Need for Reform of German Financial Supervision

Motivated by the scandals surrounding Wirecard, Cum-Ex and Co, in the latest issue of our Forum New Economy Working Paper series – available for free download here – Martin Hellwig and Gerhard Schick ask whether the old paradigm of German financial supervision with its closeness to the financial sector is still viable, or whether a new self-image including far-reaching reforms is needed to prevent further crises.

In their working paper, Hellwig and Schick analyze how financial supervision with its working methods tolerated risky developments in the German banking sector, but failed to carry out fundamental reforms – also due to a BMF report that did not see any need for action.

The authors discuss not only the undesirable developments in the run-up to and since the financial crisis (including structural problems such as the low capital ratio of German banks, the short-term financing of long-term investments via the money market, and the passivity of the supervisory authority), but also the political conditions that favored these developments. For example, in response to the global penetration of market-driven finance in the 1990s, German policymakers were keen to strengthen the international competitiveness of German banks and accepted risky behavior to do so.

Finally, the authors discuss why a paradigm shift in financial supervision would be urgently needed and desirable – even beyond the existing seven-point plan to reform BaFin – and make proposals for the cornerstones of such a new paradigm in financial supervision. These include a realignment of BaFin with greater distance between the ministry and banks and stronger consumer protection, as well as the implementation of effective deterrence and sanction options and a clearer allocation of competencies between authorities.