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Banking regulation IW News 21. December 2016

Do not measure everything with the same yardstick

According to media reports, the scientific advisors of the Minister of Economic Affairs, Sigmar Gabriel, demand that banks need a tougher regulation. However, this would unnecessarily burden the German financial institutions: their capital adequacy is good, there are hardly any problem loans - and consumers would be the losers.

The Basel Committee on Banking Supervision, a body of the supervisory authorities of the major industrialized and developing countries, wants to limit the internal risk models of banks with which they themselves calculate their credit default risks and thereby their equity capital requirements. Instead, all institutions should not deviate too much from a standardized approach. The downside is that the equity requirements for residential property as well as for infrastructure projects could increase - and such lending would become more unattractive for banks.

Fatal is the assumption that all banks can be regulated according to a one-size-fits-all approach: Different business models involve different business risks. Thus, the internationally active large banks can spread their investments more widely, but the locally active institutions are less exposed to the risks of the global capital markets. Therefore, there must be an individual risk assessment within the bank. The important task of the supervisory authority is to ensure that these models reflect the risks of the bank correctly and the bank holds sufficient equity capital against losses.

The statistics show that this is the case in Germany: the World Bank's data suggest that only 2.3 per cent of all loans are non-performing, while the European average is more than twice as high. One reason for this good result is conservative lending in Germany. The low credit losses have also helped banks to build up equity capital. According to the Deutsche Bundesbank, the core capital ratio of German banks of more than 12 percent is more than twice as high as required.

Instead of tightening regulation, it should be designed to suit banks' business risk: while not allowing them to take disproportionate risks, regulation should not limit them too much in their normal business. This risk will materialize, if regulation becomes one-size-fits-all instead of taking account of the respective business models of the banks - from regional to global.

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