Management Report 2016
about the Volksbanken Raiffeisenbanken
Cooperative Financial Network
Structure, business model, and features of the IPS*
This management report supplements the annual consolidated financial statements of the Volksbanken Raiffeisenbanken Cooperative Financial Network.
The Volksbanken Raiffeisenbanken Cooperative Financial Network consists of 972 primary banks (2015: 1,018), the DZ BANK Group, Münchener Hypothekenbank eG (MHB), the BVR protection scheme, and BVR Institutssicherung GmbH as consolidated entities. The consolidated primary banks include Deutsche Apotheker- und Ärztebank eG, the Sparda banks, the PSD banks, and specialized institutions such as BAG Bankaktiengesellschaft.
The primary banks and MHB are the legally independent, equally ranked parent entities of the Cooperative Financial Network, whereas the other entities and corporate groups are consolidated as subsidiaries.
The Volksbanken Raiffeisenbanken Cooperative Financial Network’s institutional protection scheme (IPS) is set up as a dual cooperative scheme that comprises the BVR protection scheme and the BVR-ISG protection scheme. The two institutional protection schemes are mutually complementary.
The principles and methods of the institutional protection scheme are outlined in more detail in the combined opportunity and risk report.
Definition of the main operating segments
The definitions of the operating segments Bank, Retail, Real Estate Finance, and Insurance, which are covered by the section on business performance, can be found in the notes to the annual consolidated financial statements starting on page 65.
The German economy again recorded solid growth in the financial year 2016. It was the third consecutive year in which the growth rate was higher than that of the previous year. Adjusted for inflation, gross domestic product (GDP) grew by 1.9 percent compared with 2015, following a growth rate of 1.7 percent in 2015 relative to 2014. The upward trend has therefore gained further momentum.
The positive trend was mostly fueled by impetus from within Germany. At a rate of 2.1 percent, growth in consumer spending accelerated slightly compared with the 2015 rate of 2.0 percent. Consumer spending was bolstered by stability in the labor market and favorable financing conditions resulting from the ultra-expansionary monetary policy of the European Central Bank (ECB). In particular, the 4.0 percent rise in government spending was much bigger than the increase in 2015 (2.7 percent). This increase was closely connected to measures taken by the government to manage the influx of refugees and cover integration-related costs.
Capital expenditure growth, on the other hand, remained moderate. So far, the current economic upturn has seen only below-average capital investment activity compared to past periods of economic recovery. In addition, capital spending was also spread unevenly across different sectors of the economy. Although gross investment in plant and equipment recorded moderate growth of 2.2 percent, this increase was mostly attributable to a strong pick-up in investment in house-building. Companies in the commercial construction and equipment sector enjoyed a healthy order book situation in 2016, but only showed limited propensity to invest.
Due to global economic uncertainties, there was only slight growth in German exports. Emerging economies such as China and Brazil had to weather a weak period in 2016 but managed to overcome this at the end of the year, although the underlying problems were only resolved superficially (e.g. China’s debt-driven construction boom, or the high level of dependency of oil-exporting countries on income from commodities). In addition, global trade grew less dynamically than in previous economic cycles, despite the recent emergence of an upturn. However, the German economy’s import growth declined as well, keeping the export surplus for 2016 unchanged at the high level of 7.6 percent of GDP.
One noticeably beneficial factor for the German economy was the low oil price, which temporarily dropped below US$ 30 at the start of 2016. Over the course of the year, prices stabilized just below US$ 50 per barrel after the members of the Organization of the Petroleum Exporting Countries (OPEC) reached agreement about binding production volumes and largely adhered to them. The drop in the price of crude oil led to low inflation in Germany in 2016, with an average for the year of 0.4 percent. The ECB’s efforts to boost inflation in the eurozone did not achieve a sustained rise in inflation rates, despite zero interest rates and extensive intervention in the financial markets.
The stated aim of the ECB is to guide inflation in the eurozone back to a level close to, but below, 2 percent in order to secure sustained support for growth in the eurozone through increased lending by banks. In early March 2016, the ECB therefore decided to lower the key interest rate by a further 5 basis points (from 0.05 percent to 0.00 percent) and to reduce the deposit facility for banks even further (from -0.2 percent to -0.4 percent). In addition, the ECB decided to step up its monthly bond purchases from €60 billion to €80 billion for the period from April 2016 until the end of March 2017. At its meeting on December 8, 2016, the ECB decided to continue the monthly bond purchases at a reduced volume of €60 billion until the end of 2017.
At the end of 2016, the German labor market recorded its highest level of employment since the country’s reunification. On average, 43.59 million people were employed or self-employed in 2016 (up by 530,000 compared with 2015). The unemployment rate averaged 6.1 percent (2015: 6.4 percent), coming close to the threshold for full employment. Moreover, the rising number of vacant positions indicates a pressing shortage of skilled labor in Germany.
Volksbanken Raiffeisenbanken Cooperative Financial Network
In a difficult market environment that was predominantly characterized by extremely low interest rates, the Volksbanken Raiffeisenbanken Cooperative Financial Network successfully stood its ground once again in 2016 and managed to sustain the excellent performance achieved in previous years. With a profit before taxes of €8,308 million (2015: €9,787 million), the Cooperative Financial Network reasserted its claim to a place among the most profitable banking groups in Europe and underpinned its impressive market positioning.
In 2016, the cooperative banks’ volume of lending to retail and corporate customers reached a record high, aided by robust economic conditions in general and strong domestic demand in particular. Overall, lending to retail and corporate customers increased by 4.6 percent, which is only marginally below the 2015 growth rate. Real-estate finance was once again the key driver for growth in lending to retail customers. The market share of retail customer business again increased slightly year on year. The primary banks’ lending to corporate customers again expanded significantly, recording a growth rate of 4.7 percent. The market share of corporate customer business also increased again slightly. Lending to service providers was particularly strong. This segment accounted for more than half of all corporate customer loans in the primary bank business and achieved above-average growth rates. The deposit-taking business of the Cooperative Financial Network also saw steady growth, allowing the strong increase in lending to be funded in full by the sharp rise in deposits from customers.
Equity advanced again, from €93.0 billion in 2015 to €98.6 billion in 2016. This represented a further substantial year-on-year increase in equity of €5.6 billion (2015: increase of €6.5 billion) and was achieved despite the persistently difficult operating conditions, thereby underlining the sustainability of the Cooperative Financial Network’s successful business model and strengthening its future viability. The sound level of capital adequacy provides the Cooperative Financial Network with a sufficient risk buffer while at the same time enabling it to expand its lending business with retail and corporate customers. The network also meets the standards it has set itself for satisfying the growing number of regulatory requirements.
The vitality and financial stability of the Cooperative Financial Network’s business model, with its strong market position in retail and corporate banking, have been rewarded with capital market ratings of AA- from rating agencies Standard & Poor’s and Fitch Ratings. These ratings are encouraging when viewed in comparison with the rest of the sector.
The popularity of the Cooperative Financial Network in the market was once again clearly demonstrated in 2016 by the further sustained growth in its membership. Since 2006, the membership base of the local cooperative banks has grown by more than 2.5 million members. In 2016, the German cooperative banks gained 152,000 members, bringing the total to 18.4 million as at December 31, 2016. The average number of members per local cooperative bank increased to nearly 19,000.
Net interest income for 2016 decreased slightly year on year to €18,826 million (2015: €20,021 million). This figure was primarily influenced by the ECB’s low-interest-rate policy and the resulting deterioration of margins. The local cooperative banks’ net interest income, the biggest source of income for the Cooperative Financial Network, also declined year on year, from €16,569 million in 2015 to €16,052 million in 2016.
Allowances for losses on loans and advances increased from €74 million in 2015 to €522 million in 2016. This was mainly due to a greater requirement for loss allowances on legacy exposures in ship and offshore financing against a backdrop of tough market conditions.
Net fee and commission income improved again slightly, by 2.8 percent, from €5,798 million in 2015 to €5,963 million in 2016. The increase primarily resulted from improved contributions to income from the lending and securities business.
The Bank operating segment accounts for most of the gains and losses on trading activities of the Cooperative Financial Network. In 2016, this figure increased by €492 million to a net gain of €1,099 million, compared with a net gain of €607 million in 2015. The noticeable improvement in gains and losses on trading activities resulted primarily from positive measurement effects for own issues and a larger contribution from trading income in the operating business.
Gains and losses on investments recovered from a net loss of €561 million in 2015 to a net gain of €33 million in 2016. This improvement was mainly attributable to the fact that the prior-year figure had been impacted by negative effects from the measurement of securities.
Other gains and losses on valuation of financial instruments declined from a net gain of €363 million in 2015 to a net loss of €190 million in the reporting year. The main cause of this decrease was a market-related widening of credit spreads on bonds from the peripheral countries of the eurozone. By contrast, the previous year had seen a narrowing of these credit spreads.
Net income from insurance business climbed by 12.7 percent to €1,119 million in 2016 (2015: €993 million). The main reason for this change was a marked improvement in gains and losses on investments held by insurance companies and other insurance company gains and losses with a slight increase in premium income, although some of the gains were offset by higher insurance benefit payments.
Administrative expenses increased by €710 million, from €17,234 million in 2015 to €17,944 million in the reporting period. The bulk of the administrative expenses were attributable to staff expenses, which came to €10,318 million in 2016 (2015: €10,160 million).
Income taxes amounted to €2,410 million in 2016 (2015: €2,820 million), with most of this amount (€2,497 million) attributable to current income taxes. This once again underlines the particular importance of the Cooperative Financial Network for Germany’s regional authorities by virtue of it being one of the largest municipal tax payers.
The net profit for 2016 after tax amounted to €5,898 million, compared with €6,967 million in 2015.
The Cooperative Financial Network’s cost/income ratio amounted to 67.0 percent in 2016 (2015: 63.6 percent).
Total assets of the Volksbanken Raiffeisenbanken Cooperative Financial Network had risen by €53.3 billion to €1,215.8 billion as at December 31, 2016 (December 31, 2015: €1,162.5 billion). The volume of business increased from €1,510.0 billion in 2015 to €1,599.4 billion in 2016.
Of the total assets before consolidation, 60.6 percent was attributable to the primary banks (December 31, 2015: 60.0 percent) and 36.4 percent to the DZ BANK Group (December 31, 2015: 30.2 percent). As at December 31, 2015, the WGZ BANK Group had accounted for 6.7 percent of the Cooperative Financial Network’s total assets.
On the assets side of the balance sheet, loans and advances to customers grew by 4.6 percent to €733.2 billion (December 31, 2015: €700.6 billion). In 2016 again, this rise was primarily attributable to the primary banks, which achieved a gain of 4.5 percent and thus stayed close to the 2015 growth rate of 4.7 percent. As anticipated, long-term home finance was the main growth driver in the retail customer business. The increase in lending to corporate customers (loans to non-financial companies and self-employed people) by the local cooperative banks was mainly attributable to lending to service providers.
|2016 € million||2015 € million||Change (percent)|
|Net interest income||18,826||20,021||–6,0|
|Allowances for losses on loans and advances||–522||–74||>100.0|
|Net fee and commission income||5,963||5,798||2.8|
|Gains and losses on trading activities||1,099||607||81.1|
|Gains and losses on investments||33||–561||>100.0|
|Other gains and losses on valuation of financial instruments||–190||363||>100.0|
|Net income from insurance business||1,119||993||12.7|
|Other net operating expense income||–76||–126||–39.7|
|Profit before taxes||8,308||9,787||–15.1|
Breakdown of change in profit before taxes by income statement items
A: Profit before taxes for 2015
B: Changes in net interest income
C: Change in allowances for losses on loans and advances
D: Change in net fee and comission income
E: Change in gains and losses on trading activities
F: Change in gains and losses on investments
G: Change in other gains and losses on valuation of financial instruments
H: Change in net income from insurance business
I: Change in administrative expenses
J: Change in other net operating expense income
K: Profit before taxes for 2016
Financial assets held for trading contracted by €5.3 billion or 9.9 percent to €48.3 billion as at December 31, 2016 (December 31, 2015: 53.6 billion). This decline in financial assets held for trading resulted largely from a decrease in derivatives used for hedging (positive fair values) of 4.4 percent to €23.6 billion as well as a decrease in bonds and other fixed-income securities of €4.1 billion to €9.3 billion.
On the equity and liabilities side of the balance sheet, deposits from customers grew again, from €739.2 billion as at December 31, 2015 to €774.3 billion as at December 31, 2016. Deposits from banks also increased slightly, climbing by 3.8 percent to reach €103.3 billion at the end of the year (December 31, 2015: €99.5 billion).
Corresponding to the change in financial assets held for trading, financial liabilities held for trading fell by €1.3 billion or 2.8 percent to €44.1 billion (December 31, 2015: €45.4 billion). This fall was due, in particular, to a €2.7 billion decline in derivatives used for hedging (negative fair values) to €25.1 billion.
The equity attributable to the Cooperative Financial Network remained at a robust level, increasing by 6.0 percent to €98.6 billion as at December 31, 2016 (December 31, 2015: €93.0 billion). The main reason for this rise was the appropriation of profits generated in 2016 to boost reserves.
Capital adequacy and regulatory ratios
The disclosures relate to the institutional protection scheme (cooperative joint liability scheme) and the respective reporting date. The disclosures relating to own funds and capital requirements are based on the outcome of the extended aggregated calculation in accordance with article 49 (3) in conjunction with article 113 (7) of the Capital Requirements Regulation (CRR).
The consolidation carried out as part of the extended aggregated calculation demonstrates that by far the greatest proportion of the consolidated own funds consists of the own funds of the primary institutions. From the perspective of the institutional protection scheme, the growth in own funds therefore arises primarily from the profits generated by the primary banks and network institutions. Rights issues by the network institutions are for the most part subscribed internally and consolidated within the Cooperative Financial Network (scope of consolidation based on institutional protection scheme).
Due to the exclusion of internal exposures within the network in accordance with article 113 (7) CRR, risk-weighted exposure amounts are generally not consolidated. Consolidation measures primarily include directly and indirectly held equity investments within the institutional protection scheme and therefore particularly affect equity investments of primary institutions and subordinate receivables due to them from network institutions, especially from DZ BANK AG. Consolidation measures are based on the corresponding own funds categories (corresponding approach).
The impact of consolidation on the level of the risk-weighted exposure amounts is therefore negligible, whereas own funds decrease. The method by which the consolidation is carried out results in a total capital ratio for the institutional protection scheme that is lower than the corresponding ratio for the sum of all primary institutions.
As at December 31, 2016, the own funds of the Cooperative Financial Network amounted to €92.1 billion. The corresponding Tier 1 capital ratio including reserves in accordance with section 340f of the German Commercial Code (HGB) was 15.4 percent. Given the high quality of the capital, the equivalent fully loaded ratio was only slightly below this percentage, at 15.2 percent. The bulk (89.1 percent) of the total risk exposure of €572.5 billion subject to capital charges (see table on page 19) was attributable to counterparty risk.
Breakdown of the total as - sets held in the Volksbanken Raiffeisenbanken Cooperative Financial Network as at December 31, 2016
|DZ BANK Group|
Breakdown of the total risk exposure
The leverage ratio for the institutional protection scheme of the Cooperative Financial Network as at December 31, 2016 was reported for informational purposes using the methodology specified in article 429 CRR. The capital measure was based on Tier 1 capital as determined in the extended aggregated calculation in accordance with article 49 (3) CRR, which is adjusted for all internal Tier 1 capital positions within the joint liability scheme of the members of the institutional protection scheme. The risk exposures were determined by aggregating the individual leverage ratio submissions by all the member banks and adjusting them for material internal exposures within the institutional protection scheme.
Using Tier 1 capital including reserves in accordance with section 340f HGB (fully loaded) as the capital basis, the leverage ratio was 7.3 percent. This ratio underlines the sound capital adequacy of the Cooperative Financial Network.
Breakdown of the total risk exposure
|Risk-weighted exposure amounts for credit, counterparty, and dilution risk, and for free deliveries||510,093||488,513|
|Risk exposure amount for settlement and delivery risk||2,655||0|
|Total exposure amount for position, foreign-exchange, and commodities risk||10,193||15,521|
|Total amount of risk exposures arising from operational risk (OpR)||49,707||49,244|
|Additional risk exposure amount relating to overheads||0||0|
|Total amount of risk exposures for credit valuation adjustment (CVA)||2,463||2,674|
|Total amount of risk exposures relating to large exposures in the trading book||0||0|
|Other exposure amounts||0||0|
|Total risk exposure after adjustment||572,458||555,952|
Operating segments of the Volksbanken Raiffeisenbanken Cooperative Financial Network
Bank operating segment
The net interest income of the Bank operating segment declined by €394 million to €1,623 million in 2016 (2015: €2,017 million).
The net interest margin contribution in the corporate banking business increased against a backdrop of improving margins. With regard to the funding of small and medium-sized enterprises (SMEs), it can be noted that companies generally seem to be in crisis-resistant shape and show a strong propensity to invest. However, the corporate customer business in 2016 was adversely affected by general economic uncertainty in the eurozone and slowing economic growth in some of the larger emerging markets.
The net interest margin contribution from the development lending business in the Investment Promotion division increased year on year, despite a further contraction in margins. Performance in the main areas of development activity within traditional investment finance, which primarily include business start-ups and financing of innovation projects, remained steady in this highly competitive area of business. However, some growth was achieved in the development lending portfolios within the private house-building business and commercial environmental finance.
In the syndicated business/renewable energies product field, another small rise in the net interest margin contribution from finance connected with renewable energies was achieved in an increasingly competitive environment. In acquisition finance, large numbers of customers once again made use of the high degree of liquidity in bond markets to redeem their loans. This, in combination with a selective approach to the granting of new loans, led to a year-on-year contraction in the net interest margin contribution. The net interest margin contributions from international trade and export finance business and from project finance business both increased year on year.
In transport finance, net operating interest income (excluding income from long-term equity investments) improved, principally because of lower special accelerated depreciation allowances on assets subject to operating leases in 2016. In addition, net interest income continued to be adversely affected by significant pressure on interest margins as a consequence of the global increase in financing competition in the transport markets. Global freight and passenger transport was influenced by a modest economic upward trend in the eurozone, moderate growth in the US economy, and a slowdown of economic expansion in emerging markets, particularly China. At the same time, the pace of growth in global trade remained sluggish. In addition, individual segments of the international shipping market suffered from an excess supply of transport capacity. The persistently low oil price had a negative impact on offshore markets.
The leasing business saw a decrease in net operating interest income (excluding income from long-term equity investments) in 2016. This year-on-year fall was largely attributable to a decline in net operating interest income in the real-estate leasing, automotive trade, and vehicle fleet businesses, which, together with international business, have been defined as non-core business and are being scaled back. Against a backdrop of continuing low levels of interest rates and a further small reduction in the volume of finance leases, interest income sank as existing leases with higher rates of interest were progressively replaced by new leases with lower rates of interest.
Allowances for losses on loans and advances in the Bank operating segment increased from €94 million in 2015 to €523 million in 2016. This was mainly due to a greater requirement for loss allowances on legacy exposures in ship and offshore financing against a backdrop of tough market conditions.
Net fee and commission income came to €603 million in 2016 and was therefore once again slightly higher than in the previous year (2015: €586 million). The service contribution from the corporate banking business went up slightly. The service contributions improved in the product fields of syndicated business/renewable energies and project finance. The international trade and export finance product field also generated a higher service contribution year on year, while service contribution levels in the product fields of acquisition finance and asset securitization declined compared to 2015. The service contribution generated by the Operations/Services division in 2016 was also higher than the equivalent figure reported for 2015 as a result of a rise in the income from securities custody business. Net fee and commission income from lending in the transport finance business grew in 2016, most noticeably because of an increase in such income from new transport finance business.
The Bank operating segment’s gains and losses on trading activities in 2016 came to a net gain of €851 million, up by €393 million compared with the 2015 figure of €458 million. Trends in capital markets were shaped by the ECB’s decision in spring 2016 to step up its monetary policy measures while, at the same time, lowering the benchmark rate and taking the interest rate for central bank deposits further into negative territory. At the start of December 2016, the ECB extended its bond-buying program until the end of 2017 and reduced the monthly purchasing volume.
The contribution from trading income improved considerably in the year under review. The liabilities recognized at fair value gave rise to a positive contribution to income. In addition, the Bank operating segment’s gains and losses on trading activities included a net gain from realized and unrealized gains and losses in connection with asset-backed securities (ABS).
The level of gains and losses on investments decreased from a net gain of €110 million in 2015 to a net gain of €77 million in the reporting year. The positive contribution to earnings in 2016 is primarily the result of a gain from the disposal of the longterm equity investment in VISA Europe Ltd., London. The ABS business in the Bank operating segment also generated a positive contribution to earnings, largely from disposals of ABSs that had been impaired in previous periods.
Other gains and losses on valuation of financial instruments deteriorated by €113 million to a net loss of €106 million (2015: net gain of €7 million) as a result of market conditions.
Administrative expenses went up by €229 million to €2,059 million (2015: €1,830 million) in the period under review. An addition to provisions and increased project-related management consultancy fees were the main reason for the rise in other administrative expenses. Higher staff expenses resulted primarily from a larger workforce and salary adjustments.
The Bank operating segment’s profit before taxes fell by €732 million year on year to €424 million (2015: €1,156 million). The cost/income ratio rose from 59.4 percent in 2015 to 68.5 percent in the reporting year.
Retail operating segment
The net interest income generated by the Retail operating segment in 2016 amounted to €16,618 million and was therefore slightly lower than the corresponding 2015 amount of €17,260 million. In the Retail operating segment, volume growth offset the sustained negative effects of the ECB’s low-interest-rate policy almost entirely. Net interest income from consumer finance business rose as well, thanks to buoyant consumer demand throughout the year. However, this market is generally characterized by a fierce price war and predatory competition. Historically low interest rates also make this area a very challenging one for the Cooperative Financial Network. Higher market requirements arising from the advances in digitalization are creating difficulties for the consumer finance business. The decline in net interest income is a result of shrinking contributions to income from LuxCredit foreign currency lending.
Allowances for losses on loans and advances grew from €7 million in 2015 to €51 million in 2016. The risk situation in the Retail operating segment remained stable, primarily because the age structure of outstanding receivables was favorable and the volume of terminations was low.
Net fee and commission income in the Retail operating segment advanced once again, rising from €5,911 million in 2015 to €6,034 million in the year under review. The main sources of income under net fee and commission income in this segment in 2016 were payments processing and substantial customer demand in the securities and funds business. The volume-related income contribution generated with the average assets under management was one of the key drivers for net fee and commission income in the Retail operating segment. In 2016, this contribution was slightly above the level of 2015. The contribution to income in the fund services business also improved slightly year on year.
Gains and losses on trading activities once again improved slightly year on year, rising by €22 million to a net gain of €211 million (2015: net gain of €189 million). This trend can mainly be attributed to the fact that gains and losses on exchange differences benefited from the greater volume of customer-initiated transactions after the unpegging of the Swiss franc exchange rate by the Swiss National Bank.
The level of gains and losses on investments recovered by a significant €517 million, resulting in a net loss of €94 million in the reporting year (2015: net loss of €611 million). The previous year had seen an increased requirement for the recognition of impairment losses on bonds.
In terms of costs, further efforts were made to become more efficient. Nevertheless, administrative expenses went up again by a total of 1.0 percent to €15,276 million in the year under review (2015: €15,119 million), the main reasons being average pay rises and appointments to new and vacant positions. An increase in regulatory requirements and charges and, in particular, higher costs for public relations/marketing, IT, and consulting pushed up administrative expenses in the Retail operating segment.
Given the factors described above, the Retail operating segment’s profit before taxes declined from €7,549 million in 2015 to €7,197 million in the reporting year. The cost/income ratio for 2016 came to 67.8 percent (2015: 66.7 percent).
Real Estate Finance operating segment
The net interest income of the Real Estate Finance operating segment amounted to €1,322 million in 2016 (2015: €1,593 million) and was once again adversely impacted by the low interest rates. Considerably stronger demand for advance and interim financing led to an increase in interest income in the non-collective home finance business and compensated for the lower average interest rates. In addition, the interest income generated by home savings loans business declined, mainly because of a reduction in the size of the portfolio and falling average interest rates. The increased customer demand for home savings highlights the preference for investing in tangible assets with a sound financing base.
The mortgage lending business was not quite able to maintain its prior-year level of net interest income in 2016. Economic circumstances have led to substantial interest from German and international investors looking to invest in commercial real estate in a challenging competitive environment. However, there is an increasingly limited supply available to meet this demand. In the year under review, the transaction volume generated in the German market for commercial real estate (excluding housing) amounted to €52.9 billion (2015: €55.1 billion).
The net reversal posted under allowances for losses on loans and advances in the Real Estate Finance operating segment increased from €27 million in 2015 to a net reversal of €45 million in the year under review.
The net expense traditionally reported for this operating segment under net fee and commission income dropped by €41 million to a net expense of €152 million in 2016 (2015: expense of €193 million), largely as a result of reduced fee and commission expenses incurred in line with a decline in the volume of new business.
Gains and losses on investments improved by €89 million, recovering from a net loss of €53 million in 2015 to a net gain of €36 million in the reporting year. In 2016, this figure included the reversal of an impairment loss on a bond that had been recognized in 2015. The prior-year figure had primarily included gains and losses from mortgage-backed securities, including the provision for latent risk, and the recognition of a loss effect arising from the disposal of a bond classified as an available-for-sale financial asset.
Other gains and losses on valuation of financial instruments in the Real Estate Finance operating segment fell from a net gain of €364 million in 2015 to a net loss of €46 million in the reporting year. The main cause of the decline in other gains and losses on valuation of financial instruments was a widening of credit spreads on bonds from the peripheral countries of the eurozone in the mortgage lending business, whereas spreads on these bonds had narrowed significantly in 2015.
Administrative expenses rose to €754 million in 2016 (2015: €700 million). This increase was primarily caused by higher staff expenses due to additions to personnel provisions and by additional expenses relating to increased regulatory requirements and strategic projects.
Profit before taxes in the Real Estate Finance operating segment fell by €558 million to €492 million in the reporting year (2015: €1,050 million). The cost/income ratio for the Real Estate Finance operating segment increased to 62.8 percent (2015: 40.6 percent).
Insurance operating segment
Premiums earned went up by €240 million to €14,658 million (2015: €14,418 million), reflecting the integral position held by R+V within the Cooperative Financial Network. This exceeded the impressive level of premiums earned in 2015 by 1.7 percent. Gross premiums written increased to €14,767 million in 2016, up by 1.6 percent on the impressive level of premiums generated in 2015 of €14,536 million.
Premium income in the life insurance and health insurance business of R+V decreased by a total of 3.5 percent. In the life insurance business, premium income was down by 4.2 percent. Although premium income declined in the bAV and pV Fonds businesses, premium income from pV Klassisch went up. Premium income from health insurance rose by 8.4 percent, largely due to the encouraging uptrend in regular and one-off premiums. Premium income from non-life insurance advanced by 5.3 percent. This growth was predominantly generated from vehicle insurance and from corporate customers. Premium income also rose in the inward reinsurance business, in this case by 16.1 percent. The reasons for this increase were mainly the upward trends in the vehicle and fire/non-life insurance sectors.
Gains and losses on investments held by insurance companies and other insurance company gains and losses improved by 24.0 percent to a net gain of €3,885 million (2015: net gain of €3,132 million). Long-term interest rates fell sharply from the beginning of the year under review, whereas they had risen in the prior year. Equity markets relevant to R+V did not do as well over the course of the reporting year as they had in 2015 and exchange rate movements were less favorable to R+V during 2016 than in the previous year. Overall, these trends resulted in a year-on-year increase in net gains under gains and losses on investments held by insurance companies accompanied by an improvement in realized and unrealized gains and losses, although net foreign exchange gains were lower than in 2015. Owing to the countervailing effects from the recognition of provisions for premium refunds (particularly in the life insurance and health insurance business) and claims by policyholders in the unit-linked life insurance business in the ‘insurance benefit payments’ line item presented below, however, the change in the level of gains on investments held by insurance companies only partially affected the level of net income from insurance business before taxes in 2016.
Insurance benefit payments went up by 5.0 percent to €15,400 million (2015: €14,664 million). In line with the increase in premium income and higher gains on investments held by insurance companies, higher additions were made to insurance liabilities at companies offering personal insurance. Furthermore, an amount of €626 million was added to the supplementary change-in-discount-rate reserve (2015: €559 million). Both in non-life insurance and in inward reinsurance, claims losses were within expectations for the year under review.
Insurance business operating expenses went up by a total of 7.3 percent to €2,454 million (2015: €2,287 million) in the course of ordinary business activities in all three divisions. Other net operating income amounted to a net expense of €8 million (2015: net income of €26 million) and in 2015 had included a gain of €39 million on the disposal of shares in an associate held for sale.
The factors described above meant that profit before taxes for the reporting year increased by €56 million to €681 million (2015: €625 million).
Human Resources Report
Human resources report
The sustained low level of interest rates and the ever advancing digitalization in the banking sector have a direct impact on human resources management in cooperative banks. Although the qualitative and quantitative changes to the workforce that will need to be made to adapt to new challenges are only starting to become clear, a variety of staff restructuring measures were initiated in 2016. In the primary banks and central institution, the number of employees fell by roughly 2.7 percent to 159,200 in 2016, achieved through natural wastage whereby retiring employees were deliberately not replaced. The number of people employed by the entities in the Cooperative Financial Network totaled 181,740 as at December 31, 2016.
Managerial staff and employees need to prepare for the new skill set required in an omnichannel banking environment. In light of this, it will be necessary to develop suitable continuing professional development (CPD) activities that address the changes to employees’ tasks and areas of responsibility. New processes and technologies make it more pressing than ever to devise a concept for lifelong, self-organized learning at cooperative banks. Therefore, it will become one of the key concerns of human resources work to ensure that employees identify with the modernized, digital-based business model of ‘their’ cooperative bank. Another crucial factor for a successful digital revolution at the cooperative banks will be to attract the next generation, i.e. school leavers with an affinity for digital technology and media, to join the banks’ vocational training programs. The ratio of trainees to other employees at the primary banks and central institution was 7.4 percent in 2016 (see chart ‘Ratio of trainees to other employees’, p. 28), which is high compared with the rest of the sector. The proportion of vocational trainees offered a full employment contract at the end of training is 80.9 percent, which also underlines the contribution made by the cooperative banks as employers in their respective regions.
In addition, a trainee initiative entitled ‘next – become more than a banker’ was launched in 2016. This initiative aims to create a network for the approximately 10,750 trainees working at the primary banks and central institution, while also serving to recruit new trainees. For many years, the local cooperative banks have been awarded the ‘Germany’s top 100 employers’ seal of approval – proof that school leavers consider them one of the most desirable training providers in Germany. With around 17,000 respondents, the 2016/2017 School Leavers Barometer, a representative survey carried out throughout Germany by the Berlin-based trendence Institute, is the biggest and most comprehensive study of school leavers’ career goals and preferred employers.
The local cooperative banks and the central institution also offer university graduates attractive roles and career opportunities. This is evidenced by the growth in the proportion of employees with a degree in past years, which was at 8.2 percent in 2016 (see chart ‘Proportion of employees with a degree’ on p. 29). Many young people see the possibility of obtaining a degree after or alongside their vocational training as an important factor in their choice of employer. For interested young employees, the bachelor degree programs offered through the training providers in the Cooperative Financial Network are a particularly attractive way of gaining further qualifications.
Cooperative banks are aware of how important targeted skills training for their workforce is for the future success of the business, not least when it comes to implementing the results of futureoriented projects that are currently under way. In view of the new tasks and functions in an omnichannel bank, and also the need to optimize the branch network, an important role for HR is the systematic reorganization of the workforce within the individual cooperative bank that respects the bank’s perception of itself as a regional employer and that ensures the bank is focusing on the future. This puts in place the prerequisites that will enable the banks to make the most of opportunities presented by change. The local cooperative banks are supported with a wide range of training and development activities offered for employees by regional associations and academies. Going forward, the network will continue to pursue the objective of increasing the local cooperative banks’ appeal as modern, forward-looking local employers so that they can attract the committed, performance-oriented, and motivated employees needed for the digital transformation.
Number of employees*
* Volksbanken Raiffeisenbanken Cooperative Financial Network.
Years of service
Ratio of trainees to other employees*
* Local cooperative banks, central institutions, Sparda, PSD.
Proportion of employees with a degree*
* Local cooperative banks, central institutions, Sparda, PSD.
The cooperative principle and self-image
In December 2016, UNESCO added the cooperative principle to the Representative List of the Intangible Cultural Heritage of Humanity. This is Germany’s first ever contribution to the list. The United Nations Educational, Scientific and Cultural Organization thereby acknowledged a strong and vivid ideal that has spread far beyond Germany’s borders. In doing so, it also endorsed the proven approach of collective self-organization, which is based on the cooperative principles of self-help, self-management, and self-responsibility. The cooperative banks were founded around 170 years ago on the basis of these principles, which were devised by Hermann SchulzeDelitzsch and Friedrich Wilhelm Raiffeisen. To the present day, the cooperative banks have continued to pursue their founding fathers’ principles as widely engaged sponsors and promoters of their regions with utmost commitment and a close connection to their local communities. In memory of their distinguished founder Friedrich Wilhelm Raiffeisen and to honor the values that he promoted, all cooperative banks will commemorate the 200th anniversary of his birth next year, celebrating 2018 as Raiffeisen Year. After all, Raiffeisen’s ideas are now more alive and relevant than ever before.
For many customers, a responsible approach to environmental, economic, and social topics has become an important factor when choosing service providers. Responsible practices, the integration of sustainability criteria into transparent and efficient business processes and IT systems, and optimum efficiency in the use of scarce resources are key success factors for the cooperative banks.
As part of a regular review of sustainability criteria, product requirements are double-checked and added to as necessary. Unlocking the potential offered by digitalization, which is increasingly influencing members’ behavior, is helping to create more efficient business processes. The change processes that banks will be facing in the context of digitalization require adequate preparation and involvement of the workforce. It is vital to raise employees’ awareness of the necessary changes and equip them with the new skills that they will need. The launch of new high-quality and sustainable products and services is therefore accompanied by appropriate CPD programs.
The cooperative banks have seen their membership base grow steadily for many years. At present, they can count approximately 18.4 million members in total, having gained more than 2 million new members in the past ten years. The concept of being not only a customer but also a shareholder of their bank is becoming increasingly popular with individuals and companies alike. As a result, the cooperative banks in Germany operate on a very broad membership base, maintaining close links with the local communities in their region.
The cooperative business model continues to be based primarily on a network of local bank branches and proximity to customers and members, combined with a comprehensive, high-performance internet presence. This commitment to accessibility is reflected in the nationwide branch network, which extends to almost every corner of Germany. The 972 primary banks operate 11,787 branches across the country. There are also 3,467 self-service branches. Customers can visit their local primary bank when they need to, where they will be offered direct and personal support – not just where finances are concerned.
The large number of cooperative members in Germany shows that the model of cooperative self-help and personal responsibility brings people together, promotes individual commitment, and enables them to get involved in social, cultural, and economic issues and thereby contribute something themselves. The core of the cooperative idea is to generate value for members, provide comprehensive support for associations and foundations, and provide funding for small and medium-sized regional businesses. In addition to support for members and regional business, Germany’s local cooperative banks are also strongly committed to the things that matter to their respective regions. Every year, the cooperative banks give financial aid of around €140 million back to their regional communities, e.g. by way of donations and sponsorship. The lion’s share of these funds goes toward projects for children and young people and to local clubs and associations. The total foundation assets raised by the cooperative banks amount to around €300 million. Of these funds, €30 million is invested in community and citizens’ foundations. The establishment and promotion of foundations enable the local cooperative banks to create reliable and sustainable funding structures. This commitment fits in seamlessly with the selfimage of the network. Nearly half of all local cooperative banks encourage and support projects that their employees engage in during their working hours. Well over a third of all employees of the Volksbanken Raiffeisenbanken Cooperative Financial Network are actively involved in community life on a voluntary basis in their free time.
In the field of loans in the agricultural and forestry sectors, the Cooperative Financial Network is by far the market leader. Renewable energies were one of the main drivers of demand for credit. Cooperative banks contribute to local employment and social integration and provide support for the specific causes and concerns of their respective regions. They are local employers for local people and thereby create career opportunities for many people, including in rural areas.
Combined Opportunity and Risk Report
The Volksbanken Raiffeisenbanken Cooperative Financial Network again enjoyed a successful year overall in 2016, enabling it to continue carrying out its consistent and stabilizing role in the German financial sector. This positive impact is attributable to its sustainable business model. The protection scheme run by the BVR (BVR-SE) and BVR Institutssicherung GmbH (BVR-ISG), a scheme established in 2015, ensure the stability of the entire Cooperative Financial Network and confidence in the creditworthiness of all its members. Both schemes together, and each in its respective functions and area of responsibility, guarantee institutional protection and form the backbone of the cooperative risk management system.
The credit ratings of the Cooperative Financial Network remained stable and unchanged as year 2016. Credit rating agencies Standard & Poor’s and Fitch have each given the Cooperative Financial Network a rating of AA-. The soundness of these ratings is corroborated by the calculation method used by the rating agencies. Each rating is based solely on the economic strength of the Cooperative Financial Network: The capital market ratings correspond to the individual ratings. The rating agencies point to the consistently successful business model focused on retail banking as the reason for their positive assessment. Thanks to the business model, funding is structurally secured by the retail deposits. Liquidity is ensured by means of an extensive and highly diversified portfolio of marketable securities, combined with the cash pooling that takes place within the Cooperative Financial Network. Capital adequacy is also judged to be above average. The rating agencies emphasize the ability and propensity of the Cooperative Financial Network to build up capital from its own resources by retaining profits. The granular credit structure and proportion of mortgages in the retail business are the hallmarks of the overall high level of quality in the customer lending business. The BVR protection scheme is seen by the rating agencies as an important connecting link and a crucial element of the risk management system within the Cooperative Financial Network.
The description of the risk management system is based on the structure and functional principles of the Cooperative Financial Network’s institutional protection scheme at a primary level, but also takes into account the risk management of the affiliated individual institutions and banking groups as a secondary element.
Risk reporting covers all entities in the scope of consolidation. The scope of consolidation for the consolidated financial statements therefore goes beyond the companies consolidated for regulatory purposes and is not limited to those required to be members of the joint liability scheme by law.
In this context, risk management at the level of the bank-protection scheme refers to management in the narrower sense and therefore primarily involves preventing individual institutions from getting into difficulties.
Opportunities and opportunity management
Membership is a distinctive feature of the cooperative banks’ business model and one that is ideally suited to conveying and imparting the values and characteristics of the cooperative idea. It offers the cooperative banks the opportunity to distinguish themselves from rival banking groups. Being able to stand out clearly and positively from competitors typically results in a high level of customer acquisition. Customer loyalty is measured by means of an index that includes aspects of customer satisfaction, customers’ readiness to recommend their bank, and the continuation of the customer relationship. Strong customer retention results in measurable economic benefits, e.g. income growth for the cooperative banks and the protection of their market share. Differentiating themselves from competitors requires the banks to implement an adequate quality management system that defines standards for processing times and encourages employee feedback.
Even in the digital sphere, the business model of the cooperative banks puts people and their wishes and objectives first. Measures derived from the KundenFokus 2020 (customer focus 2020) project have been implemented in order to take account of the changes in customer behavior and to adjust and strengthen the business model accordingly. Personal contact will remain a key component of the customer relationship, alongside high-quality advisory services and the possibility for customers to choose how they would like to communicate with their branch. The Cooperative Financial Network is therefore establishing efficient customer touchpoints and enabling its members to access all information and services through all the relevant channels – whether in branch or via digital media.
Digitalization and its increasing influence on members’ behavior also offer the banks potential to improve their cost situation. A stronger focus on offering and promoting new digital payment methods such as paydirekt, expansion of the network of merchants that accept paydirekt, and implementation of an online inquiry process for financing, leasing, and investment plans will address customer needs and attract new customers. To this end, banks are specifically targeting young, technology-savvy members with their digital products and services.
The cooperative banks are very conscious of the effects of demographic change. Around half of the cooperative banks are taking action in this respect by regularly reviewing demographic trends, ensuring that their customer contact points are accessible for everyone, and providing products and services that take the increasing life expectancy of customers and members into account.
Consumer spending is expected to be boosted further by the positive trends in employment and wages. It is realistic to assume that this will lead to higher demand for banking products and services. Given the current low level of interest rates, a sustained rise in interest rates may open up substantial opportunities.
Risk management in a decentralized organization
Institutional protection scheme of the Cooperative Financial Network
BVR protection scheme
Section 4 of the BVR’s articles of association requires the BVR to manage a protection scheme. This facility was specified expressly as a bank-protection scheme in section 12 of the legislation implementing the EU deposit guarantee schemes and investor compensation schemes directives until the effective date of the German Deposit Guarantee Act (EinSiG) on July 3, 2015. From August 1, 1998, the protection scheme was therefore subject to monitoring by the Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin) [Federal Financial Supervisory Authority] (section 12 (1) in conjunction with section 7 (3) of the German Deposit Guarantee and Investor Compensation Act, EAEG); as a result, the member institutions did not need to participate in any statutory compensation scheme until July 2, 2015. Since the effective date of the EinSiG, the protection scheme has been continued as an additional voluntary institutional protection scheme in accordance with section 2 (2) and section 61 EinSiG.
The main and unchanged aims of the BVR protection scheme are to safeguard the credit standing of the member institutions by averting imminent financial difficulties or eliminating any such existing problems at the affiliated institutions and to prevent any negative impact on confidence in the cooperative institutions. The BVR manages a guarantee fund and a guarantee network to assist with any supporting measures needed in this connection. The basic structures of the work of the protection scheme have remained in place since the EinSiG came into force.
In 2016, the protection scheme met, without qualification, all its responsibilities as a bank-protection scheme in accordance with the articles of association. A total of 983 institutions of the Cooperative Financial Network belonged to the BVR protection scheme as at December 31, 2016 (December 31, 2015: 1,033 members). The decrease in membership stemmed solely from mergers.
BVR Institutssicherung GmbH
Since July 1, 2015, BVR Institutssicherung GmbH (BVR-ISG) has been operating an institutional protection scheme within the meaning of article 113 (7) of Regulation (EU) No. 575/2013 for CRR credit institutions. The scheme was recognized as a deposit guarantee scheme in accordance with section 43 EinSiG in a notice issued by BaFin on June 30, 2015. By operating the institutional protection scheme, BVR-ISG satisfies its responsibility under its articles of association to avert or eliminate imminent or existing financial difficulties in the institutional protection scheme’s member credit institutions as defined by article 4 (1) no. 1 of Regulation (EU) No. 575/2013. To this end, BVR-ISG will initiate any preventive or restructuring action, as required. Where, in accordance with section 10 EinSiG, BaFin identifies a compensation event in relation to a CRR credit institution that is a member of the BVR-ISG protection scheme, BVR-ISG will compensate the customers of the credit institution concerned in accordance with sections 5 to 16 EinSiG. BVR-ISG thus fulfills the statutory deposit protection requirements.
Together with the BVR protection scheme, BVR-ISG forms the Cooperative Financial Network’s protection scheme, which has been subject to further development to create this dual approach. The members of the BVR-ISG protection scheme are those CRR credit institutions that belong to the BVR, are affiliated to the BVR protection scheme, and that have joined the BVR-ISG scheme by giving an appropriate undertaking regarding participation and commitment. As at December 31, 2016, the membership comprised 981 CRR credit institutions (December 31, 2015: 1,031 institutions) and therefore all the cooperative banks authorized in Germany by BaFin.
Under section 50 (1) EinSiG, BVR-ISG is subject to supervision by BaFin, which, in accordance with section 50 (3) EinSiG, holds the auditing rights and rights to information specified in section 44 (1), (4), and (5) of the German Banking Act (KWG). BVR-ISG is also subject to monitoring by the German Federal Court of Audit with regard to its responsibilities to compensate depositors in accordance with sections 5 to 16 EinSiG and with regard to funding and target funding levels in accordance with sections 17 to 19 EinSiG.
To the extent possible under EinSiG, BVR-ISG’s organizational and decision-making structures match the proven organizational and decision-making structures of the BVR protection scheme. To carry out the duties for which it is responsible by law and in accordance with its articles of association, BVRISG will for the time being use the BVR employees who also carry out the corresponding functions for the BVR protection scheme. Given the long-established successful operation of the BVR protection scheme, this ensures that BVR-ISG can properly carry out its duties as an institutional protection scheme (including classification, collection of contributions, etc.). BVR-ISG has also engaged a third-party service provider to carry out the processing of potential compensation procedures, although such procedures have as yet never been required, nor are any currently identifiable.
In 2016, the focus of the activities of BVR-ISG was on fulfilling its responsibilities as defined by law, the articles of association, and regulatory requirements. The activities centered mostly on the risk-based collection of contributions, which is compliant with the relevant guidance of the European Banking Authority (EBA), and on the management of funds. With no action required to be taken to protect depositors or banks at any time in 2016, BVR-ISG can look back on a highly successful year.
Risk identification and analysis
The Cooperative Financial Network is a decentralized organization made up of legally independent institutions that are linked by their business operations and – through the protection scheme – by their liability. In contrast to banking groups with a parent company at the top of a hierarchical structure, the Cooperative Financial Network has a decentralized structure in which the individual institutions have their own decision-making powers. In this system, risk management focuses primarily on analyzing the risk carriers – i.e. the institutions – rather than on isolated analysis of the risk types. This fundamental methodological approach ensures that, in establishing that each individual institution’s financial position and risk position are appropriate and its financial performance is adequate, the entire system – i.e. the entire Cooperative Financial Network – as a unit can be considered to be on a sound economic footing.
The BVR protection scheme includes reliable systems for identifying and classifying risks and for monitoring the risks of all its members and of the institutional protection scheme as a whole. Risks are rated on the basis of the BVR protection scheme’s classification system, which was implemented in 2003. The aim of this rating process, which is based on the annual financial statements, is to obtain an all-round, transparent view of the financial position, financial performance, and risk position of all members and thus of the BVR protection scheme. Rating a bank in accordance with the classification system provides the basis for determining the risk-adjusted guarantee fund contributions of the protection scheme and is also the starting point for preventive management.
The results of the classification are supplemented by further analysis, in particular evaluations of the data collected as part of an annual comparative analysis. This is a data pool that the BVR compiles from data collected from its member institutions and consists, above all, of accounting and reporting data. The data from the annual comparative analysis forms the basis for analyses that use key risk indicators to identify and examine particular abnormalities. In addition, the BVR prepares special analyses on specific issues, such as determining the impact of sustained low interest rates.
In accordance with its risk-oriented procedure, the protection scheme performs individual bank analyses on institutions of major financial significance to the protection scheme as a whole. This also includes the unclassified member banks. In doing so, the protection scheme is applying the concept used to analyze large banks, taking into account the risks resulting from the size category of the affiliated institutions.
To assess the protection scheme’s risk-bearing capacity, probabilities of default are determined on the basis of various stress scenarios and Monte Carlo simulations are used to calculate the possible restructuring amounts. This involves carrying out scenario-specific classifications on the basis of different assumptions (e.g. interest-rate changes, declining credit ratings in the customer lending business).
Besides assessing each individual member institution, the BVR protection scheme supports the development of standard tools, methods, and guidelines that provide each member institution in the scheme with a similar internal structure for managing risk (including VR-Control and the VR rating system). The institutions use this standardized concept to tackle their strategic and operational challenges.
The auditing associations check that the concept is implemented consistently, applying the assessment benchmark of risk proportionality during the audit of the annual financial statements.
Classification process and contributions to the protection scheme
The classification system uses eight key figures relating to financial position, financial performance, and risk position to assign the banks to one of nine credit rating categories ranging from A++ to D. The classification system is based on quantitative key figures, most of the data for which is taken from the banks’ audited annual financial statements and audit reports. The protection scheme receives this data electronically from the regional auditing association responsible for the individual bank.
All banks covered by the protection scheme are included in the classification system, apart from institutions in the Cooperative Financial Network that are rated by an external rating company. In 2016, the most notable exceptions are the central institution, the mortgage banks, and Bausparkasse Schwäbisch Hall AG.
The classification process in 2016 was based on an analysis of data from the 2015 financial statements. There was a moderate year-on-year deterioration in the class distribution based on the 2015 financial statements, reflecting the banks’ slightly weaker financial performance. Despite continued pressure on margins, the primary banks managed to maintain their net interest income at a nearly unchanged level thanks to volume increases. Net fee and commission income went up slightly, whereas fair value gains and losses on securities declined year on year. With negative effects from the lending business remaining at an unusually low level, sufficient net profit was generated to strengthen the financial position further by retaining profits.
In light of the fact that an additional contribution to the guarantee fund of BVR-Institutssicherung GmbH is payable from 2016, the rate for contributions to the guarantee fund of the protection scheme was lowered to the basic contribution rate of 0.04 percent (2015: 0.12 percent) of the assessment basis for those institutions that are also members of BVR-Institutssicherung GmbH. For the other member institutions, the contribution rate was set at 0.088 percent of the assessment basis or 2.2 times the basic contribution rate, in each case in consideration of any individual discounts or surcharges resulting from the classification.
Risk management and monitoring
The results of the BVR’s classification process also provide a basis for the BVR protection scheme’s systematic preventive management. Preventive management continues to be used when a bank is classified as B- or lower on the basis of its annual financial statements, but sometimes earlier. In addition, other key figures and data have increasingly been used over the past few years so that any abnormalities at institutions can be identified at an early stage. In 2016, this data included information on the banks from a survey on the effect of the low-interest-rate environment carried out by Deutsche Bundesbank, which was made available to the BVR protection scheme in full, and from the extended statutory reporting for banks to which the protection scheme has access.
Before the prevention phase, the monitoring of conspicuous institutions is playing an ever more significant role in the early analysis of institutions. In 2016, the monitoring once again also included institutions that were not showing any particular indications of risk but that could potentially represent a major risk simply because of the size of their balance sheet. This underpins the long-term trend of shifting the focus of the protection scheme’s work away from restructuring and toward end-toend preventive management that now also includes monitoring. Significantly more institutions are now in the preventive phase of restructuring rather than the support phase.
The aim of preventive management is to identify and counteract adverse economic trends at an early stage, thereby helping to prevent the need for supporting measures. Data and other information from the banks that might be affected is analyzed and, following additional discussions with the management of these banks, appropriate measures are agreed that are aimed at stabilizing and improving their business performance.
In order to supplement the prevention phase enshrined in the statutes, the protection scheme established a monitoring process some years ago that precedes the actual preventive action. Irrespective of the results of the classification, further information sources available to the protection scheme are used to analyze the institutions in order to ascertain if there is anything conspicuous that might indicate unusual trends at an early stage.
The work of the protection scheme in restructuring member institutions is firstly aimed at ensuring that these institutions’ annual financial statements are able to receive an unqualified auditors’ opinion, which it does by providing restructuring assistance. The next stage is to contractually agree appropriate measures in order to ensure that the bank’s business regains its competitiveness and future viability while accommodating the interests of all members of the Cooperative Financial Network.
The Manual for Reorganizing and Restructuring Cooperative Banks forms the basis for providing restructuring assistance and carrying out restructuring measures. The principles documented in the manual provide affected banks with guidance on restructuring and describe concepts for re-establishing their fundamental profitability. The aim is for the banks to enter this restructuring phase within no more than five years. The protection scheme’s manual also specifically targets banks undergoing preventive measures and institutions that have identified the need for reorganization by themselves (either entirely or partly). BVR-SE began to revise this manual in the second half of 2016, completing the task in mid-2017
The BVR protection scheme continued to perform well in the year under review in terms of its restructuring activities. Once again, no new first-time support measures were required in 2016. Costs were therefore incurred solely in connection with legacy cases, where risks already covered had become acute or loss allowances were recognized in the protection scheme’s annual financial statements. The total restructuring amounts in need of protection were not only significantly lower than expected, they were also – on a net basis – again smaller than the repayments under debtor warrant obligations and other guarantee release obligations. This once more meant that the capital base of the cooperative institutional protection scheme (comprising the BVR protection scheme and the BVR-ISG protection scheme) was further strengthened in 2016 and the guarantee fund resources and statutory funds at its disposal could be expanded yet again.
Outlook for the BVR protection scheme
In financial terms, the protection scheme expects to maintain its positive performance in 2017. At present, there is no sign of any scenarios resulting from the BVR protection scheme’s remit – as defined in its statutes – that might present a material threat to the stability of the scheme. Given the robust state of the German economy, the level of support and assistance provided by the protection scheme is not expected to increase in 2017. For this reason, the BVR protection scheme is also not planning to make any significant changes to its guarantee fund capital in 2017, especially as the accumulation of funds in the dual cooperative protection scheme will be focused for the time being primarily on the BVR-ISG protection scheme in order to achieve the required target funding level in accordance with section 17 (2) EinSiG.
At its meeting on November 24, 2016, the BVR Association Council approved a resolution to set the rate for contributions to the guarantee fund of the protection scheme in 2017 at 0.036 percent of the assessment basis for those institutions that are also members of the BVR-ISG protection scheme in order to prevent these institutions incurring a double charge. For the other member institutions, the contribution rate was set at 0.0828 percent of the assessment basis or 2.07 times the basic contribution rate of 0.04 percent.
Following a successful first full financial year after implementation of the EinSiG in the dual system, the BVR protection scheme faces new tasks in 2017 in connection with implementing requirements to prepare recovery plans within the meaning of sections 12 to 20 of the German Bank Recovery and Resolution Act (SAG). It is also likely that new challenges will arise as a result of the indirect and sectoral supervision responsibilities of the ECB (primarily increased reporting requirements). The BVR protection scheme expects yet more issues to emerge in this regard, involving national and international institutions such as the Bundesanstalt für Finanzmarktstabilisierung (FMSA) [German Federal Agency for Financial Market Stabilization], the European Single Resolution Board (SRB), the EBA, and the European Commission. Such issues could affect the BVR protection scheme and/ or BVR-ISG.
Tools and methods for identifying and measuring risk
The framework concept for earnings and risk management in conjunction with the concepts for VR-Control have provided the cooperative primary institutions with a system that ensures the consistent measurement of market risk and credit risk across the entire business of each institution. In line with their individual business and risk strategies and in accordance with regulatory requirements such as the Minimum Requirements for Risk Management (MaRisk), the local cooperative banks choose which of the available methods to use.
Historical simulations are used to calculate market risk. Credit risk from the customer lending business is determined using a variant of the Credit Suisse model (Credit Risk+), which focuses on industries as the main risk drivers and has Value-at-risk (VaR) as the main indicator. Besides calculating the VaR, the banks can develop stress scenarios for the specified risks.
An integrated approach is available to the institutions for measuring credit risk in own-account investing activities. It takes full account of the securities’ risk drivers by simulating spread risk, migration risk, and credit risk in the securities portfolio. Furthermore, the risk arising from securities of the issuers in the Cooperative Financial Network is determined using simplified spread shifts. The end result is that the bank receives an expected portfolio value and a corresponding risk value in the form of an unexpected loss. For a periodic management analysis, expected and unexpected fair value gains and losses can also be determined. In addition, it is possible to calculate stress scenarios. The portfolio model and its parameters are regularly refined and validated by the relevant unit at parcIT GmbH, a subsidiary of the computing center Fiducia & GAD IT AG.
The banking regulator is increasingly focused on banks’ inhouse assessment of their own risk-bearing capacity for the bank as a whole. With the MaRisk, the regulator specifically deals with the calculation of risk coverage potential and the risk profiles in the banks’ different approaches. The cooperative institutions also conduct numerous stress tests as part of the risk-bearing-capacity calculation.
Risk capital management
As legally independent companies, the cooperative institutions are responsible for their own capital management. Therefore, they manage their riskbearing capacity in compliance with the MaRisk and to fit in with their business strategy.
The BVR protection scheme supports the consistent use of tools for measuring and managing risk capital. The risk-bearing-capacity calculation carried out by each of the institutions forms the basis for the management of risk capital. According to the data collected by the BVR protection scheme, the going concern approach is the predominant approach used by the banks. The main risks are interest-rate risk and credit risk. The former is generally determined by simulating the effects of interest-rate scenarios on a bank’s planned net interest income, whereas portfolio models are used to determine credit risk. As per the analysis for 2015, pillar 2 risk-bearing capacity is satisfied in the form of its utilization, even in the conservative approaches used by the banks. The protection scheme analyzes risk-bearing capacity once a year and aggregates the main results. These are then made available to the banks for information purposes.
In 2016, BaFin carried out the first-ever calculation of bank-specific surcharges for interest-rate risk and other material risks, and of a stress scenario surcharge in accordance with the survey on the situation of German banks in the low-interest-rate environment (NZU survey) for the purposes of pillar 1 requirements, as per EBA guidance on the Supervisory Review and Evaluation Process (SREP). These surcharges are intended to complete the pillar 1 capital requirement for individual banks.
The Cooperative Financial Network provides a comprehensive overview of its financial position and financial performance by preparing annual consolidated financial statements. These statements include a group-level presentation of key figures such as equity, the Tier 1 capital ratio, and the total capital ratio.
The consolidated capital ratios for 2016 were calculated using the extended aggregated calculation pursuant to article 49 (3) CRR in conjunction with article 113 (7) CRR.
On January 2, 2014, BaFin permitted the institutions in the Cooperative Financial Network that are affiliated with the BVR protection scheme to not deduct investments within the Cooperative Financial Network when calculating their capital ratios, as provided for in article 49 (3) CRR. This waiver of the requirement to deduct long-term equity investments was granted, among other reasons, because multiple application of own funds between the members of the institutional protection scheme has been eliminated.
The Cooperative Financial Network’s regulatory total capital ratio was 16.1 percent as at December 31, 2016 (December 31, 2015: 15.8 percent). Overall, regulatory own funds increased by €4.5 billion to €92.1 billion. The increase was largely attributable to the retention of profits.
The Tier 1 capital ratio improved significantly to 13.1 percent (December 31, 2015: 12.4 percent). For information only, the material Tier 1 capital ratio – i.e. classifying the reserves pursuant to section 340f HGB as Tier 1 capital – was 15.4 percent (December 31, 2015: 14.8 percent). The Cooperative Financial Network’s capital is predominantly held by the primary institutions.
Information concerning the regulatory capital ratios relates to the reporting date of December 31, 2016 and does not include the retention of the profits reported in the 2016 annual financial statements. It is expected that this retention of profits will further strengthen the capital basis.
The total risk exposure as at December 31, 2016 amounted to €572.5 billion (December 31, 2015: €556.0 billion). This 3 percent increase was driven by growth in the customer lending business.
The protection scheme analyzes the regulatory capital ratios of each member bank. The following chart shows the distribution of total capital ratios in the Cooperative Financial Network as at the reporting date of December 31, 2016 and as at December 31, 2015. It highlights the continuing healthy level of capital adequacy of the individual banks.
The Cooperative Financial Network has healthy capital adequacy thanks to equity of €98.6 billion (December 31, 2015: 93.0 billion). It has continually boosted its level of capital in recent years by retaining profit. This trend substantiates the Cooperative Financial Network’s sustainable business model with its broad diversification of sources of risk and income.
The leverage ratio, which is determined independently of risk and calculated at the level of the institutional protection scheme, came to 6.3 percent as at December 31, 2016 (December 31, 2015: 6.0 percent). This is further proof of the aboveaverage capital adequacy within the Cooperative Financial Network. In the calculation conducted on a material basis, i.e. including the reserves in accordance with section 340f HGB and taking into account full application of the relevant CRR provisions, the leverage ratio was 7.3 percent (December 31, 2015: 6.9 percent).
Distribution of total capital ratios in the Cooperative Financial Network*
Proportion of institutions (percent)
Total capital ratio up to … percent
* As at December 31, 2016
Credit risk, market risk, liquidity risk, and operational risks
Credit risk is the most important risk category given the cooperative banks’ high volume of customer lending business. The cooperative banks manage their credit risk efficiently and sustainably using extensive, high-quality methods of risk measurement. So that they can assess the creditworthiness of individual borrowers, the cooperative banks have access to a rating system that is tailored to their requirements and satisfies the regulatory requirements. The rating system was developed by the BVR together with its partners in the Cooperative Financial Network. Credit risk at portfolio level is measured using value-at-risk methods along with structural analysis of credit ratings, size categories, proportion of unsecured lending, and sectoral concentrations.
The Cooperative Financial Network’s strategy focuses on the profit-oriented assumption of risk, while taking its level of equity into consideration and pursuing a cautious lending policy. The cooperative banks are conservative in their lending decisions, with knowledge of the customer and borrowers’ capacity to meet their obligations playing a central role. Overall, the Cooperative Financial Network’s customer lending business has a granular credit structure and a high proportion of mortgages. The granularity and extensive regional diversification of the Cooperative Financial Network’s business activities limit the formation of risk clusters.
The Cooperative Financial Network registered further significant growth in its lending business in 2016. Loans and advances to customers increased by a substantial 4.6 percent year on year. Once again, long-term home finance was a key growth driver. Home finance lending by the cooperative banks benefited from the favorable economic conditions. The combination of low interest rates, a healthy level of employment, and rising household incomes fueled strong demand for real-estate loans. However, residential real-estate prices in Germany continued to go up in 2016. On average across all 402 municipal and rural administrative districts, prices for residential properties rose by 4.8 percent (2015: 3.1 percent). At national level, it was the sixth consecutive increase. The strongest price surges were recorded in urban centers, but there are currently no signs of excessive price inflation on a broader scale or even a real-estate price bubble.
To help the member institutions to monitor the regional markets, the BVR teamed up with vdpResearch GmbH to develop a concept for measuring market volatility in individual postal code areas: BVR real-estate market monitoring. The measurements from BVR real-estate market monitoring provide additional regional information to complement the German Banking Industry Committee’s market volatility concept. This enables the cooperative banks to determine the geographical areas forming their relevant markets and better comply with regulatory requirements.
The growth in corporate banking was predominantly driven by lending to service sector companies, agriculture and forestry, and companies from the energy and mining industries. Because of their regional roots, the local cooperative banks have established a strong foothold in the renewable energies market and provide financial support to companies in relation to projects for increased energy efficiency and for power generation from renewable sources.
Allowances for losses on loans and advances rose to €522 million in 2016 (2015: €74 million). This increase was primarily due to the recognition of additional allowances for legacy exposures in ship and offshore financing in view of the continuing downturn in many shipping industry segments, and to strained economic conditions in offshore markets caused by the weak oil price. Despite these adverse effects, allowances for losses on loans and advances remained low at 0.07 percent of the volume of loans and advances to customers and banks (total volume: €774,588 million). In summary, the cooperative banks operate a healthy lending business overall.
Interest-rate risk has a significant influence on the banks’ financial performance. Due to the low interest rates in 2016, the Cooperative Financial Network’s net interest income reduced by 6.0 percent. According to analysis, the largest proportion of net interest income was generated from the net interest margin contribution in the customer business, as was the case in prior years. Given the persistently low level of interest rates and growing competition for deposits, the banks expect interest margins to be narrower in the future. Moreover, a reversal of interest rates in financial markets poses certain risks because the funding costs of the loans extended in the current environment of low interest rates will go up in the event of an interest-rate hike.
Along with credit risk, interest-rate risk plays an important role for most of the cooperative banks. The banks could face huge challenges if either the current low level of interest rates continues or there is a rapid and significant rise in interest rates. Supervisory authorities are factoring this problem into appropriate regulatory activities. For example, the Basel Committee on Banking Supervision published its new ‘Interest-rate risk in the banking book’ standard in 2016, which will come into force in 2018. The new EBA guidelines on managing interest-rate risk in the banking book have been available since 2015 and came into effect at the beginning of 2016. One aspect common to both the Basel standard and the EBA guidelines is that, although they continue to provide for the modeling of interest-rate risk in the banking book in Pillar 2, they place greater emphasis on the quality and consistency of the management of interest-rate risk in institutions. If the internal management does not satisfy the requirements of supervisors, they can require an institution to use a standard model as described in the new Basel standard.
The protection scheme monitors the appropriateness of the member institutions’ level of interest rate risk, in particular by using simulations to calculate net interest income.
Following the implementation of the new Basel ‘Interest-rate risk in the banking book’ standard, the regulatory test criterion is also determined on the basis of six interest-rate shock scenarios instead of the previous two scenarios. It will play a key role in determining the SREP supplement for interest-rate risk in the banking book.
For many years, the Cooperative Financial Network has had a reliable liquidity structure that is deemed crisis-resistant. The loan to deposit ratio of the Cooperative Financial Network is 95 percent. The basis for this lies in the diversifying, risk-mitigating effect created by the stable business structure of the banks, which tends to be divided into small units, and, in particular, in the institutions’ traditional method of obtaining funding through customer deposits. Customers therefore recognize and reward the effectiveness of the institutional protection provided by the BVR protection scheme, which particularly aims to safeguard deposits but extends beyond the statutory deposit protection requirements.
The cooperative central institution collects the liquidity surpluses of the individual institutions, enabling cash pooling within the network of primary banks and specialized service providers. Analysis shows that all member institutions of the BVR protection scheme complied with the requirements relating to the liquidity coverage ratio (LCR). As at December 31, 2016, the median LCR of all cooperative institutions was 156 percent.
The systems and internal processes implemented by the cooperative banks aim to reduce operational risks that can lead to losses resulting from the inadequacy or failure of internal processes, people, or systems or as a consequence of external events.
A variety of measures are taken to address operational risk, including clear procedural instructions, separation of functions, the use of standardized contract templates that have been reviewed by a legal expert, and the appointment of security, compliance, data protection, and anti-money-laundering officers. In addition, business continuity plans for failure of technical equipment and unexpected staff absences are in place.
Internal control processes ensure that material operational risks are identified, analyzed, and assessed on a regular basis. The institutions can use guidelines to conduct a systematic risk assessment in keeping with market standards. Any loss event is recorded in a database. Based on the outcome of the loss event analysis, internal procedures are adjusted and preventive safeguards implemented as necessary.
Operational risk is measured in consideration of the business model of the individual institution. The dominant methods are quantification by means of a plausible lump sum or based on historical loss event data, sometimes supplemented by value-at-risk approaches. Based on the analysis, the limits set by the institutions as part of their individual risk management are regularly met.
Real economy and banking industry
At the start of 2017, the economy gained some momentum. According to estimates by the Statistisches Bundesamt (StaBA) [German Federal Statistical Office], GDP growth at the start of the year (after adjustment for inflation, calendar, and seasonal effects) was at 0.6 percent compared with the previous quarter, following 0.2 percent in the third quarter and 0.4 percent in the fourth quarter of 2016. For the remainder of the year, economic indicators point to further steady growth, although growth rates might be slightly lower in the quarters to come.
Based on data from the first quarter of 2017, the BVR expects German GDP to grow at a rate of 1.7 percent in real terms. This figure is slightly below the 2016 growth rate of 1.9 percent, but the difference can mostly be attributed to the fact that 2017 is a year with fewer working days.
The positive economic conditions are largely the result of a domestic economy that remains buoyant and is being boosted by increasing household incomes and a healthy labor market, combined with low interest rates. Growth in consumer spending is projected to continue in 2017, but at a lower rate due to factors such as rising inflation, which curbs households’ purchasing power. In addition, government spending should only increase moderately, as the influx of refugees is expected to reduce.
Investment in residential construction is likely to continue its recovery. And in view of high overall economic demand, there should be incentives for companies to increase their production capacity. However, capital expenditure growth will remain moderate compared with previous economic cycles, despite the projected upturn.
Foreign trade is expected to gain further momentum in 2017, backed by solid economic growth in emerging markets as well as in the eurozone. The euro’s current weakness is also contributing to the upturn in foreign trade. However, as imports will probably rise at a similar rate to exports, foreign trade is unlikely to generate impetus for growth overall.
The labor market is expected to remain robust in 2017. In the early months of the year, unemployment continued to fall and reached a rate of 5.6 percent in May. At the same time, the number of vacancies increased. So far, growing numbers of refugees entering the labor market do not seem to have pushed up unemployment, although it can be expected that the integration of these migrants into the labor market will take some time. Employment is expected to continue rising this year and may even cross the threshold of 44 million people in employment.
Monetary policy is likely to remain extremely expansionary, following the ECB’s decision to extend its bond-buying program until December 2017, albeit at a reduced level. No significant changes to yields on government bonds are on the horizon for the rest of the year. Despite a noticeable rise in inflation at the start of the year, which was closely connected with the year-on-year effect of a low oil price in early 2016, inflation should remain well below 2 percent over the further course of the year, as rates are expected to fall slightly in the second half of 2017.
It is now apparent that, in essence, the forecasts for the banking industry have barely changed in recent years, and the familiar adverse conditions of low interest rates and increasing regulatory requirements continue to apply this year. The outlook for 2017 therefore remains cautiously optimistic. As a result, small and medium-sized banks in particular still face major challenges because they are disproportionately affected by regulation. The capacity of banks to accumulate capital by retaining profits is also being further reduced, which in some cases might create an incentive to assume excessive risk in order to generate income and stabilize profits.
This year, banks are continuing to address the everincreasing pressure on earnings and the strict regulatory requirements with intensive efforts to increase their cost efficiency and review their value chains, including optimizing processes and products. The number of mergers for economic reasons should remain high, while employee numbers are likely to decrease further. As before, the banks will attempt to hold their position against competitors by aiming for an even greater focus on customer requirements, for example by expanding digital products and services in the context of omnichannel banking. Competition will become fiercer as fintechs try to gain more market share.
Despite the significant adverse effects of the sustained period of low interest rates on the banking industry, an interest-rate hike – particularly a very swift one – poses a genuine threat in these circumstances. Improvements to the capital adequacy of banks in recent years do not change this fact. In addition, negative effects may arise from the continuing sovereign debt crisis in Europe, from the consequences of the Brexit vote, and uncertainties in foreign policy and foreign trade.
Volksbanken Raiffeisenbanken Cooperative Financial Network
Since the financial crisis, the financial sector has faced considerable pressure in terms of both adjustment and costs caused by the need to comply with regulatory reforms, involving greater capital requirements and changes to regulatory systems. Moreover, the outlook for the business performance of the Cooperative Financial Network shows that 2017 will also be influenced by the low absolute level of interest rates. It is expected that the adverse impact of these influencing factors on the financial performance of the Cooperative Financial Network will persist in 2017. The future financial performance of the Cooperative Financial Network could be subject to risks arising from the political and general economic environment, particularly in the eurozone, the US, and Germany. From today’s perspective, it is not possible to gauge the potential risks that may result from the Brexit negotiations between the EU and the UK, the future financial situation of some banks, particularly in Italy, and future political developments in individual eurozone countries. For 2017 as a whole, the Cooperative Financial Network expects to generate a satisfactory profit before taxes that should enable it to strengthen its reserves.
Net interest income will decline, e.g. in the Retail operating segment, above all as a consequence of the persistently low interest rates. In particular, income from interest-rate-dependent business models within the Cooperative Financial Network could be subject to volatility in 2017. Moreover, the rather modest economic growth in the eurozone may adversely affect net interest income.
Following the recognition of some negative non-recurring items in 2016, allowances for losses on loans and advances will return to their normal level in 2017 and should be in line with the lending portfolio, the envisaged volume of new business, and long-term standard risk costs. The potential effects of uncertain political developments on capital markets could have a detrimental impact on allowances for losses on loans and advances.
The Cooperative Financial Network expects net fee and commission income to be just as good as in 2016. Any lasting uncertainty in capital and financial markets could have a negative impact on confidence among retail and institutional investors, thereby depressing net fee and commission income.
In all probability, net gains under gains and losses on trading activities will decline in 2017, because the net gains in 2016, particularly in the Bank operating segment, were influenced by positive one-off items in connection with the remeasurement of financial instruments. Customer-driven capital markets business may well provide some impetus in 2017. The positive income forecast particularly reflects the continuing systematic implementation of strategic measures, especially in connection with institutional customers (but with retail customers too). The primary prerequisite for a steady level of net gains under gains and losses on trading activities will be a stable capital markets environment.
Net gains under gains and losses on investments are predicted to remain at a level similar to that in 2016 in view of plans to sell some long-term equity investments in 2017.
Other gains and losses on valuation of financial instruments are expected to follow a positive trend, mainly due to the potential that exists to reverse impairment losses in the portfolios of instruments from public issuers in the Real Estate Finance segment. Volatility in capital markets and the widening of credit spreads on securities from government issuers could have an adverse impact on the forecast improvement in these gains and losses.
Net income from insurance business is expected to contract in 2017. Assuming growth in the net premiums from the different divisions, the decline in net income is expected to be caused by a deterioration in gains and losses on investments held by insurance companies, reflecting the current environment of low interest rates. Exceptional events in financial and capital markets, changes in underwriting practices, or potential changes in the regulatory requirements faced by insurers (Solvency II) may adversely affect the level of net income expected to be earned from insurance business.
A further substantial rise in administrative expenses is predicted for 2017. Strategy-related investment in innovation management and digitalization has also been factored in for 2017.
As a result of the higher expenses coupled with lower income forecasts, the cost/income ratio for the Cooperative Financial Network is likely to rise in 2017.
A compelling business model, supported by sound risk-bearing capacity, is one of the stand-out features of the Cooperative Financial Network. The strong support from members and customers, combined with strong capital ratios, enables the Cooperative Financial Network to seize any opportunities for growth that present themselves and thus to successfully maintain its outstanding market position in a challenging regulatory environment.