Motives and aims

A smoothly functioning banking supervision regime is one of the cornerstones of any financial system. Only a stable financial system, which is one of the key aims of state regulation and oversight, can optimally fulfil its macroeconomic function of efficient and low-cost transformation and provision of financial resources.

Banking supervision basically entails the rules that have to be complied with when setting up banks and carrying out banking business. The liberalisation of the financial markets has created new business opportunities for banks which can significantly increase their risk. To enable banking supervisors to prevent bank insolvencies, new risks require new methods of banking supervision. It is thus not surprising that the liberalisation of the financial markets over the past two decades has led to a tighter regime of prudential supervision.

The legal basis for the supervision of banking business and financial services (banking supervision) is the Banking Act.

This Act is aimed at safeguarding the viability of the financial sector, which is particularly sensible to fluctuations in confidence, by protecting creditors. The Act seeks to achieve this aim while paying due regard to free market principles, ie the entire responsibility for business decisions rests with the managers of the credit and financial services institutions (institutions). The activity of the institutions is restricted only by qualitative and quantitative general provisions and the obligation to open their books to the supervisory authorities. The intensity of supervision of the financial services institutions depends on the type and scale of the financial services provided. The supervisory authorities do not intervene direct in institutions' individual operations.

Ever since the introduction in Germany of general state banking supervision, the central bank has been integrally involved in supervision. The Bundesbank's defined role in banking supervision continues this tradition. There was no uniform regulatory framework throughout the Federal Republic until the passing of the Banking Act of 10 July 1961, which at the same time created the legal basis for the establishment of the Federal Banking Supervisory Office. Prior to that the federal states (Länder), from their establishment in 1948, performed the functions of banking supervision together with the respective Land Central Banks.

The extension of credit institutions' business operations, in particular outside Germany, fairly soon raised the question of how the instruments of banking supervision could be brought into line with these developments.

The amendment of the Banking Act in 1976 confined itself to closing the gaps in banking supervision which had become particularly obvious upon the failure of Bankhaus I.D. Herstatt in 1974. In preparation for an extensive revision of the Banking Act, the Federal Ministry of Finance set up a Commission of Inquiry into "Basic Banking Questions" in November 1974. The Commission also had to examine whether the structure of the German banking system should be changed. In its report, which was submitted in May 1979, it came to the conclusion that the German banking system had proved to be effective. However, the Banking Act would have to be adjusted to the changes in the credit institutions' risk position. It was necessary to ensure that individual institutions and groups of institutions had adequate capital. These findings of the inquiry were in line with the demands which the banking supervisory authorities had been making in the light of their practical experience.

The Third Act Amending the Banking Act which came into force on 1 January 1985 introduced a consolidation procedure for prudential purposes in addition to the existing supervision of individual credit institutions. Until that time, credit institutions could build up credit pyramids through their subsidiaries without any increase in the parent institution's capital base, and thus bypass the restrictions on business operations that were based on the credit institutions' capital.

The further amendments, the most recent one being the Sixth Act Amending the Banking Act as of 1 January 1998, served to implement Directives of the European Union and thereby to harmonise banking supervision legislation in the European Economic Area (EEA). As a result, the legal conditions have been created for the freedom of banking activities and financial services in the single European market.

EC Directives aimed at harmonising banking supervision:

• Fourth Act Amending the Banking Act
  Second Banking Coordination Directive
  Own Funds Directive
  Solvency Ratio Directive
  
• Fifth Act Amending the Banking Act
  Second Consolidation Directive
  Large Exposures Directive
  
• Sixth Act Amending the Banking Act
  Capital Adequacy Directive
  Investment Services Directive
  Post-BCCI Directive

Harmonisation of banking supervision in Europe has thus been largely completed.

The implementation of the Investment Services and Capital Adequacy Directives by means of the Sixth Act Amending the Banking Act harmonised, in particular, the supervision of investment firms and credit institutions. Investment firms, though they are in direct competition with the German-type universal banks, were previously subject to limited supervision only. The Capital Adequacy Directive harmonises the own funds requirements for the assumption of market, free delivery, settlement and large exposures risks associated with carrying out transactions in financial instruments (securities, derivatives etc.).

For this purpose, the concept of "trading book institution" was introduced into the Banking Act, as solely these institutions are affected by the changes to the Sixth Act Amending the Banking Act in respect of market and large exposures risks. Trading book institutions are institutions which take on proprietary positions, regardless of whether or not this is done as a service for third parties. Hence the trading book is deemed to include all proprietary positions in financial instruments, marketable assets and equities taken on by the institution with the intention of profiting in the short term from price variations and differences between buying and selling prices.

Institutions with negligible trading book business are not required to comply with the trading book provisions. In this case, the banking book provisions apply to positions which actually should be included in the trading book. This exemption is subject to the condition that the trading book business does not normally exceed 5 % of the institution's total on and off-balance-sheet business, or 15 million, and never exceeds 6 %, or 20 million.

The definition of financial services institutions used in the Banking Act does not coincide with that of investment firms in the Investment Services Directive (classification of institutions in the Banking Act (only available in German)).

With a view to ensuring comprehensive supervision of the market for financial services in the broader sense, not only investment services providers (own account trading as a service for third parties, contract and investment broking and portfolio management), but also non-EEA deposit broking, money transmission services and foreign currency dealing, for example, are defined as financial services, going beyond the scope of the Investment Services Directive. The investment services of principal broking services and underwriting business have been declared to be part of the banking book.

In line with a recommendation from the Council of the European Monetary Institute, the list of banking book business was extended to include prepaid card business and also network money business. This makes it possible to counteract undesirable developments in the field of these new (electronic) forms of payment at an early stage and to ensure the safety and viability of cashless payments, which play an important role in the economy as a whole.