Flexible banking supervision is needed now

Prospects for banking regulation and supervision in 2023

The current crises and developments have a massive impact on the banking sector. Banking regulation and supervision have to face the challenges and developments and adapt.

2022 was an extremely challenging year by all economic standards. The Russian war of aggression on Ukraine meant that every forecast had to be revised multiple times, without exception. Economists rarely have been more unsure in their predictions as in 2022.

The existing considerable uncertainties persist and stretch into the new year. The Ukraine war is anything but over, the Corona pandemic has not yet been fully defeated and the supply chains - keyword China - have not yet been completely rebuilt.

Globalization is experiencing a setback, which is anything but good news for Germany as an export nation. In addition, inflation has gotten out of hand worldwide this year and is placing an extreme burden on private households, companies and public finances. Although the energy crisis has varied effects from region to region, it is hitting Germany harder than almost all other economies, as the @International Monetary Fund, among others, recently noted.

Massive impact on banking sector

Some of these developments had already been on the horizon for a while, but were undoubtedly unforeseeable. This has not diminished their massive impact - how could it be otherwise - on the banking sector, as can easily be seen, for example, from the rising interest rates, the decline in real estate financing and the increased need for asset write-downs on securities holdings of balance sheets.

In addition, the market for banking services has been undergoing sustained change for some time and there is no sign of this structural change abating. On the contrary, value chains are breaking up more and more and new players are entering the market, some of them unregulated.

Worldwide, more lending is now taking place outside the traditional banking sector than within it. Business models of banks and savings banks will therefore have to adapt and change accordingly.

Banks are facing new risks

And as if this is not enough bad news already: Beyond the classic banking risks unfortunately, new categories of risk are emerging. ESG and cyber risks are just two examples. These two types alone show that the new emerging risks are of a very considerable, existential magnitude to which banks and savings banks must respond to in their risk management.

Adapting to changed framework conditions

Customers are moving in this new environment, which means that their needs and expectations are increasingly adapting to changed conditions. It is well known that customers nowadays predominantly demand online services, so that banks and savings banks are faced with the question of their local presence or branch closures.

All this means that banks need to come up with new concepts for customer acquisition and retention in a timely manner and to align their own products or develop new ones. 

Banking supervision must adapt

The developments described here clearly leave their mark on banking supervision. It has the task of adapting to the changes in its "objects of supervision" in the best possible and most efficient way. For the supervisory authority, this is not an optional extra, but a compulsory program. 

It must, to name just 2 important examples,

1. understand the changing business models and

2. be able to adequately assess new technologies.

Both are anything but trivial. It is therefore not only the risk models of banks and savings banks that will reach their limits in the coming years, but also those of banking supervision. For this reason, it is absolutely right that the Bundesbank and BaFin are making immense efforts to build up new expertise and to keep it constantly available, e.g., in information technology. In perspective, these efforts will extend over the next two years. 

It is my firm conviction that the banking supervisory regulations and the supervisory toolbox must now be adapted to the changed conditions described above. In particular, I am considering the new business models of banks and savings banks that are now being developed and will soon enter the market.

The major challenge for banking supervision in this context is not to act in a way that impedes innovation while exercising all due care; desirable developments must not be restricted out of exaggerated risk aversion. In addition, I recommend that multi-client service providers as well as integrated solutions and recommendations should be more strongly included in the supervisory horizon in the future.

It all comes down to the data

The crises of the recent past - especially those that manifested themselves in 2022 - highlight the need for the availability of granular data, and this for banks and savings banks on the one hand and for supervision on the other. As an example, I would like to refer to this year's feasibility study "Realignment of the Regulatory Reporting System", which contains the potential of high efficiency gains and represents an enormous step forward.

In addition, in my opinion, data available in the Bundesbank outside the banking supervision should be used even better across central divisions. Here I am thinking in particular of data sets and insights available at the Bundesbank in the important central areas of statistics, payments, financial stability, and economics. All these data and insights are invaluable for effective market monitoring - especially when crises are looming - as they can help to identify problems in specific sectors and their potential impact on banks and savings banks at an early stage.

Banking supervision must digitize

Finally, it should be mentioned that banking supervision itself must also be the object of digitization. New methods and tools, such as those that can be used in the context of artificial intelligence, make data-driven supervision possible today, at least in part. It is essential to exploit these possibilities.

In this context, data quality is becoming increasingly important; therefore data science is the necessary qualification of banking supervisory staff at the Bundesbank and BaFin. 

Diligence and a balanced approach are required

2023 will undoubtedly be another challenging year. Inflation will remain well above the central banks' target, interest rates will continue to rise, shadow banks will remain active and markets will be volatile. The latter also applies to the banking market. It is incumbent on the supervisory authorities to respond to the evolving risks with caution.

German banks and savings banks will need understanding supervision in 2023. I am sure that this can be achieved in view of the capital and liquidity buffers that have been built up in the banking and savings bank sector in this country in recent years. With this in mind, I wish all of us a happy and successful New Year 2023. 

Article was published first in the eBook "Outlook for the banking year 2023“ by German financial news outlet Der Bankblog