Bundesbank brings digitalisation to banking supervision Interview published in Börsen-Zeitung
02.10.2018 | Joachim Wuermeling
Interview with Joachim Wuermeling conducted by Bernd Neubacher and Bernd Wittkowski.
Translation: Deutsche Bundesbank
Mr Wuermeling, at the beginning of September, you succeeded Andreas Dombret as the Bundesbank’s Executive Board member responsible for banking and financial supervision. Do you intend to shift the focus to new issues or will everything continue on as before?
I was already responsible for banking and financial supervision on a transitional basis in the four months prior. During that time, I got the impression that we are reaching a turning point, given the upcoming change of leadership in European banking supervision, a new legislative period in the European Parliament, a different strategic approach in US regulation, as well as Brexit. This, however, does not fundamentally change anything regarding our risk-oriented approach to supervision, although new issues will come to the forefront.
In what respect?
In the ten years since the Lehman Brothers collapse, banking supervision has been focused, to a certain extent, on “fixing the roof” following the crash as well as – and I do not mean this judgementally – learning from hindsight. Once most of this work has been completed – thanks in part to the efforts of my predecessor – we can then turn more to the issues of the future. These will be defined to a large extent by digitalisation, which has a number of implications for banking supervision.
The institutions that we supervise are undergoing significant changes due to digitalisation. It affects business models – especially internal processes – but also the fragmentation of value chains as well as outsourcing. In principle, we regard innovation as extremely positive from an economic standpoint. It leads to gains in efficiency and welfare, and it can lead to improvements in financial intermediation and risk transfer. We have to ask ourselves whether we are actually in a position with our supervisory work and our rules to manage these processes of innovation in a constructive way – first, to be able to take advantage of the opportunities presented and, second, to ensure financial stability and the stability of financial institutions.
Will this ultimately result in more or less regulation than we have at present? Some argue that, after ten years of regulation following the Lehman Brothers collapse, it is now again time to regulate a little less.
It is not about lowering standards, but assessing whether regulation needs to be adapted to more recent developments. I view this as one of my most important tasks in the coming years. I would like to bring up a second point: as supervisors, we ourselves can take advantage of digital opportunities for improvement. Supervision is heavily reliant on processing and evaluating data. With modern digital tools, both of these tasks can be carried out in entirely new ways, at faster speeds, in greater volumes as well as using completely different data sources than has been possible up to now.
So what should banks expect from supervision by the Bundesbank in the future?
We will have to systematically face up to new realities in order to ensure that we as supervisors keep risks adequately in mind. To give an example: at the moment, our approach to supervision revolves entirely around institutions. If institutions outsource services to external providers, they themselves have to bear responsibility for any resulting risks. If, however, a large number of banks use the same services from the same cloud provider in the future, supervisors will need to consider whether or not to single out individual components of the value chain in order to monitor them across the board. In this context, we have to take care that supervision remains technologically neutral.
What does that mean?
We cannot set out any rules that ultimately result in only one specific technology having to be used.
What is your opinion of blockchain technology?
Blockchain technology is just an umbrella term for a variety of different distributed ledger applications. There is an immeasurable number of different variants in the field of crypto tokens alone. In theory, there are even more interesting areas of application in financial services. The market needs to develop these, then we will take a look at them.
So that means you don’t discriminate against banks that want to work with blockchain?
That is out of the question. Quite the contrary: we generally take a positive attitude towards innovation.
Can you name some other examples?
It always depends on the particular application. However, we have to make sure that the use of new technologies does not pose any unmanageable risks. Cybersecurity must be guaranteed. Furthermore, there is the question of how we prevent these systems from taking on a life of their own, as well as of how we deal with platforms that are essentially upstream of the supervised institutions and, in some cases, make independent decisions on issues such as creditworthiness.
Do you believe that these platforms are lacking in terms of supervision as they perhaps take advantage of regulatory arbitrage?
That is also an issue that is open to debate. I don’t currently see regulatory arbitrage in that area.
You want to avoid a situation in which every bank is outsourcing to the same cloud provider. In your opinion, does this boil down to the fact that the Bundesbank also needs a kind of body for macroprudential oversight for Germany – as the ECB’s European Systemic Risk Board is for Europe – with people who collect data from a completely different perspective than those who conduct supervision using an institutions-based approach?
There are an increasing number of areas where macroprudential and microprudential supervision overlap. Cyber risk, for instance, can be a problem for financial stability as a whole, but also for the stability of individual institutions. Perhaps we will see even more phenomena like this that demand an integrative approach on the part of supervisors, too.
Wouldn’t that up a whole new can of worms for supervision?
I don’t see any way around that yet. But, as you know, I am also responsible for IT at the Bundesbank, and we believe that some of the hype surrounding fintech firms has shifted to big banks and big tech companies. But we do also recognise the massive changes that have been brought about by financial technologies.
Would you prefer that big tech companies were also within your remit?
If you have a banking licence, you fall within our remit in any case. But big tech firms’ core business is focused on other areas. These are not subject to banking supervision. However, companies like Amazon and Google do also have to comply with legal requirements, and so their banking-related business activities are subject to banking supervision.
Is that legally sound?
Banking supervision covers all constructs that relate to banking business. There is a clear legal basis for this in the Banking Act (Kreditwesengesetz).
So far, there has been a notion that, to an extent, German financial supervisors want to keep all of these new developments at arm’s length. For instance, BaFin President Felix Hufeld has unequivocally expressed his opposition to a regulatory sandbox for fintech firms.
For reasons of fairness, we would also be opposed to a regulatory sandbox. The same risks must be subject to the same rules.
So do banks need capital add-ons for cyber risk?
In cases where operational risks are identified and there are weaknesses in business organisation, we do in actual fact have the option of imposing individual capital add-ons.
How is the process of internal digitalisation coming along at the Bundesbank? Felix Hufeld is also striving towards this at BaFin.
At the Bundesbank, we are of course putting a great deal of effort into digitalisation. I believe that new tools such as artificial intelligence and machine learning offer huge potential that will allow us to fulfil our legal mandate even more effectively in the future. That is the analytical domain. And it goes without saying that the Bundesbank is also an organisation with complex internal processes. Digital tools open up a range of possibilities for improving these processes. At the moment, we are still in the phase of launching pilot projects using various methods. Many aspects are especially exciting for us, and I think that, during the course of next year, we will adopt a digital agenda of sorts outlining our plans for digitalisation.
Would it not make sense to coordinate this with BaFin?
A common digital agenda would not be of much benefit as our work is very different. As an authority, BaFin is essentially concerned with the application of law, while we operate in the field of supervision. Furthermore, we also have many other areas of activity such as monetary policy, cash and cashless payments, economic analyses, and statistics, amongst others.
But don’t both authorities need to have access to supervisory data?
Even today, BaFin also has access to all data. This is clearly enshrined in law. And we are consistently working to further enhance technical implementation.
Actually, we’ve never heard anything about the Bundesbank’s IT.
That’s as it should be. Generally speaking, you only hear about IT when there’s a problem.
So what is your IT department like?
We have a high-performance, constantly evolving IT department with around 1,000 members of staff. We are part of Germany’s critical infrastructure and operate the TARGET2 payment system, which requires high levels of security, for instance. We also have a large number of special applications that are tailored to our tasks.
Are all of these developed in-house?
We use both standard software applications and software we have developed ourselves, depending on what is best suited to the task in question.
If you were to become a digital supervisor now, would you have to invest in and modernise your IT?
It goes without saying that the whole thing will also require considerable future investment, which we will have to discuss as part of our digital agenda. All in all, however, I believe that digitalisation will bring us significant efficiency gains, meaning that the outlay will pay off.
That’s something you hear a lot, but it often turns out not to be true. Another IT issue is the introduction of the credit register AnaCredit. What do you make of the progress – or lack of progress – in this area?
The project is progressing according to plan. The challenges associated with a statistical project of this scale, complexity and internationality are being tackled successfully. IT systems and data quality are improving all the time. However, there is still some way to go before data can be made available for analysis and publication.
The reporting software provider BearingPoint has recently experienced problems relating to AnaCredit reporting.
In our view, banks that are using BearingPoint to implement AnaCredit requirements are also still able to submit reports as before, and are not at a disadvantage in terms of data quality compared to the market as a whole.
With respect to introducing a “small banking box”, i.e. regulatory relief for small banks, there are hopes of reaching an agreement this year. What is the Bundesbank’s take on the state of play?
We targeted the reporting regulations that create a substantial burden for smaller banks. If things go our way, reduced requirements will also apply to the long-term net stable funding ratio. Everything else will depend on the negotiations in Brussels. Overall, we have come fairly close to achieving many of the aims we formulated in our small banking box proposal. Unfortunately, however, it was ultimately not possible to implement the even more integrated approach we pursued at the EU level.
What bothers you the most about that?
We at the Bundesbank supported a separate set of rules for small and medium-sized institutions. It would have been simpler to deal with a few things this way rather than through exemptions. But at the end of the day, we have to face up to the realities of Europe and be prepared to compromise. And I think we have still come a long way.
Isn’t it too late for all this, since many of the circumstances have already changed? After all, as an observer, you could say that the networks have consolidated to such an extent that the relief has come too late for many institutions.
The consolidation process, which has in fact been taking place for decades, is a natural, market-driven process that we consider to be less the result of regulation and more the consequence of business requirements and technological progress.
Those affected see it differently.
I’m sure there are also a few institutions that have given up because they could not cope with regulatory requirements. Relief will be provided in future, and this is a success that my predecessor Andreas Dombret can claim credit for.
Various players, from the banking associations, for instance, hope that the implementation of Basel III will mean that various exemptions and eased requirements can be enforced.
A minimum level of harmonisation for global banking supervision legislation is a real step forward. Nobody should jeopardise it or bend the rules to give others an excuse for doing the same. An extensive impact study is currently being carried out at the European level. You can be sure that we will make use of any leeway it reveals. However, we will not allow deviations from the Basel standards.
You have just come back from a trip to the United States. What is your impression of implementation there?
Our analysis shows that all of the changes that have recently been made in the United States also meet the Basel standards. Everyone I discussed the issues with assured me that the United States is fully committed to supporting the Basel minimum level of harmonisation.
You recently floated the idea of a digitally networked European financial centre. What has the response been?
The response from some has been very positive. Others, meanwhile, have jumped straight to the difficulties involved in achieving a digitally networked financial centre of this kind. If the idea were to be pursued, it would in fact be a European project, and the initiative for it would have to come from the European Union. Other Member States should be involved. But now, in the late stages of the European legislative period, the energy to tackle a topic such as this is lacking. However, I believe that once Brexit has taken place, the need to strengthen Europe as a financial centre will move up the agenda in Brussels. I expect a great deal from the German presidency here in the second half of 2020.
Isn’t there a risk that everyone will then cherry-pick?
Of course, that’s always an argument used by critics. However, if it were possible to create something like a European financial platform, the value added within Europe would be much larger, too. That is very important to market participants. Specifically from a prudential perspective, I also have particular concerns about major European domestic financial flows being routed via an offshore location.
How do you mean?
If, for instance, a large European insurer takes its contributions from life insurance activities in the EU to London, where they are picked up again by a large German group to finance its business activities in the EU, this would mean that supervisory access to the financial system as a whole would no longer be possible because financial flows first leave the EU before they return to it.
Another issue is the reform of the interest rate benchmark. The ECB has already presented the future replacement for the EONIA. However, at the same time, it has also made it clear that it does not want a great deal to do with reforming the EURIBOR. Is the Bundesbank taking part in this discussion?
We are heavily involved in this issue. As the Board member formerly responsible for the Directorate General Markets, I was one of the individuals who helped to launch this process at that time.
What expectations do you have of the successors to SSM chief Danièle Nouy, whose term of office expires at the end of the year?
The very successful pioneering work carried out by the SSM has a great deal to do with Danièle Nouy and Sabine Lautenschläger as individuals, who have achieved outstanding results. But the problems we have in Europe’s banking system – whether these are the low profitability caused by the low interest rate environment and non-performing loans, digitalisation or Brexit – will remain, and we must continue to work intensively on them.
So you are expecting a certain amount of continuity?
I assume that, in principle, work will continue as before. But digitalisation and Brexit are issues that Ms Nouy’s successor is bound to tackle even more vigorously.
What do you make of HSH Nordbank’s changeover from the institutional protection scheme used by public institutions to the deposit protection scheme offered by private sector banks?
I get the impression that discussions between the parties involved are progressing constructively and productively. Also, as a general rule, I do not comment on ongoing negotiations at individual institutions.
One quick final question: when will the zero risk weighting of government bonds be lifted – in one year, ten years, or not even in a hundred years’ time?
While we have pushed this issue in the Basel Committee, attempts to make decisions that would take us in this direction have failed for the time being in the face of resistance from a number of countries. That said, the issue remains extremely important in terms of counteracting the sovereign-bank nexus and reducing false incentives for running up government debt. An end to the zero risk weighting of government bonds will not take place for some time yet, because many countries have no interest in it. However, we will continue to fuel the debate.
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