Cablegate: German Financial Sector Reactions to Pittsburgh G-20 Summit

DE RUEHFT #2800/01 3030755
P 300755Z OCT 09





E.O. 12958: N/A

SUBJECT: German Financial Sector Reactions to Pittsburgh G-20 Summit

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1. (SBU) Summary: The consensus in German banking circles and the
ECB is that the G-20 Summit in Pittsburgh set the stage for
financial reforms and a new architecture that together will help
reduce the dangers of another meltdown. In recent meetings with
Economic Minister Counselor Robert Pollard and Consulate
representatives in Frankfurt, top bankers, including the Vice
President of the European Central Bank and the President of the
Federal Financial Supervisory Authority (BaFin), expressed
satisfaction with the results of the G-20 Summit, including the
enhanced responsibilities of the Financial Stability Board (FSB).
German bankers remain committed to the Basel II accords, but seek
transatlantic agreement on what constitutes core capital and favor
tighter regulation of rating agencies. Most believe it is too early
to implement exit strategies from fiscal measures intended to
counteract the economic crisis. End Summary.

The New Financial Oversight Architecture
2. (U) All of our interlocutors uniformly saw the "successful"
Pittsburgh G-20 meeting as proof that governments are now more
willing to cooperate on financial issues. It was a real "turning
point" according to Thomas Mayor, Chair of the Management Board, JP
Morgan Germany. Many parties also remarked that the quality of the
G-20 discussion has improved with more members in it, including
India and China although a few, such as Karlheinz Walch, Head of the
Banking Sector Analysis Division at the Bundesbank, wondered if the
wider forum will make it harder to reach consensus. Professor
Andreas Noelke from Goethe University thought that the non-G7
countries will benefit because they will be able to enhance their
negotiating positions through coalitions while others thought the G7
countries would still wield disproportionate influence in guiding
financial reform.

3. (SBU) Members of the European Central Bank (ECB) in particular
hailed the enhanced role of the recreated Financial Stability Board
(FSB, formerly the Financial Stability Forum.) According to Lucas
Papademos, Vice President of the ECB, the FSB's mandate is to
prevent another financial crisis by coordinating between nations and
reporting its findings to G-20 countries. Yet Papademos did note
that in its new form, the FSB has more than 60 members, including
institutions such as the Basel Committee and the IMF. This has
tripled the number of committee meetings that Papademos himself must
attend, he noted, while multiplying the number of individual
agendas. Mauro Grande, Director of Financial Stability and
Supervision at the ECB, also observed that "there is a bit of
tension about who does what." Grande feels however that the FSB
committees still play a crucial role in macroprudential supervision
by implementing common standards. So far, he said, Chairman Mario
Draghi is doing a good job.

Core Capital
4. (SBU) Stronger core capital for banks is viewed among contacts as
essential for financial stability. But German bankers remain
concerned about differing international standards on what
constitutes "Tier 1" core capital. BaFin President Sanio and Stephen
Kohns from the Bundesbank both asserted that "silent partnerships"
that are widespread in German banking, i.e. equity capital from
investors who do not take part in management, is Tier 1 capital.
The US has not always agreed. Sanio said that "we feel badly treated
by the US" on this issue and criticized what he called an attempt to
create an "uneven playing field to the disadvantage of continental
banks." For Sanio, silent partnerships fulfill the same function as
common stock (without the voting rights) and meet the three key
criteria for core capital (participation in the business losses,
being honored last in insolvency cases, and longevity.)

6. (SBU) While core capital is necessary, Karlheinz Walch from the
Bundesbank warned that regulations that set capital percentages too
high could affect the availability of credit in the German market.
Walch said that German banks currently tend to keep their capital
ratio around 4 percent points higher than the legal limit (at around
8-9 percent instead of the legally required 4 percent.) If the legal
requirement moves up to 8-10 percent, Walch fears that banks may
shift their benchmark to a level so high that it will dry up the
credit market and sharply reduce bank profitability. Dr. Ralph
Solveen, Senior Vice President of Commerzbank's Economic Research,

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posited that the federal German government would not let such a
credit crunch take place.

Leverage Ratios and Basel II

7. (SBU) Everyone we met was confident the EU will stick with Basel
II. Mauro Grande from the ECB affirmed that the EU will implement
Basel II regulations by 2011, including Basel II's risk sensitive
requirements. Both he and Walch and Kohns from the Bundesbank did
think, however, that some Basel II elements (treatment of the
trading book, the calibration of credit risks, and the need for
anticyclical buffers) should be revised. Sanio of BaFin urged the
US to stick to its implicit commitment to Basel II (as evident in
the "Framework for Strong, Sustainable, and Balanced Growth.") He
added that if the US does not meet this commitment, its credibility
in international negotiations will be undermined.

8. (SBU) The consensus for the high core capital standards in Basel
II was complemented by consensus against the introduction of a
leverage ratio (Tier 1 capital divided by average total consolidated
assets) as a further measurement tool in regulation. Not only is it
inconsistent with Basel II, Guenther Gebhardt, Professor of
Accounting at Goethe University, pointed out, but there is,
according to Bernhard Speyer, Head of Banking Research at Deutsche
Bank, "no empirical evidence of a correlation between a bank failure
and a bank's leverage ratio." President Sanio of Bafin, in fact,
considers it "totally insane" to first create Basel II with
risk-weighted capital requirements and then put a risk-indifferent
measure like the leverage ratio on top of it. To him this is
combining "stone-age with modern financial regulation." Another,
more neutral observer pointed out that it is difficult to evaluate
Basel II because it was just coming into effect when the global
crisis hit, and Basel II should be given a chance to work before
fiddling with it.

Rating Agencies and Insurance Supervision

9. (U) The quality of core capital would improve with better rating
agency supervision, Mauro Grande of the ECB and Joachim Sanio of
BaFin predicted, since the erroneous high ratings of "dirty core
capital" greatly contributed to the crisis. An April 2009 EU
Commission proposal empowers the European Securities and Markets
Authority (ESMA) to regulate rating agencies starting in 2010,
Grande noted. The ESMA will examine whether registered agencies (and
they must now register in each EU country where they operate) comply
with the International Organization of Security Commissions (IOSCO)
Code of Conduct.

10. (SBU) President Sanio also argued that U.S. federal agencies
need to monitor insurance companies (currently regulated at the
state level), which would have helped in the crisis. The lack of a
federal insurance regulator forces BaFin to sign numerous
Memorandums of Understanding (MoUs) with state insurance regulators
that have proven incapable of supervising global firms like AIG.
When BaFin examined the US subsidiary Allianz Life of the German
insurer Allianz, they found the U.S. regulator (based in the
Midwest) to be very "locally oriented." Sanio thought that limited
know-how of this nature poses a "global systemic risk."

Exit Strategies

11. (U) Central bankers think it is still too early to implement an
exit strategy from recent financial rescue programs. The timing of
exit strategies is also tricky, ECB Vice-President Papademos pointed
out, as even the IMF is uncertain whether greater risk comes with
exiting too early or too late. Dealing with adjustments in monetary
policy is particularly difficult, according to both Papademos and
Walch from the Bundesbank, since transmission mechanisms are longer
than in the past, around 1.5 years. In other words, central bankers
must anticipate what will be happening 1-2 years from now since
their adjustments take that much time to reach the real economy.
Walch was concerned that government policy in the U.S. might
interfere with appropriate monetary adjustment. If the Fed, for
example, waited to adjust monetary policy until unemployment rates
went down, this would likely come too late to dampen demand.

12. (SBU) For his part, Papademos expressed confidence in U.S.

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officials, praising the very good coordination between the Fed and
the ECB in response to the financial crisis, particularly the Lehman
Brothers collapse. He said, however, that the ECB and Fed do not
necessarily need to coordinate on future interest rate changes.
"There will be an information exchange and informal consultations,
but no formal cooperation." Papademos expects that interest rate
increases by the ECB and the Fed will not take place at the same
time because the US is likely to come out of the recession earlier
than the EU.

13. (U) This cable has been coordinated with Embassy Berlin.


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