06 February 2013

BFM: German Government approves draft bank separation law and new criminal law provisions for the financial sector

The bill, which was presented by German Finance Minister Wolfgang Schäuble, contains important additional building blocks in Germany’s new regulatory framework for financial markets. The legislation includes provisions relating to three areas. First of all, it aims to simplify the winding up and reorganisation of credit institutions and financial groups. Under the draft law, credit institutions will have to prepare in advance plans for how their own restructuring and winding up can be carried out in the event of a worst-case scenario occurring. The second element of the bill involves provisions requiring banks to separate risky activities from their deposit-taking activities. Thirdly, the law introduces clear rules for criminal liability for executives at banks and insurance companies should such executives violate their duties.

Finance Minister Schäuble stated: “From the outset of this legislative period, the German Government has been pursuing a clear objective of ensuring that no financial market, stakeholder or product goes unsupervised. We are gradually creating a new regulatory framework for financial markets. Today, through our bill on bank separation, we have begun the process of introducing another important package of legislation. With it, we are taking a head-on approach to the financial system’s lack of resilience to crisis as well as the lack of accountability on the part of banks and bankers. And we are adding important building blocks to the new regulatory framework for financial markets that we have sought resolutely since the start of this legislative period.”

‘Living wills’ for banks

The draft law creates rules for planning the reorganisation and winding up of credit institutions and financial groups, so that preventative action can be taken in good time to help systemically important banks that have got into difficulties. The affected institutions will have to present reorganisation plans so that in cases of doubt supervisory authorities can act more quickly and obstacles to winding up an institution can be removed. The supervisor will be able to demand that obstacles to resolution be eliminated even before problems arise.

This is an additional element that is required in order to effectively tackle the problem posed by having banks that are too big or too interconnected to fail (i.e. financial institutions that are so large and complex that they cannot be wound up without negative consequences for financial markets as a result of their high level of interconnectedness with other parts of the financial system). The new law is designed to prevent the situation arising in the future where taxpayers are left to cover the costs of a bank collapse. This is also the objective of Germany’s Restructuring Act of 2010, which created instruments for orderly bank resolution including the bank levy and the Restructuring Fund. By taking this step, Germany will become, together with France, one of the first EU countries to tackle the legislative implementation of this contingency planning for banks, known as ‘living wills’, that was agreed internationally at the October 2011 meeting of the Financial Stability Board. The German Government will continue to play a constructive and committed role in the discussions relating to the EU’s recovery and resolution directive that began in June 2012. However, the German Government wanted to take the lead again by approving the draft law and is pressing forward with national regulatory arrangements, as in the areas of high frequency trading, short selling and fee-based investment advice.

Separation of banking activities

The second focus of the draft law is to enhance the protection of retail banking against risks arising from speculative activities. This will benefit retail customers and ultimately also taxpayers. The draft legislation largely follows the findings and recommendations of the EU’s Liikanen Report. It also implements an agreement with France to push forward with national arrangements in Europe such as creating a system for separating banking activities. If certain thresholds are exceeded, deposit-taking credit institutions and groups that include deposit-taking institutions will no longer be allowed to combine in one entity deposit-related activities and proprietary trading (i.e., the purchase or sale of financial instruments on own account that is not a service for a third party). Instead, they will have to spin off proprietary trading into a company that is legally, economically and organisationally separate and that will require a licence in accordance with Germany’s Banking Act.

Separating risky activities from retail banking will increase the solvency of an institution and contribute to the stabilisation of financial markets. If a financial group exceeds the relevant thresholds, it will only be allowed to make loans to hedge funds and other comparable highly leveraged companies, or issue guarantees for their benefit, if it does so via the independent company that conducts its proprietary trading.

The thresholds, which are based on the recommendations of the Liikanen expert group, are as follows: The relative threshold is exceeded if assets associated with trading activities comprise more than 20 per cent of the total balance sheet, while the absolute threshold is surpassed if trading-related assets are worth more than €100 billion. The relative threshold is supplemented by a simple criterion which stipulates that only companies with total assets of over €90 billion will be affected by the rules. This is intended to ensure that the regime does not apply to an excessive number of smaller banks that would otherwise exceed the relative threshold. Additionally, a trading unit that has been separated off may not benefit from less stringent supervisory requirements that apply to other institutions in the same financial group.

However, deposit-taking credit institutions will still be able to carry out proprietary trading on behalf of clients – i.e., to conduct the purchase and sale of financial instruments on own account as a service for third parties. This also includes the practice known as market-making. The German financial supervisory authority, BaFin, will however be empowered to demand the separation of market-making activities in individual cases, so that it is able to deal with special circumstances.

Criminal-law provisions

The draft legislation also tackles the issue of individual responsibility. To that end, the bill significantly strengthens and clarifies the ability of authorities to take criminal action in cases of severe breaches of duty that could get an entire bank or insurance company into difficulty. The draft legislation assigns specific responsibilities for risk management to senior managers at banks and insurance companies, based on existing rules. The violation of important risk-management duties will be punishable with a maximum of five years’ imprisonment should it threaten a credit institution’s viability as a going concern (in accordance with the Banking Act) or if it jeopardises insurance companies’ abilities to meet their obligations relating to insurance policies (in accordance with the Insurance Supervision Act). These provisions create sanctions for mismanagement that will help to prevent future corporate crises and their associated negative effects on society and the economy.

The rules that were approved on 6 February 2013 by the German Cabinet are scheduled to come into effect in January 2014, following the entry into force of German legislation to implement the EU’s CRD IV Directive. The separation of business activities within banks will then have to be carried out by July 2015, as is also planned in France.

Press release

© Bundesfinanzministerium