Management Report 2015
Germany's economic upturn continued in 2015. According to the latest calculations, inflation-adjusted gross domestic product (GDP) rose by 1.7 percent year on year. The growth rate was therefore marginally higher than in 2014 (1.6 percent).
Economic growth remained relatively steady despite the weaker pace in emerging markets and a renewed deterioration in the Greek debt crisis during the summer months. Compared with previous years, there was little fluctuation in the quarterly GDP growth rates (after adjustment for inflation, calendar, and seasonal effects).
The key economic growth driver continued to be consumer spending, which rose significantly, boosted mainly by the upward trends in employment and collective pay deals – trends already established for some time – and by one-off factors such as the introduction of the general statutory minimum wage of €8.50 per hour and gains in purchasing power caused by the low oil price. Demand was also stimulated by the substantial influx of migrants into Germany.
In contrast, capital investment and foreign trade made less of a contribution to the rise in GDP. Although German exports grew markedly, the robust domestic demand also led to a substantial rise in imports. Capital expenditure went up but the increase did not match the investment growth seen in previous upswings given the significant economic uncertainties still prevailing. Capital investment in the construction sector flatlined for the most part.
General inflationary pressure continued to ease in the year under review with the rate of inflation dropping from 0.9 percent in 2014 to just 0.3 percent in 2015. The critical factor was the fall in the price of oil, which gained momentum again towards the end of the year following a temporary period of stabilization during the spring.
The job market fundamentally remained in good shape. However, the growth in employment slowed slightly following the introduction of the general statutory minimum wage and of provisions allowing persons who meet certain criteria to retire at the age of 63 without incurring deductions to their pension benefits.
The average number of people employed in Germany in 2015 rose by 329,000 to 43.0 million, with the number of people out of work falling by 104,000 to just under 2.8 million, equating to an unemployment rate of 6.4 percent. The influx of refugees into the country had not yet had an impact on the unemployment figures.
Volksbanken Raiffeisenbanken Cooperative Financial Network
In 2015, against the backdrop of the generally sound performance of the German economy, the Volksbanken Raiffeisenbanken Cooperative Financial Network managed to sustain the excellent performance achieved in previous years.
The declared aim of the European Central Bank (ECB) was to counter the threat of a deflationary trend and bolster growth in the eurozone by supporting greater lending by banks. To this end, the ECB made a decision at the beginning of 2015 to maintain its interest rate on main refinancing operations at 0.05 percent and its rate on the deposit facility for banks at –0.2 percent. It also decided to carry out a monthly bond-buying program with a value of €60 billion over the period March 2015 to September 2016 with a view to steering inflation once again to a level close to, but below, 2 percent. In addition, the regulatory environment presented significant challenges in 2015, especially for smaller and medium-sized banks.
With its focus on value creation and customers, the regionally oriented business model of the Cooperative Financial Network continued to prove robust in 2015 in these difficult operating conditions. Profit before taxes amounted to €9,787 million, coming close to the outstanding equivalent prior-year figure of €10,655 million. The Cooperative Financial Network therefore once again demonstrated that it is one of the most profitable banking groups in Europe.
In the lending business with retail and corporate customers, the cooperative banks gained further market share in 2015 against the backdrop of a robust economy. Overall, lending business with retail and corporate customers grew by 4.8 percent year on year, significantly exceeding the former record levels achieved in each of the previous two years. Given lower growth in the market as a whole, the market share held by the primary banks rose by 0.4 percent to 15.8 percent. In lending business with corporate customers, the performance of the primary banks stood out clearly from the crowd with year-on-year growth of 4.7 percent compared with a growth rate for the sector of 1.4 percent.
The primary banks also gained market share in the year under review in lending business with retail customers, with year-on-year growth of 4.8 percent driven mainly by long-term home finance. The Cooperative Financial Network also managed to generate an increase of 4.5 percent in customer deposits despite the ECB's policy of zero interest rates.
Equity advanced again, from €86.5 billion in 2014 to €93.0 billion as at December 31, 2015. This represented a further substantial year-on-year increase in equity of €6.5 billion (2014: increase of €7.1 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 allowing 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 and is one of the best capitalized banking groups in Europe.
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 2015 by the further sustained growth in its membership. Cooperative banks support their members, promote the flow of business activity in the regions, and thereby help to develop the economy as a whole. Relationships with customers are based on long-term partnerships and the activities of the cooperative banks generate social benefits that extend far beyond the provision of financial services. In 2015, the German cooperative banks gained 258,000 members, bringing the total to 18.3 million as at December 31, 2015.
In 2015, net interest income was virtually unchanged year on year at €20,021 million (2014: €20,047 million). This figure continued to be affected by the environment of low interest rates and the resulting deterioration in spreads as well as by very fierce competition in the market. Once again, the main factor that enabled the absolute net interest income figure to be maintained more or less at the same level year on year was the growth in interest-bearing customer business. This success against competitors would be much more obvious in net interest income if the interest rates dictated by monetary policy were set at 'normal' levels.
Allowances for losses on loans and advances at €74 million had an extremely modest impact on the Cooperative Financial Network's financial performance in 2015. This figure represented a decrease of €225 million or 75.3 percent compared with 2014. The lower interest burden faced by borrowers continued to provide a boost for their debt service capacity and was also a contributing factor in the ongoing contraction in the number of insolvencies among both retail and corporate customers. If interest rates were to increase in the foreseeable future, the potential risk would need to be sufficiently determined in good time and adequate allowances recognized.
The Cooperative Financial Network's net fee and commission income went up again in the year under review to €5,798 million, which equated to year-on-year growth of 6.1 percent. The principal growth driver was the strong customer demand for securities and funds, to which the cooperative banks were able to respond with individual advice and high-quality financial products and services. Growth across practically the entire range of products and services was evident in the local cooperative banks' customer business. The areas particularly worthy of note were the securities broking and custody business as well as the agency business for consumer finance and real estate. Payments processing again also accounted for a significant portion of net fee and commission income, although substantial regulation expense was incurred in connection with this business.
The Cooperative Financial Network is committed to providing this infrastructure service. It is worth noting that competitors – and even fintech companies – are also increasingly coming to the conclusion that infrastructure services cannot be cross-subsidized by other areas of business on a permanent basis.
The Cooperative Financial Network's gains and losses on trading activities in 2015 came to a net gain of €607 million compared with a net gain of €752 million for 2014. This decline was largely attributable to non-operating items, such as the widening of spreads in the measurement of bond portfolios.
Gains and losses on investments amounted to a net loss of €561 million, whereas there had been a net gain of €148 million in 2014. The fall was primarily accounted for by negative effects from the measurement of securities and the absence in 2015 of significant positive one-off items that had been recognized in 2014, notably the positive impact from the disposal of securities written down in previous periods.
Other gains and losses on valuation of financial instruments declined from a net gain of €435 million in 2014 to a net gain of €363 million in the reporting year, the main reason being the fall in positive valuation effects in connection with bonds from the peripheral countries of the eurozone.
Net income from insurance business went down in 2015 by 22.5 percent to €993 million. Critical factors included the decline in gains and losses on investments held by insurance companies caused by the low interest rates. However, some of the decline was offset by a positive impact from continued dynamic growth in various insurance segments, resulting in an overall growth in premium income of 3.5 percent.
Administrative expenses rose by €339 million to €17,234 million in the year under review. The bulk of the administrative expenses were attributable to staff expenses, which came to €10,160 million. Staff expenses went up largely because of collectively agreed pay increases and additional expenses in connection with retirement pension provisions.
|2015 € million||2014 € million||Change in percent|
|Net interest income||20,021||20,047||-0.1|
|Allowances for losses on loans and advances||–74||–299||–75.3|
|Net fee and commission income||5,798||5,467||6.1|
|Gains and losses on trading activities||607||752||–19.3|
|Gains and losses on investments||–561||148||>100.0|
|Other gains and losses on valuation of financial instruments||363||435||–16.6|
|Net income from insurance business||993||1,281||–22.5|
|Other net operating expense/income||–126||–281||–55.2|
|Profit before taxes||9,787||10,655||–8.1|
|Net profit||6,967||7, 807||–10.8|
Breakdown in profit before taxes by income statement item
A: Profit before taxes for 2014
B: Change in net interest income
C: Change in allowances for losses on loans and advances
D: Change in net fee and commission 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 income
K: Profit before taxes for 2015
Income taxes in 2015 remained virtually unchanged year on year at €2,820 million (2014: €2,848 million). However, current income taxes in the reporting year at €2,680 million were €172 million higher than in 2014. The regional focus of our cooperative banks, which are organized on a decentralized basis, meant that, in around 1,000 local authorities, considerable tax sums could be sustainably invested precisely in those areas in which the members and customers of our banks are based.
In 2015, consolidated net profit after tax therefore amounted to €6,967 million, falling between the outstanding figure of €7,807 million achieved in 2014 and the strong net profit of €6,862 million generated in 2013.
The cost/income ratio for the Cooperative Financial Network came to 63.6 percent in the year under review. The rise of 2.9 percentage points in the ratio was attributable to both the decline in income referred to above and the marginally higher administrative expenses. Initiatives have been launched centrally in the Cooperative Financial Network and locally in the banks to limit administrative expenses, particularly with a view to counteracting the rising costs caused by regulation.
The consolidated total assets of the Volksbanken Raiffeisenbanken Cooperative Financial Network had risen by €26.7 billion to €1,162.5 billion as at December 31, 2015 (December 31, 2014: €1,135.8 billion). The volume of business had increased by 4.4 percent to €1,510.0 billion as at December 31, 2015.
The growth in total assets over the year under review was mainly attributable to the rise in volume at the primary banks, as already discussed under net interest income. The central institutions did not increase their total assets in 2015. As a consequence, the breakdown between the central institutions and the primary banks shifted by around one percentage point. Of the total assets, 60.0 percent was thus attributable to the primary banks (December 31, 2014: 59.2 percent), 30.2 percent to the DZ BANK Group (December 31, 2014: 30.5 percent), and 6.7 percent to the WGZ BANK Group (December 31, 2014: 7.2 percent).
On the assets side of the balance sheet, loans and advances to customers grew by 4.5 percent to €700.6 billion (December 31, 2014: €670.7 billion). In 2015, this rise was again predominantly attributable to the primary banks. They achieved a gain of 4.7 percent – split almost equally between corporate and retail customers –, a further increase on the previous year's gain of 4.1 percent. As anticipated, long-term home finance was the main growth driver in the retail customer business.
Financial assets held for trading contracted by €7.6 billion or 12.4 percent to €53.6 billion as at December 31, 2015. This decline in financial assets held for trading resulted largely from a decrease in the positive fair values of derivatives of 22.6 percent to €24.7 billion and from a decrease in securities of €2.8 billion to €14.4 billion. Some of the contraction in the financial assets held for trading was offset by a rise in the loans and advances reported under this item of €2.4 billion to €14.1 billion.
On the equity and liabilities side of the balance sheet, deposits from customers also grew by 3.6 percent from €713.5 billion as at December 31, 2014 to €739.2 billion as at December 31, 2015 despite the fierce competition. Deposits from banks declined by 3.9 percent to €99.5 billion at the end of the year.
Corresponding to the change in financial assets held for trading, financial liabilities held for trading fell by €7.4 billion or 14.0 percent to €45.4 billion. In addition to a decrease in the negative fair values of derivatives of €4.4 billion to €27.8 billion, the liabilities reported under financial liabilities held for trading also declined by €3.9 billion to €5.9 billion.
The consolidated equity attributable to the Cooperative Financial Network remained at a robust level, increasing by 7.5 percent to €93.0 billion as at December 31, 2015 (December 31, 2014: €86.5 billion). The main reason for this rise was the appropriation of profits generated in 2015 to boost reserves.
Breakdown of the total assets held in the Volksbanken Raiffeisenbanken Cooperative Financial Network as at December 31, 2015
|DZ BANK Group|
|WGZ BANK Group|
Capital adequacy and regulatory ratios
The disclosures relating to own funds and own funds requirements are based on the outcome of the extended aggregated calculation (EAR) in accordance with article 49 (3) CRR in conjunction with article 113 (7) CRR as at the reporting date of December 31, 2015. The entities included in the consolidation comprise the members of the institutional protection scheme.
The consolidated own funds pursuant to the EAR largely consist of the own funds of the primary banks. From the perspective of the protection scheme, the growth in own funds therefore also arises primarily from the profits generated by the primary banks because new issues and rights issues by the central institutions are for the most part subscribed internally and consolidated within the Cooperative Financial Network (scope of consolidation based on institutional protection scheme). Own funds are consolidated on the basis of the corresponding own funds categories (corresponding approach).
The impact of consolidation on the level of the risk-weighted exposure amounts is negligible because of the exclusion of internal exposures within the network in accordance with article 113 (7) CRR, whereas own funds decrease. The total capital ratio for the Cooperative Financial Network (scope of consolidation based on institutional protection scheme) is therefore lower than the corresponding ratio for all the primary banks taken together.
For the first time, the leverage ratio for the institutional protection scheme of the Cooperative Financial Network as at December 31, 2015 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. 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.
As at December 31, 2015, the own funds of the Cooperative Financial Network amounted to €87.6 billion. On an IFRS basis, the corresponding common equity Tier 1 capital ratio including reserves in accordance with section 340f of the German Commercial Code (HGB) was 14.6 percent. Given the high quality of the capital, the equivalent fully loaded ratio was only slightly below this percentage. The bulk (87.9 percent) of the total risk exposure of €556.0 billion subject to capital charges (see table on page 17) was attributable to counterparty risk.
Calculated from an IFRS perspective and using Tier 1 capital including reserves in accordance with section 340f HGB (fully loaded) as the capital basis, the leverage ratio was 6.9 percent. These ratios underline the sound capital adequacy of the Cooperative Financial Network (scope of consolidation based on institutional protection scheme).
Breakdown of the total risk exposure
|Risk-weighted exposure amounts for credit, counterparty, and dilution risk, and for free deliveries||488,513|
|Risk exposure amount for settlement and delivery risk||0|
|Total exposure amount for position, foreign-exchange, and commodities risk||15,521|
|Total amount of risk exposures arising from operational risk (OpR)||49,244|
|Additional risk exposure amount relating to overheads||0|
|Total amount of risk exposures for credit valuation adjustment (CVA)||2,674|
|Total amount of risk exposures relating to large exposures in the trading book||0|
|Other exposure amounts||0|
|Total risk exposure after adjustment||555,952|
Operating segments of the Volksbanken Raiffeisenbanken Cooperative Financial Network
Bank operating segment
The net interest income of the Bank operating segment rose by €100 million to €2,017 million in 2015 (2014: €1,917 million).
In corporate banking, net interest income in the Bank operating segment was unchanged year on year given growing competition, associated pressure on margins, and the persistently muted demand for corporate loans. Despite the historically low interest rates and stable economic conditions in Germany, businesses remained reluctant to commit to capital investment. Many corporate customers appeared unsettled, primarily because of the geopolitical instability and the weakening of economic growth in China. In addition, many businesses remain in a position where they fund capital spending from their own resources, precisely because they are continuing to perform well in terms of income and liquidity.
New development lending business expanded compared with 2014. The focus was once again on energy-efficient new building and renovations in the privately owned housing sector. The year under review also saw an encouraging trend in commercial development lending.
In the syndicated business/renewable energies product field, net interest margin contribution rose significantly in 2015 because DZ BANK is well positioned in the market for finance connected with renewable energies. 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 and the selective granting of new lending, especially outside Germany, led to a reduction in the size of the portfolio. There was a small year-on-year increase in net interest margin contribution from international trade and export finance business and from project finance business.
The decrease in net operating interest income (excluding income from long-term equity investments) in transport finance in 2015 resulted for the most part from a drop in leasing proceeds combined with higher special accelerated depreciation allowances in connection with ships taken over as part of a bailout purchase, and from liquidity costs as a result of a continuing high level of early loan redemptions in this business.
Global freight and passenger transport was influenced by a continuing economic recovery in the eurozone, moderate growth in the US economy, and a slowdown of economic expansion in emerging markets, particularly China. In addition, individual segments of the international shipping market suffered from an excess supply of transport capacity.
The leasing business also saw a slight contraction in net interest income in 2015. This year-on-year fall was largely attributable to a decline in net interest income in areas of activity that are not part of the defined core business and that are being systematically scaled back. One of the consequences of the geopolitical crises affecting the economic environment was that the willingness of businesses to commit to capital spending was rather subdued.
Allowances for losses on loans and advances decreased in the Bank operating segment from €147 million in 2014 to €94 million in 2015.
Net fee and commission income came to €586 million in 2015 and was therefore once again slightly higher than in the previous year (2014: €576 million). The service contribution in the asset securitization product field climbed significantly, boosted by the trend in the euro/US dollar exchange rate. In the international trade and export finance business, fiercer competition led to a lower contribution to earnings. The service contribution rose in 2015 on the back of a higher level of income from the securities custody business. Greater competition was also a significant factor behind the year-on-year fall in net fee and commission income from lending in the transport finance business.
The Bank operating segment's gains and losses on trading activities in 2015 came to a net gain of €458 million, down by €112 million compared with the figure of €570 million for 2014. This year-on-year decline was largely attributable to non-operating items, although the widening of spreads (primarily in connection with bank bonds) was virtually entirely offset by the increase in the contribution from trading on customer account. Interest-rate-related increases in the value of cross-currency basis swaps – the purpose of which was to hedge currency risk – were also reflected in gains and losses on trading activities in 2015.
In addition, the balance of recognized and unrecognized gains and losses relating to asset-backed securities (ABSs) had a slightly negative impact on gains and losses on trading activities in the Bank operating segment.
As in previous years, the gains and losses on trading activities in 2015 stemmed mainly from customer-related business in investment and risk management products involving the asset classes of interest rates, equities, loans, and foreign exchange at competitive prices. These products are complemented by a broad range of advisory and research services, structuring expertise, and platforms.
The main factors shaping trends on capital markets in the year under review were the retention of the historically low key lending rate, the negative interest rate on central bank deposits, and the monetary policy action taken by the ECB. In 2015, the regulatory environment also impacted markets and market players, and consequently also the gains and losses on trading activities in the Cooperative Financial Network.
The level of gains and losses on investments improved from a net gain of €61 million in 2014 to a net gain of €110 million in the reporting year. The improvement was largely attributable to the disposal of shares, although some gains were partially offset by value adjustments.
Other gains and losses on valuation of financial instruments improved from a net loss of €39 million in 2014 to a net gain of €7 million in 2015, largely because of a year-on-year improvement in the gains and losses on the valuation of non-derivative financial instruments using the fair-value option and in gains and losses on derivatives used for purposes other than trading.
Administrative expenses went up by €155 million to €1,830 million in the period under review. Growth in headcount and salary adjustments were the main reasons behind a rise in staff expenses. A larger project portfolio and a rise in premiums, contributions, and fees were also the principal factors that led to an increase in other administrative expenses.
The Bank operating segment's profit before taxes advanced by €60 million year on year to €1,156 million (2014: €1,096 million). The cost/income ratio rose from 57.4 percent in 2014 to 59.4 percent in the reporting year.
Retail operating segment
The net interest income generated by the Retail operating segment in the year under review amounted to €17,260 million and was thus only marginally lower than the corresponding 2014 amount of €17,277 million. The narrowing of margins in the deposit-taking and lending businesses caused by persistently low interest rates once again presented the primary banks with a difficult challenge. Brisk customer business meant that net interest income was only just under the level of the previous year. Net interest income from consumer finance was also affected by the gathering pace of competition and advancing digitization but nevertheless increased slightly year on year, driven by strong customer demand throughout the year. In LuxCredit foreign-currency lending, the volume of loans guaranteed for the local cooperative banks’ clients in 2015 remained marginally below the prior-year level.
Allowances for losses on loans and advances decreased from €174 million in 2014 to €7 million in 2015. The risk situation in this operating segment proved stable, above all because of the improved economic environment in Germany.
Net fee and commission income in the Retail operating segment advanced significantly, rising from €5,542 million in 2014 to €5,911 million in the year under review. The main sources of income under net fee and commission income in this segment in 2015 were payments processing, account management, and substantial customer demand for fund, building society, and insurance products. In addition, the marked growth in average assets under management following the sharp rise in net new business contributed to the higher net fee and commission income in the Retail operating segment. The volume of fund services business was also expanded in 2015. Likewise, this was a contributing factor to the rise in net fee and commission income.
Gains and losses on trading activities once again fell slightly year on year, declining by €21 million to a net gain of €189 million. Within the overall contraction in the level of gains and losses on trading activities, there was a positive impact from the improvement in the gains and losses on exchange differences as a result of the customer-driven increase in transaction volume, caused in turn by the expansion of the fund services business.
The level of gains and losses on investments deteriorated by a significant €665 million, resulting in a net loss of €611 million in the reporting year (2014: net gain of €54 million). The principal determining factors were impairment losses recognized in respect of bonds.
The negative change in other gains and losses on valuation of financial instruments in the Retail operating segment to a net loss of €6 million (2014: net gain of €12 million) was attributable to a lower fair value measurement of own-account investments compared with 2014.
In terms of costs, further efforts were made to become more efficient. Nevertheless, administrative expenses in the Retail operating segment went up again by a total of 1.6 percent to €15,119 million in the year under review (2014: €14,880 million), the main reasons being collectively agreed pay rises, additional retirement pension expenses, and appointments to new and vacant positions. Higher consultancy, property, occupancy, and IT costs also contributed to the rise in administrative expenses in the Retail operating segment.
Given the factors described above, the Retail operating segment's profit before taxes declined from €7,845 million in 2014 to €7,549 million in the reporting year. The cost/income ratio for 2015 came to 66.7 percent (2014: 65.0 percent).
Real Estate Finance operating segment
The net interest income generated by the Real Estate Finance operating segment slightly exceeded the prior-year level at €1,593 million (2014: €1,552 million). The persistently brisk 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 the home savings loans business, a smaller portfolio and the drop in average interest rates led to a fall in interest income.
Net interest income also increased slightly in the mortgage lending business. Given limited alternative investment options in terms of returns and against the backdrop of stable economic and political conditions, the transaction volume for commercial real estate in Germany rose substantially again to €55.1 billion in the reporting year. On the other hand, heavy demand from customers in both Germany and abroad for commercial real estate investments forced up purchase prices, leading to increasing downward pressure on yields.
The net reversal posted under allowances for losses on loans and advances in the Real Estate Finance operating segment increased from €9 million in 2014 to a net reversal of €27 million in the year under review.
The net expense traditionally reported for this operating segment under net fee and commission income increased in 2015 by €47 million to a net expense of €193 million (2014: net expense of €146 million), largely as a result of higher fee and commission expenses incurred in line with the growth in the volume of new building society business.
Gains and losses on investments declined by €61 million to a net loss of €53 million (2014: net gain of €8 million). The deterioration in gains and losses on investments in the Real Estate Finance operating segment was attributable for the most part to impairment losses 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 amounted to another very strong net gain of €364 million in the reporting year, but fell short of the net gain of €454 million posted for 2014. The gain reported for 2015 reflects the weaker narrowing of credit spreads compared with 2014 on bonds from the peripheral countries of the eurozone in the mortgage lending business.
Administrative expenses were reduced slightly to €700 million in the year under review (2014: €735 million). The main factors behind this reduction were the cost-cutting measures introduced by Bausparkasse Schwäbisch Hall in 2014 and projects to enhance efficiency.
Profit before taxes in the Real Estate Finance operating segment fell by €131 million to €1,050 million in the reporting year (2014: €1,181 million). The cost/ income ratio for the Real Estate Finance operating segment increased to 40.6 percent (2014: 38.5 percent).
Insurance operating segment
Premiums earned grew by €491 million to €14,418 million, reflecting the integral position held by R+V within the Cooperative Financial Network. The already very high level of premiums earned in 2014, which had been boosted by significant growth stimulus, was therefore again exceeded, this year by 3.5 percent. Gross premiums written increased to €14,536 million in 2015, up by 3.5 percent on the impressive level of premiums generated in 2014 of €14,040 million.
Premium income in the life insurance and health insurance business grew year on year by 1.0 percent. In Germany, the gain was as much as 5.1 percent, substantially stronger growth than in the market as a whole. Premium income in the non-life insurance business went up by 4.1 percent, the growth being mainly driven by vehicle insurance and by business with retail and corporate customers. Inward reinsurance saw premium income rise by 16.6 percent, mainly as a result of upward trends in the vehicle and fire/non-life insurance sectors and positive currency effects.
Gains and losses on investments held by insurance companies and other insurance company gains and losses declined by 30.1 percent to a net gain of €3,132 million (2014: net gain of €4,481 million). The rise in long-term interest rates in the year under review contrasted with a marked fall in corresponding interest rates in 2014. Equities markets relevant to R+V improved during the course of 2015. The previous year had also seen gains, but to a lesser extent. Furthermore, exchange rate movements in 2015 were slightly more unfavorable for R+V than in the previous year. Overall, within the gains and losses on investments held by insurance companies, the market trends described above resulted in lower unrealized gains and higher impairment losses. 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 2015.
In 2015, insurance benefit payments declined by 3.9 percent to €14,664 million (2014: €15,264 million). In line with the change in premium income and lower gains on investments held by insurance companies, lower additions were made to insurance liabilities in respect of personal insurance. The rise in insurance benefit payments in the non-life insurance business was attributable to a number of factors, notably higher claims under natural disasters insurance.
Insurance business operating expenses incurred in the course of ordinary business activities went up by 0.1 percent to €2,287 million (2014: €2,284 million).
Profit before taxes in the Insurance operating segment went down by €231 million to €625 million in the reporting year (2014: €856 million).
Human Resources Report
The changes in the economic, legislative, and technical parameters faced by cooperative banks require continuous refinement of the successful business model and therefore of the human resources management system. Up to 2014 – not least because of the requirements imposed by regulation – the policy regarding the number of employees at the local cooperative banks and the central institutions still focused on attracting additional employees with appropriate skills and qualifications. In 2015 however, the number of employees fell by roughly 2.0 percent to 163,650, 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 187,616 as at December 31, 2015 (see chart on page 25).
One of the key concerns of human resources activities is to ensure that employees identify with the customer-focused business model of 'their' cooperative bank. An important component of this approach is the provision of sound inhouse training and continuous professional development for trainees. The ratio of trainees to other employees at the local cooperative banks and the central institutions was 7.9 percent in 2015 (see chart on page 26), which is high compared with the rest of the sector. The range of training offered by the cooperative banks clearly puts them in a strong position compared with other companies in what is becoming, from the perspective of employers, an increasingly small market of potential trainees. From the perspective of school leavers, cooperative banks are some of the most sought-after employers in Germany; they are among the holders of the seal of approval awarded to companies included in 'Germany's top 100 employers'. The appeal of the cooperative banks has been confirmed by the 2015/16 School Leavers Barometer, a representative survey carried out throughout Germany by the Berlin-based trendence Institute. The School Leavers Barometer involves around 10,000 respondents and is the largest and most comprehensive survey of school leavers' career objectives and target employers. The proportion of vocational trainees offered a full employment contract at the end of training is more than 80 percent, which also underlines the contribution made by the cooperative banks as employers in their respective regions.
The local cooperative banks and the central institutions also offer university graduates attractive roles and career opportunities. This is demonstrated by the fact that the proportion of employees with degrees has been rising steadily for a number of years. In 2015, the ratio was 8.3 percent (see chart on page 27). The results from the trendence Graduate Barometer Europe confirm that the local cooperative banks also have a good reputation among future university graduates and are even among the holders of the seal of approval awarded to Europe's top 100 employers in 2015. The European survey involved responses from around 300,000 students at 900 universities in 24 countries.
Cooperative banks are aware of the importance of the knowledge and experience of employees for the long-term success of the business. Cooperative banks are regionally based employers who understand that key objectives of personnel activities are to retain suitably qualified employees in the bank, to motivate and develop them, and to attract new employees. 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. This collaboration has borne fruit, demonstrated not least by employees' long periods of service. Almost a third of employees have worked for 'their bank' for more than 25 years (see chart on page 28).
Our objective will continue to be to increase the attractiveness of the Volksbanken Raiffeisenbank Cooperative Financial Network as a place to work and to highlight their unique selling proposition as an employer.
Number of employees*
* Volksbanken Raiffeisenbanken Cooperative Financial Network
Ratio of trainees to other employees*
* Volksbanken, Raiffeisenbanken, central institutions
Proportion of employees with a degree*
* Volksbanken, Raiffeisenbanken, central institutions
Staff members's years of service
The Volksbanken Raiffeisenbanken Cooperative Financial Network again enjoyed a very successful year in 2015, 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 and the BVR Institutssicherung GmbH newly 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 at December 31, 2015. The credit rating agencies Standard & Poor's and Fitch have each given the Cooperative Financial Network a rating of AA–. These ratings have been unaffected by changes to the methodologies employed by the rating agencies, as a result of which the calculation of ratings takes only limited account of the probability of governmental support. The changes have led to numerous rating downgrades in the banking sector. The rating agencies point to the consistently successful business model focused on retail banking as the reason for their positive assessment. A good level of liquidity and funding is structurally secured by virtue of the business model. Capital adequacy is also judged to be above average. The granular credit structure and high proportion of mortgages are the hallmarks of the overall high level of quality in the customer lending business.
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 2015 the protection scheme met, without qualification, all its responsibilities as a bank-protection scheme in accordance with statutory requirements and the articles of association. A total of 1,033 institutions of the Cooperative Financial Network belonged to the BVR protection scheme as at December 31, 2015 (December 31, 2014: 1,062 members). The decrease in membership stemmed solely from mergers.
Further development of the institutional protection scheme
One of the key changes in 2015 was further development to create a dual cooperative protection scheme comprising the existing BVR protection scheme and the newly established BVR Institutssicherung GmbH. The two institutional protection schemes are mutually complementary.
In order to satisfy the changes in the statutory requirements specified in the EinSiG while maintaining the existing level of protection, the Cooperative Financial Network's protection scheme was developed into a dual scheme, for the purposes of which BVR Institutssicherung GmbH (BVR-ISG), a wholly owned BVR subsidiary, was established.
BVR Institutssicherung GmbH
The BVR established BVR Institutssicherung GmbH (BVR-ISG) in 2015; the registered office of the new company is situated in Berlin. The necessary resolutions were unanimously approved at a general meeting of the BVR's members on May 6, 2015.
BVR-ISG operates 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.
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, 2015, the membership comprised 1,031 CRR credit 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.
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 wich 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 contributions to the guarantee fund 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 obtains itself 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 or evaluating levels of capital under Basel III.
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 develops 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 particular, these are in 2015 the central institutions, the mortgage banks, and Bausparkasse Schwäbisch Hall AG.
The overall results of the classification on the basis of the 2014 annual financial statements showed that the prior-year level – which was already very good – was sustained with a slight increase in the average total score. Despite persistent downward pressure on margins, net interest income was maintained on the back of volume growth. Net fee and commission income went up and the cost/income ratio remained at a sound level despite a marginal increase. Viewed over the long term, fair value gains and losses on the measurement of loans and advances are very low. Fair value gains and losses in the securities business also contributed to the good level of earnings overall, which were used by the banks primarily to further bolster their Tier 1 capital.
The rate of contributions paid into the BVR protection scheme's guarantee fund was held in 2015 at 0.12 percent of the assessment basis.
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 2015, this data included information on the banks from a survey on the effect of the low interest rate environment carried out by Deutsche Bundesbank. The information was also made available to the BVR protection scheme in full.
Before the prevention phase, the monitoring of conspicuous institutions is playing an ever more significant role in the early analysis of institutions. In 2015, the monitoring also included institutions that were not showing any particular indications of risk but that could potentially represent a huge 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-to-end 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 strategies for re-establishing 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).
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 2015. Costs were therefore solely incurred 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 2015 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 2016. 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 2016. For this reason, the BVR protection scheme is also not planning to make any significant changes to its guarantee fund capital in 2016, especially as the accumulation of funds in the dual cooperative protection scheme will be focused for the time being primarily on the BVRISG protection scheme to achieve the required target funding level in accordance with section 17 (2) EinSiG.
At its meeting on February 16, 2016, the BVR Association Council approved a resolution based on the protection scheme's statutes to set the rate for contributions to the guarantee fund of the protection scheme in 2016 at 0.04 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 two other member institutions, the contribution rate was set at 0.088 percent of the assessment basis or 2.2 times the basic contribution. Further resolutions concerning contributions were included on the agenda for the general meeting of the BVR's members to be held on June 10, 2016 as part of the approval required for the new BVR-ISG contribution rules.
Following the successful implementation of the EinSiG in mid-2015 with the creation of the dual scheme, the BVR protection scheme is faced with new tasks in 2016 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, following on from initial discussions in 2015, new challenges will arise as a result of the indirect and sectoral supervision responsibilities of the ECB, as demonstrated for example by the ECB's public consultation on institutional protection schemes initiated in the first quarter of 2016. The BVR protection scheme expects yet more issues to emerge in this regard, involving national and international institutions such as the ECB, the German Federal Agency for Financial Market Stabilization (FMSA), the European Single Resolution Board (SRB), and the European Commission.
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.
A historical simulation is 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.
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 risk-bearing 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. Pillar 2 risk-bearing capacity is satisfied in the form of its utilization by existing capital buffers, 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. Under the new German Financial and Risk-Bearing-Capacity Information Regulation (FinaRisikoV), this process will be extended to cover all institutions from 2016.
Together with the primary banks, central institutions, associations, and computing centers, a concept for the bank-wide allocation of risk capital on the basis of a statement of assets and liabilities has been developed. The method underlying this concept is the Markowitz approach to creating efficient portfolios. By implementing the concept, each bank is able to use the strategic risk categories it has selected to carry out an allocation process from an efficiency perspective and to calculate possible allocations.
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 2015 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 15.8 percent as at December 31, 2015 (December 31, 2014: 15.1 percent). Overall, regulatory own funds increased by €6.1 billion to €87.6 billion. The increase was largely attributable to the retention of profits.
The Tier 1 capital ratio improved significantly to 12.4 percent (December 31, 2014: 11.5 percent). For information only, the material Tier 1 capital ratio, i.e. including the reserves pursuant to section 340f HGB, was 14.8 percent (December 31, 2014: 13.8 percent). The Cooperative Financial Network's capital is predominantly held by the primary institutions.
The total risk exposure as at December 31, 2015 amounted to €556.0 billion (December 31, 2014: €541.4 billion). The resulting own funds requirements amounted to €44.5 billion as at December 31, 2015 (December 31, 2014: €43.3 billion).
The protection scheme analyzes the regulatory capital ratios of each member bank. The chart on pages 38/39 shows the distribution of total capital ratios in the Cooperative Financial Network as at the reporting date of December 31, 2015 and as at December 31, 2014. It highlights the continuing healthy level of capital adequacy of the individual banks. The unweighted average for the total capital ratio as at December 31, 2015 was unchanged year on year at 19.0 percent.
The Cooperative Financial Network has healthy capital adequacy thanks to equity of €93 billion (December 31, 2014: 86.5 billion). It has continually boosted its level of capital in recent years by retaining profit. This 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, was calculated for the first time at the level of the institutional protection scheme (BVR protection scheme/BVR-ISG) as at December 31, 2015. The resulting figure of 6.0 percent (minimum requirement of 3.0 percent) also demonstrates the above-average 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 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, 2015
Credit risk, market risk, and liquidity risk
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. The system was developed by the BVR together with its partners in the Cooperative Financial Network and satisfies the regulatory requirements. 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 2015. Lending to retail and corporate customers saw a substantial increase of 4.5 percent compared with 2014. A key factor here was again the rise in home loans and loans to businesses. The growth in corporate banking was predominantly driven by lending to companies in the services, energy, and mining sectors. 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.
Long-term home finance was again a key growth driver in the retail customer business. Consumer home finance lending by the cooperative banks benefited from the favorable economic conditions.
However, residential real estate prices in Germany also continued to go up in 2015. Price rises were particularly high in conurbations, although more modest when considered across the board. In the majority of towns, cities, and rural areas, prices were in line with trends in income and rents.
To help the member institutions monitor the regional markets, the BVR teamed up with vdp Research 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.
Allowances for losses on loans and advances decreased in 2015 by 75.3 percent to €74 million. These allowances remained low, equating to a ratio of 0.01 percent of the total lending volume. In summary, the cooperative banks operate a healthy lending business overall. The Cooperative Financial Network's exposures in respect of bonds from public-sector borrowers in countries particularly affected by the sovereign debt crisis remained at a manageable level, as was the case in previous years. The total carrying amount of these bonds came to €13.6 billion as at December 31, 2015 (December 31, 2014: €13.9 billion).
Interest-rate risk has a significant influence on the banks' financial performance. Despite low interest rates in 2015, the Cooperative Financial Network's net interest income remained largely steady. As in prior years, the largest proportion of net interest income was generated from the net interest margin contribution in the customer business. 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, in April of this year the Basel Committee on Banking Supervision published its new 'Interest rate risk in the banking book' standard, 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. However, specific details still need to be published by the German supervisor during the course of this year. 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 will also be 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 Supervisory Review and Evaluation Process (SREP) supplement for interest rate risk in the banking book.
As in previous years, the Cooperative Financial Network has a reliable liquidity structure that has always proved crisis-resistant so far.
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 institutions collect the liquidity surpluses of the individual institutions, enabling cash pooling within the network of primary banks and specialized service providers. All member institutions of the BVR protection scheme complied with the newly introduced requirements relating to the liquidity coverage ratio (LCR).
Real economy and banking industry
The upward trend in economic growth in Germany continued at the beginning of 2016. According to official preliminary calculations, GDP growth in the first quarter (after adjustment for inflation, calendar, and seasonal effects) was strong at 0.7 percent compared with the previous quarter. The rate of economic growth therefore more than doubled compared with the fourth quarter of 2015 (0.3 percent). However, the pace of expansion in the economy is expected to slow in the second and third quarters.
Based on the data available in the early summer, the BVR anticipates that German economic output adjusted for inflation will rise by around 1.5 percent year on year on average in 2016. This forecast is based on a number of assumptions, including that the economic recovery in the eurozone will be sustained despite the majority vote by the people of the United Kingdom to leave the European Union (Brexit) and that the global economy will gain some momentum. The price of oil is expected to increase slightly and it is not anticipated that there will be any great change in the exchange rate between the euro and the US dollar.
According to forecasts, the marked expansion in consumer spending will remain the main growth driver in 2016. This spending will also continue to be boosted by the influx of refugees into Germany. On the other hand, only a small amount of stimulus is likely to be provided overall by capital investment and foreign trade. One of the factors that is likely to depress capital expenditure is the uncertainty about the future relationship between the United Kingdom and the rest of Europe.
Employment will continue to rise in line with the sustained economic upturn. The number of people in work is likely to rise by around 500,000 in 2016 to 43.5 million. Disregarding the increasing inclusion in the statistics of migrants seeking employment, the unemployment rate will fall by 0.2 percentage points to 6.2 percent.
This outlook is subject to considerable imponderables with the overall prospects on a downward trajectory.
Should the Brexit decision give momentum to centrifugal forces in the European Union thereby weakening the cohesion between the member states or should global economic growth turn out to be weaker than anticipated, this would be likely to lead to a lower rise in GDP in Germany. However, it is also conceivable that global uncertainties could recede faster than predicted, leading to higher growth in the German economy.
The ECB's monetary policy will probably remain highly expansionary, at least initially. The bond-buying program expanded in 2016 will be continued until at least March 2017. The ECB is only likely to consider any increase in interest rates after this program has come to an end. The yields on German government bonds with long maturities will therefore probably remain very low compared with yields in the past.
Compared with 2015, there will be little change in the imminent challenges faced by the banking industry. The outlook therefore remains cautiously optimistic. We now find ourselves in the eighth year of a monetary policy that has prescribed low, zero, and negative interest rates. At the same time, there is barely any slowdown in the growth of regulatory requirements. This continues to present enormous challenges, particularly for smaller and medium-sized banks. These circumstances will again have an adverse impact on the financial performance of the banking industry. The capacity of banks to accumulate capital from their own resources is being impaired. In some cases, this could create an incentive to take excessive risk.
Banks are addressing the growing pressure on income and increasing volume of regulation by initiating further cost efficiency measures, which are resulting in the streamlining of processes and products, but are also causing a fall in employee numbers and rising merger activity. The banks are also attempting to hold their position against competitors by aiming for an even greater focus on customer requirements, for example by expanding digital products and services (omnichannel banking).
Despite the improvements in capital adequacy over the last few years and the reduction in leverage, a rapid rise in interest rates following the long period of low rates would be a dangerous scenario that banks need to take extremely seriously. The persistent European sovereign debt crisis and the consequences of the Brexit decision could also have a potentially negative impact.
Volksbanken Raiffeisenbanken Cooperative Financial Network
The outlook for the business performance of the Cooperative Financial Network in 2016 highlights that the persistently low interest rates, the rise in costs caused by regulatory requirements, and the European bank levy will continue to have an adverse effect on the financial performance of the Cooperative Financial Network. The future financial performance of the Cooperative Financial Network could be subject to risks arising from the general economic climate. Some European countries still have high levels of indebtedness and further intervention by the ECB and/or necessary austerity measures implemented by the governments concerned could have a negative impact on economic trends. Overall, the slight contraction in earnings in 2016 is likely to continue.
Net interest income will decline in all operating segments, 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 will continue to come under increasing pressure. A weakening of economic growth in the eurozone and/or further monetary policy measures by the ECB would probably also have an adverse effect on net interest income.
Allowances for losses on loans and advances are predicted to rise year on year in 2016. In 2015, significant reversals of specific loan loss allowances had a positive impact on overall allowances for losses on loans and advances and such reversals are not planned for 2016. The Cooperative Financial Network expects allowances for losses on loans and advances to normalize in 2016 and change in line with the lending portfolio, new business volume, and the long-term standard risk costs. Allowances for losses on loans and advances recognized in the Cooperative Financial Network would be negatively impacted, in particular, by a sharp economic downturn combined with rising sovereign debt in Europe, the effects of which even Germany would then be unable to escape.
The Cooperative Financial Network expects net fee and commission income to be just as good as in 2015. In particular, the positive assessment of the current capital market environment gives reason to believe that performance fees in the Retail operating segment will lead to a rise in fee and commission income.
Any renewed 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.
Net gains under gains and losses on trading activities are projected to increase in 2016, boosted by the customer-driven capital markets business. The positive income forecast particularly reflects the systematic implementation of strategic measures, especially in connection with institutional customers. The improvement in gains and losses on trading activities depends on there being no further significant fall in interest rates and capital markets remaining stable.
Gains and losses on investments are likely to remain subdued in 2016 because of the absence of positive one-off items.
Other gains and losses on valuation of financial instruments, which in 2015 were primarily influenced by positive effects, are expected to deteriorate significantly in 2016. The forecast trend in this case also reflects the reduced potential for reversing impairment losses.
Net income from insurance business is expected to contract in 2016. One of the main reasons will be an anticipated decline in the net gains under gains and losses on investments held by insurance companies. On the other hand, the targeted increase in market share could give rise to an extremely strong countervailing effect from growth in premiums. Exceptional events in financial and capital markets or changes in underwriting practices may affect the level of net income earned from insurance business.
Administrative expenses are predicted to rise moderately again in 2016. This forecast rise reflects tighter regulatory and statutory provisions and the expenses in connection with the European bank levy. Innovation-related expenditure and capital investment will also go up to safeguard the competitiveness of the Cooperative Financial Network over the long term. In view of the rising administrative expenses, one of the strategic aims is to improve the cost/income ratio by rigorously managing costs and accelerating growth in the operating business.
The merger of DZ BANK and WGZ BANK in 2016 is expected to create not only extensive synergies but also growth potential and earnings potential, especially in the Bank operating segment, although the benefits will only materialize in the medium term from 2017 onward. The Cooperative Financial Network has a compelling business model, supported by sound risk-bearing capacity. The strong support from members and customers, combined with strong capital ratios, enables the Cooperative Financial Network to seize opportunities for growth that present themselves and thus to successfully maintain its outstanding market position in a challenging regulatory environment.