergency. But that isn't enough to convince the opposition. The Green Party is particularly critical of the fact that there is to be no independent check. "We're relying on the bank's own risk models and letting them work out for themselves how much equity they need," said Gerhard Schick, the Greens' financial policy spokesman. The Greens are also calling for the introduction of a debt limit for banks to further contain risk.

The new regulatory capital requirements are based on a model from the Basel Committee on Banking Supervision from December 2010, an update of previous regulations named Basel III, which is part of the European Capital Requirements Directive, or CRD IV. This regulation, which the European Parliament passed in April, and which the Bundestag this week passed into German law (as one of the first EU countries), contains further new regulations for the banking world.

No more excessive bonuses

In the future, bank executives will have to manage with much smaller bonus payments than they are perhaps used to. The maximum reward is to be set at an additional year's salary, and only the shareholders will have the power to approve a bonus amounting to double year's salary, and then only if they vote for it by a two-thirds majority at the annual general meeting.

On top of that, executive boards will be obliged to make risk management a higher priority than before, and could be threatened with five years in prison if they endanger their business by violating crucial obligations and regulations imposed by regulators.

But what happens if a bank really does fall into financial difficulty? Financial institutions themselves are now expected to prepare for such cases in advance, and draw up plans during the good times for how restructuring will be carried out, both in logistical and business terms. These so-called "bank testimonies" are to be created in collaboration with the German financial supervision organization BaFin, which will set up its own unit for that purpose.

Making banks pay

All this is too little for Germany's political opposition, which is calling for an independent European resolution authority with the right to recapitalize and liquidate banks. Then again, that would require a European liquidation fund that the banks would have to fill themselves, if the SPD and the Greens had their way. "So that the banks themselves and not the taxpayer take on the risk," said SPD financial market expert Manfred Zöllmer.

The German government disagrees. Finance Minister Wolfgang Schäuble, of the CDU, is continuing to argue for a network of national authorities across Europe, to which Zöllmer's response is: "Even in Germany there is no suitable fund capable of taking on the task." The SPD politician thinks the bank levy agreed by the government is much too small. "There's nothing there at all that can contribute to it nationally," he said in the debate.

Separation and supervision

In order to better protect customers' deposits, banks will now be legally obliged to put high-risk business into legally, economically and logistically independent institutions and so separate them from traditional banking. By 2016 they are being required to create two subsidiaries - independent of each other - if trade exceeds 100 billion euros ($129 billion) or 20 percent of total assets. The subsidiaries can be managed within an umbrella holding company.

In Germany, only Deutsche Bank, Commerzbank, and the regional savings bank Landesbank Baden-Württemberg (LBBW) are likely to be affected by this. But critics of the segregated banking system doubt that it will even be possible to draw clear boundaries between individual business sectors. SPD, Green, and Left party representatives in the Bundestag also criticized the fact that the government did not make the segregation as strict as was proposed by Europe's expert commission, led by Erkki Liikanen, governor of the Bank of Finland.

ECB supervision

Politicians in Berlin are also arguing over how to re-structure banking supervision. Tasks that have been dealt with at a national level are to be taken over by the European Central Bank. The Bundestag conducted a preliminary debate on a proposed new law on Friday (17.05.2013). The SPD acknowledged the necessity of finding a quick solution, but it also thinks the ECB should only take on this responsibility temporarily. Finance policy and supervision cannot really be separated, warned Zöllmer, since conflicts of interest will be inevitable. "How is the ECB supposed to supervise a bank when it is also its business partner and creditor?" he asked the parliament.