Management Report 2018
about the Volksbanken Raiffeisenbanken
Cooperative Financial Network
Structure, business model, and features of the IPS*
This management report supplements the consolidated financial statements of the Volksbanken Raiffeisenbanken Cooperative Financial Network.
The Volksbanken Raiffeisenbanken Cooperative Financial Network consists of 875 cooperative banks (2017: 915), the DZ BANK Group, Münchener Hypothekenbank eG, the BVR protection scheme, and BVR Institutssicherung GmbH as consolidated entities. The consolidated cooperative banks include Deutsche Apothekerund Ärztebank eG, the Sparda banks, the PSD banks, and specialized institutions such as BAG Bankaktiengesellschaft.
The cooperative banks and Münchener Hypothekenbank eG are the legally independent, equally ranked parent entities of the Cooperative Financial Network, whereas the other banking groups and entities 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 BVR Institutssicherung GmbH.
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 referred to in the Annual Report – Retail Customers and SMEs, Central Institution and Major Corporate Customers, Real Estate Finance, and Insurance – can be found in the notes to the consolidated financial statements starting on page 69.
The pace of growth in the German economy slowed markedly in 2018. Adjusted for inflation, gross domestic product (GDP) rose by 1.4 percent year on year, compared with 2.2 percent in 2017.
Factors on both the demand side and the supply side contributed to this weakening of growth. On the one hand, companies increasingly faced supply-side shortages, primarily of workers and intermediate goods. Moreover, manufacturing was impacted by one-off factors such as strikes, a severe flu epidemic in the early part of 2018, and a backlog of new car registrations (caused by problems with the new Worldwide Harmonised Light Vehicles Test Procedure, WLTP), which weighed heavily on macroeconomic output in the second half of the year. On the other hand, global trade lost some of its momentum compared with the previous year, which took its toll on demand.
The main reasons for the slower pace of global trade were that global economic growth had peaked and trade relations had deteriorated. The latter was predominantly due to the US government’s trade policy, with US President Donald Trump progressively imposing new tariffs on the import of various products, including steel and aluminum. The affected trading partners – above all China, but also European countries – responded with retaliatory tariffs of their own. Nevertheless, Germany’s economic growth was only slightly dented by the trade disputes, not least because domestic demand carried on expanding robustly.
Spending on capital equipment, for example, continued to go up thanks to higher capacity utilization in the manufacturing sector and because funding terms remained extremely favorable.
Construction investment also maintained its growth trajectory, even though shortages of workers became increasingly evident. Rising spending, both by consumers and the state, continued to be an important source of support for macroeconomic expansion. By contrast, foreign trade notionally decreased economic growth, because the increase in imports far outweighed the moderate growth of exports.
In 2018, consumer prices were up by 1.8 percent compared with the previous year and thus rose at a slightly stronger rate than in 2017 (up by 1.5 percent). The main drivers of this overall trend were prices for energy and food, which went up at a disproportionately strong rate due to higher crude oil prices and a poor harvest.
The labor market remained in fundamentally good health, with the number of people in work in Germany climbing by 572,000 year on year to reach 44.8 million.
The number of people out of work continued to fall. Germany’s Federal Employment Agency had 2.3 mil- lion people registered as unemployed on its books, which was 193,000 fewer than in 2017. The unem- ployment rate dropped by 0.5 percentage points to 5.2 percent.
In 2018, the European Central Bank (ECB) gradually began to move away from ultra-expansionary monetary policy. It closed its bond-buying program (quantitative easing) at the end of the year but left key interest rates at their historically low levels. The ECB’s main refinancing rate for eurozone financial institutions remained at 0.0 percent, while the deposit rate was still in negative territory at minus 0.4 percent.
Volksbanken Raiffeisenbanken Cooperative Financial Network
In a difficult market environment shaped by the ECB’s long-standing policy of low interest rates and the continuation of fierce competition, combined with the influence of demanding regulatory requirements, the Volksbanken Raiffeisenbanken Cooperative Financial Network had yet another successful year in 2018. Profit before taxes amounted to €7,771 million, which fell short of the excellent prior-year figure of €8,916 million. With its focus on value creation and customers, the regionally oriented business model of the Cooperative Financial Network nevertheless again proved robust and reliable in these difficult operating conditions. This was clearly demonstrated by the fact that the Cooperative Financial Network’s core operating business generated a very stable level of income that was on a par with 2017. The decrease was largely attributable to turmoil in the capital markets at the end of 2018 and the related falls in securities prices.
In 2018, the cooperative banks generated strong and stable growth in their lending business with retail and corporate customers. Overall, lending to retail and corporate customers increased by 5.5 percent, which was only just short of the 2017 growth rate of 5.6 percent. The main driver of this sustained growth in the lending business was again brisk customer demand for long-term home loans, which was supported by low interest rates on loans, rising incomes, and the positive trends in the labor market. The cooperative banks slightly increased their share of the retail customer market once again compared with the previous year. Their share of the corporate customer market was also a little higher. The Cooperative Financial Network’s deposit-taking business continued to see stable and granular growth, contributing to the funding of its expanding lending business.
Equity advanced by 3.2 percent to €107.7 billion (December 31, 2017: €104.4 billion). This figure underlines the sustainability and future viability of the Cooperative Financial Network. The sound level of capital adequacy provides the Cooperative Financial Network with a sufficient risk buffer while, at the same time, enabling it to seize opportunities for expanding its lending business with retail and corporate customers.
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 FitchRatings. These ratings are encouraging when viewed in comparison with the rest of the sector and emphasize the extraordinary strength of the Cooperative Financial Network by European and international comparison.
The continued popularity of the Cooperative Financial Network in the market was once again clearly demonstrated in 2018 by the sustained growth of its membership. It attracted a further 45,000 members in 2018, both retail and corporate, taking the total membership of the cooperative banks to 18.6 million as at December 31, 2018. Over the past ten years, the Cooperative Financial Network’s membership base has grown by 2.3 million.
Net interest income again decreased slightly year on year to reach €18,368 million in 2018 (2017: €18,638 million). This figure was primarily influenced by the low-interest-rate policy of the ECB and the resulting deterioration of margins. The cooperative banks’ net interest income – the biggest source of income for the Cooperative Financial Network – declined by just 0.8 percent, from €15,917 million in 2017 to €15,783 million in 2018.
Net fee and commission income improved by 5.0 percent, from €6,491 million in 2017 to €6,816 million in 2018. This was primarily due to a rise in fee and commission income and a simultaneous fall in fee and commission expense.
The Cooperative Financial Network’s gains and losses on trading activities decreased to a net gain of €461 million, which was €248 million lower than the prior-year figure of €709 million. Most of this change was accounted for by gains and losses on trading activities in the DZ BANK Group.
Gains and losses on investments deteriorated significantly to a net loss of €913 million (2017: net loss of €144 million). This decrease largely resulted from higher write-downs on securities than in the previous year.
Loss allowances, which were determined in accordance with IFRS 9 for the first time in 2018, amounted to a net addition of €151 million (2017: net addition of €576 million).
Other gains and losses on valuation of financial instruments declined from a net gain of €289 million in 2017 to a net loss of €122 million in the reporting year, predominantly due to the widening of credit spreads. By contrast, the previous year had seen a narrowing of these credit spreads.
The net income from insurance business omprises premiums earned, gains and losses on investments held by insurance companies and other insurance company gains and losses, insurance benefit payments, and insurance business operating expenses. In 2018, this figure decreased by 32.7 percent to €863 million (2017: €1,283 million). This year-on-year change was attributable to a significant fall in gains and losses on investments held by insurance companies and other insurance company gains and losses.
Despite the objective of reducing administrative expenses, they rose slightly in the year under review, by 1.1 percent or €195 million, to €18,079 million (2017: €17,884 million). The bulk of the administrative expenses were attributable to staff expenses, which came to €10,076 million (2017: €10,137 million), and general and administrative expenses, which amounted to €7,011 million (2017: €6,793 million).
Income taxes amounted to €2,369 million in 2018 (2017: €2,843 million), with most of this amount €2,731 million (2017: €2,649 million) attributable to current income taxes. This underscores the particular importance of the Cooperative Financial Network for Germany’s regional authorities, given that it is one of the largest municipal tax payers.
Net profit after tax fell by 11.0 percent to €5,402 million in 2018, compared with €6,073 million in 2017.
The Cooperative Financial Network’s cost/income ratio came to 69.5 percent in 2018 (2017: 65.3 percent).
The consolidated total assets of the Volksbanken Raiffeisenbanken Cooperative Financial Network had risen by €49.9 billion to €1,293.2 billion as at December 31, 2018 (December 31, 2017: €1,243.3 billion). The volume of business increased from €1,662.8 billion in 2017 to €1,724.9 billion in the reporting year.
Of the total assets before consolidation, 62.1 percent was attributable to the cooperative banks (December 31, 2017: 61.7 percent) and 34.9 percent to the DZ BANK Group (December 31, 2017: 35.3 percent). As had also been the case at the end of 2017, the remaining 3.0 percent was attributable to Münchener Hypothekenbank, the BVR protection scheme, and BVR Institutssicherung GmbH.
On the assets side of the balance sheet, loans and advances to customers grew by €33.0 billion or 4.3 percent to €794.9 billion (December 31, 2017: €761.9 billion). As in previous years, this rise in 2018 was predominantly attributable to the cooperative banks, whose loans and advances to customers rose by 5.5 percent and thus kept pace with the excellent 2017 growth rate of 5.6 percent. The main driver of this sustained growth in the lending business was again brisk demand for long-term home loans, which was well supported by persistently low interest rates on loans, rising incomes, and the positive trends in the labor market.
Financial assets held for trading contracted by €0.6 billion or 1.6 percent to €37.5 billion as at December 31, 2018 (December 31, 2017: €38.1 billion). This decline in financial assets held for trading resulted largely from a decrease in derivatives (positive fair values) of €1.5 billion, in shares and other variable-yield securities of €0.4 billion, and in loans and advances of €0.5 billion. These decreases were partly offset by an increase in bonds and other fixed-income securities, which were up by 19.7 percent or €1.8 billion to €10.8 billion.
Investments fell sharply, by €4.6 billion, to €239.1 billion as at December 31, 2018 (December 31, 2017: €243.7 billion). The principle reason was a €5.0 billion reduction in the portfolio of securities. This was partly offset by a small rise in equity investments. Investments held by insurance companies went up by €4.4 billion year on year. This rise was due, in particular, to an increase in fixed-income securities of €4.0 billion and in registered bonds of €0.3 billion.
On the equity and liabilities side of the balance sheet, deposits from customers again grew markedly, rising from €801.0 billion as at December 31, 2017 to €842.4 billion as at December 31, 2018. Deposits from banks also increased, by 5.5 percent, to reach €119.3 billion (December 31, 2017: €113.1 billion).
Financial liabilities held for trading rose by €5.7 billion or 15.5 percent to €42.5 billion (December 31, 2017: €36.8 billion). This was largely due to the 55.4 percent increase to €20.3 billion in the volume of bonds issued including share- and index- and other debt certificates issued (December 31, 2017: €13.0 billion). Conversely, derivatives (negative fair values) declined by €0.7 billion to €16.1 billion and liabilities by €1.3 billion to €5.0 billion.
The Cooperative Financial Network was again able to report a robust level of equity, which advanced by 3.2 percent to €107.7 billion (December 31, 2017: €104.4 billion). The main reason for this rise was the appropriation of profits generated in 2018 to boost reserves. This growth strengthens the Cooperative Financial Network and gives it scope to continue expanding the lending business and to invest for the future.
Capital adequacy and regulatory ratios
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) of the Capital Requirements Regulation (CRR) in conjunction with article 113 (7) 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 cooperative banks. The growth in own funds therefore arises primarily from the profits generated by the cooperative banks and network institutions. Rights issues by the network institutions are for the most part subscribed internally and consolidated within the Cooperative Financial Network.
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 own funds instruments within the
Cooperative Financial Network and therefore particularly affect equity investments of cooperative banks and subordinate receivables due to them from the network institutions, especially from DZ BANK AG. The amounts are consolidated in the relevant own funds categories.
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 Cooperative Financial Network that is lower than the corresponding ratio for the sum of all cooperative banks.
The Cooperative Financial Network’s Tier 1 capital ratio increased again to stand at 13.6 percent as at the end of 2018 (December 31, 2017: 13.4 percent). If the reserves pursuant to section 340f of the German Commercial Code (HGB) are classified as Tier 1 capital, the Tier 1 capital ratio was unchanged year on year at 15.6 percent. At 15.8 percent, the regulatory total capital ratio was down slightly compared with a year earlier (December 31, 2017: 16.0 percent), due in large part to the effect of regulatory transitional provisions. Overall, the Cooperative Financial Network’s own funds increased by €4.0 billion to €101.7 billion. The rise in own funds was largely attributable to the retention of profits from 2017 by the cooperative banks.
As at December 31, 2018, risk-weighted assets stood at €642.4 billion, which was up by €30.9 billion year on year (see the table on page XX). This increase was predominantly due to the growth of loans and advances in customer-related business. In total, credit risk exposures made up 89.6 percent of risk-weighted assets. The banks in the Cooperative Financial Network primarily use the Standardized Approach to credit risk to determine their regulatory capital requirements. Some institutions also apply internal ratings-based (IRB) approaches, including the DZ BANK Group, Münchener Hypothekenbank eG, and Deutsche Apothekerund Ärztebank eG.
Using Tier 1 capital (including reserves in accordance with section 340f HGB and applying the new CRR provisions in full) as the capital basis, the leverage ratio was 7.8 percent as at December 31, 2018 (December 31, 2017: 7.7 percent). This ratio underlines the sound capital adequacy of the Cooperative Financial Network.
|2018 € million||2017 € million||Change (percent)|
|Net interest income||18,368||18,638||–1.4|
|Net fee and commission income||6,816||6,491||5.0|
|Gains and losses on trading activities||461||709||-35.0|
|Gains and losses on investments||-913||-144||>100.0|
|Other gains and losses on valuation of financial instruments||-122||289||>100.0|
|Net income from insurance business||863||1,283||-32.7|
|Other net operating income||528||110||>100.0|
|Profit before taxes||7,771||8,916||-12.8|
Breakdown of change in profit before taxes by income statement items
A: Profit before taxes for 2017
B: Changes in net interest income
C: Change in net fee and comission income
D: Change in gains and losses on trading activities
E: Change in gains and losses on investments
F: Change in loss allowances
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 2017
Breakdown of the total assets held in the Volksbanken Raiffeisenbanken Cooperative Financial Network as at December 31, 2018
|DZ BANK Group|
Breakdown of risk-weighted assets
|Dec. 31, 2018||Dec. 31, 2017||Change (percent)|
|of which Standardized Approach to credit risk|
|of which corporates||174,537||157,653||10.7|
|of which retail business||128,375||122,107||5.1|
|of which secured by mortgages on immovable property||83,224||79,159||5.1|
|Total under the Standardized Approach to credit risk||473,191||447,637||5.7|
|of which IRB approaches|
|of which corporates||43,786||42,808||2.3|
|of which retail business||22,516||20,300||10.9|
|of which equity investments||22,368||21,561||3.7|
|Total under IRB approaches||102,071||99,368||2.7|
|Total credit risk||575,454||547,241||5.2|
|Total market risk||12,927||11,184||15.6|
|Total operational risk||50,884||49,853||2.1|
|Total other exposures (including CVAs)||3,087||3,212||-3.9|
Operating segments of the Volksbanken Raiffeisenbanken Cooperative Financial Network
The operating segments ‘Retail Customers and SMEs’ and ‘Central Institution and Major Corporate Customers’ were previously called ‘Retail’ and ‘Bank’. Their composition has not changed.
Retail Customers and SMEs operating segment (2017: ‘Retail’)
The net interest income generated by the Retail Customers and SMEs operating segment amounted to €16,321 million in 2018 and was therefore again lower than the prior-year amount (2017: €16,489 million ). In the Retail Customers and SMEs operating segment, volume growth only partly offset the sustained negative effects of the ECB’s low-interest-rate policy. The volume of LuxCredit foreign currency lending was almost at the level of the prior year. Net interest income from consumer finance business rose once again thanks to a significant consumer propensity to buy goods and services and take on finance, fueled by the stability of the German economy along with low interest rates and rising real wages.
Net fee and commission income rose significantly, advancing from €6,646 million in 2017 to €6,918 million in the year under review. Net fee and commission income in the Retail Customers and SMEs operating segment in 2018 was once again primarily influenced by income from payments processing and strong customer demand in the securities and funds business. As a result of the sustained period of low interest rates, retail investors are increasingly turning to investment products backed by real estate and tangible assets to supplement their interest-related investments. The volume-related income contribution generated from the average assets under management was one of the key factors in the increase in net fee and commission income in the Retail Customers and SMEs operating segment. However, income from performance-related management fees and from real estate fund transaction fees fell short of the amounted generated in 2017. The contribution to income from the fund services business also improved a little year on year, whereas the volume of assets under management relating to high-net-worth clients was down slightly.
Gains and losses on trading activities in the Retail Customers and SMEs operating segment declined year on year, amounting to a net gain of €195 million (2017: net gain of €213 million). Gains and losses on trading activities are derived from trading in financial instruments, gains and losses on trading in foreign exchange, foreign notes and coins, and precious metals business, and gains and losses on commodities trading.
The level of gains and losses on investments deteriorated by a substantial €956 million to a net loss of €1,130 million in the reporting year (2017: net loss of €174 million), mainly due to write-downs on securities and lower realized gains on the sale of funds in own-account investing activities.
Loss allowances, which were determined in accordance with IFRS 9, amounted to a net addition of €232 million in 2018 (2017: net reversal of €95 million).
In terms of costs, there were further efforts to make the Cooperative Financial Network even more efficient. Overall, it was not possible to further reduce administrative expenses in the Retail Customers and SMEs operating segment and they amounted to €15,386 million in the year under review (2017: €15,245 million). The main influences on this segment’s administrative expenses were appointments to new and vacant positions and average pay rises, although there was a mitigating effect from people leaving – mainly due to retirement. Capital expenditure on the cooperative banks’ digitalization initiative and spending on the standardization of IT banking processes impacted on costs, too. However, this investment is strengthening the Cooperative Financial Network’s future competitiveness. Increased expenses for external research services and higher costs for IT and marketing in the consumer finance business also pushed up administrative expenses in the Retail Customers and SMEs operating segment during the reporting year. For these reasons, a further reduction in administrative expenses was not possible in 2018.
As a result of the factors described above, the profit before taxes of the Retail Customers and SMEs operating segment fell from €8,088 million in 2017 to €6,208 million in 2018. Accordingly, the cost/income ratio increased by 2.6 percentage points to 68.2 percent (2017: 65.6 percent).
Central Institution and Major Corporate Customers operating segment (2017: ‘Bank’)
The net interest income of the Central Institution and Major Corporate Customers operating segment declined again, by €154 million, to €1,371 million in 2018 (2017: €1,525 million).
The Cooperative Financial Network’s corporate banking business has been pivotal in supporting the sustained economic upturn that began some years ago. Over the past few years, the volume of lending has consistently grown at a much faster rate than that of the market as a whole, enabling a sharp rise in the network’s share of the corporate customer lending market. Although economic growth slowed in 2018, the German economy remains robust and is thus making a key contribution to net interest income in the Central Institution and Major Corporate Customers operating segment. At the same time, however, the increasingly challenging competitive environment continues to put pressure on credit margins. Both digitalization and the shift in customer behavior are intensifying the need for innovation and optimization in corporate banking. The sound capital and liquidity position of the majority of large and medium-sized companies enables them to meet their capital investment requirements from their own cash flows or reserves rather than take out loans.
Net interest income also decreased in the money and capital markets business due to portfolio contraction resulting from the shortening of the duration of own-account investments. The adverse impact of subordinated capital diminished as a consequence of the decrease in liabilities-side business.
In the transport finance business, the prior year had been significantly affected by special accelerated depreciation allowances on assets subject to operating leases. The international transport industry again experienced overcapacity within some segments of the international maritime shipping market in 2018, resulting in sharply falling freight rates and considerable downward pressure on ship prices.
Even though shipyards continue to offer attractive prices, ordering activity was fairly sluggish. Supply and demand may therefore need to be realigned. Further orders for new vessels could jeopardize the recovery.
The leasing business saw an increase in net interest income in 2018, mainly due to a sharp rise in the volumes of the digital products ‘VR Smart flexibel’ and ‘VR Smart express’. This offset a slight drop in the non-core business, which is being scaled back in accordance with the strategy. The non-core business includes real estate leasing, centralized settlement, IT leasing, hire purchase and leasing business with a value of more than €750,000, and factoring and international business.
Net fee and commission income in the Central Institution and Major Corporate Customers operating segment came to €550 million in 2018 and was therefore slightly higher than in the previous year (2017: €519 million). The principal sources of net fee and commission income are service fees in corporate banking, capital markets business, and transaction banking. As well as guarantees, these encompass international business, securities issuance business, payments processing, and securities custody. In 2018, net fee and commission income from lending in the transport finance business was on a par with 2017. The levels in the asset management and advice business also changed only minimally.
Gains and losses on trading activities in the Central Institution and Major Corporate Customers operating segment came to a net gain of €267 million in 2018, down by €218 million compared with the net gain of €485 million in 2017. The deterioration of gains and losses on trading activities was predominantly attributable to market-price-related measurement losses, specifically spread-induced measurement losses in interest-rate and fixed-income trading.
Key influences on capital markets during the year under review were the aforementioned continuation of the ECB’s program of quantitative easing and the four interest-rate hikes by the Fed described earlier. The weakening of economic growth that was discernible in Germany and the eurozone in 2018, far-reaching geopolitical changes, and the trade disputes between the United States and China had a detrimental impact on export-dependent sectors of the economy and led to far more volatile stock market prices.
The level of gains and losses on investments improved from a net loss of €17 million in 2017 to a net gain of €195 million in the reporting year as a result of gains from the disposal of securities in the liquidity pool. Some of these gains were offset by losses arising from the termination of hedges in the context of portfolio fair value hedge accounting.
In the transport finance business, the figure for the prior year had notably been affected by impairment losses recognized in respect of equity-accounted entities. The figure for 2018 predominantly comprised gains on the sale of an equity-accounted investment.
Loss allowances, which were determined in accordance with IFRS 9 for the first time in 2018, amounted to a net reversal of €70 million in the reporting year compared with a net addition of €693 million in 2017. This positive trend was predominantly due to borrowers’ rating improvements and successful restructuring and recovery measures, but also to the generally lower loss allowance requirement in the transport finance business.
Other gains and losses on valuation of financial instruments deteriorated to a net loss of €79 million in 2018 (2017: net loss of €10 million) as a result of market conditions. This decrease was mainly attributable to IFRS-related measurement effects relating to hedge accounting and to interest-rate-related measurements of cross-currency swaps.
Administrative expenses went down by €25 million to €1,944 million in the period under review (2017: €1,969 million). In 2017, this item had still been adversely affected by merger-related expenses in connection with the migration of data. The Central Institution and Major Corporate Customers operating segment was able to make savings on its staff expenses in 2018 due to reduced expenditure on variable remuneration. These savings were partly offset by higher expenses for the bank levy and by increased project-related consultancy and IT expenses.
Profit before taxes in the Central Institution and Major Corporate Customers operating segment climbed by €524 million year on year to €431 million (2017: loss of €93 million) due to the factors described above. The cost/income ratio rose from 76.6 percent in 2017 to 84.3 percent in the reporting year.
Real Estate Finance operating segment
The net interest income of the Real Estate Finance operating segment amounted to €1,423 million in 2018 (2017: €1,492 million) and was again adversely affected by the sustained low level of interest rates in the capital markets. In the case of loans issued under advance or interim financing arrangements, the Cooperative Financial Network’s Real Estate Finance operating segment managed, at the same time, to strengthen its non-collective income base in terms of volume on the back of a marked expansion in business over the last few years and despite a fall in average returns. Thanks to expansion of the portfolio, this growth more than offset the decline in income from home savings loans and other building loans. The increased customer demand for home savings bears testimony to the particular merits of home savings, which enable customers to enjoy steady capital growth irrespective of economic conditions. The German investment market for commercial real estate also made an encouraging contribution in 2018, although it did not quite match the income generated in 2017. The high prices of real estate assets in prime locations encouraged German investors to invest in properties at sites outside the major cities. The increase in the level of competition in previous years, combined with higher demand caused by pressure from investors in Germany and abroad, led to a further rise in the prices of commercial real estate and in prices in the market for commercial investments in housing in the year under review. Higher tax receipts for local authorities resulted in growth in the public-sector business as well in 2018.
The net expense traditionally reported for this operating segment under net fee and commission income dropped by €12 million to a net expense of €110 million (2017: net expense of €122 million). This improvement was due to a fall in fees and commissions not directly attributable to the conclusion of a home savings contract. The substantial growth in home savings and home finance underscores the marked preference among German citizens for personal pension arrangements based on home ownership.
The level of gains and losses on investments in the Real Estate Finance operating segment declined, by €19 million, to reach a net gain of €6 million (2017: net gain of €25 million). Gains and losses on investments consist of gains and losses on securities and gains and losses on investments in subsidiaries and equity investments.
The net reversal posted under loss allowances in the Real Estate Finance operating segment decreased from €12 million in 2017 to €2 million in the year under review.
Other gains and losses on valuation of financial instruments in the Real Estate Finance operating segment deteriorated significantly year on year, amounting to a net loss of €16 million in 2018 (2017: net gain of €292 million). This decrease was mainly caused by a widening of credit spreads on bonds from the peripheral countries of the eurozone in the mortgage lending business, whereas credit spreads had narrowed in 2017.
Administrative expenses rose to €885 million in 2018 (2017: €804 million). This increase was mainly due to additional expenses for consultancy and IT costs in relation to strategic projects as well as measures to enhance the Real Estate Finance operating segment.
Profit before taxes in the Real Estate Finance operating segment fell by a substantial €451 million to €477 million in the reporting year (2017: €928 million). The performance of the Real Estate Finance operating segment, as outlined above, meant that the cost/income ratio rose to 65.1 percent (2017: 46.7 percent).
Insurance operating segment
Net premiums earned went up by €816 million to €15,997 million (2017: €15,181 million), reflecting the integral position held by the R+V subgroup within the Cooperative Financial Network. This exceeded the level of premiums earned in 2017 by 5.4 percent. Gross premiums written increased by 5.2 percent to €16,133 million in the year under review (2017: €15,338 million), also surpassing the excellent level of premiums written in 2017.
Premium income in the life insurance and health insurance business grew by a total of 3.2 percent to €7,868 million. In the life insurance business, premiums rose markedly, by 2.9 percent, to €7,273 million. This growth was predominantly attributable to higher one-off premiums, particularly in the Neue Garantien and bAV (occupational pensions) product lines, whereas premiums from products in the classic and unit-linked businesses declined.
In the health insurance business, net premiums earned rose by 6.3 percent to €595 million. The year-on-year growth in the full health insurance and other supplementary insurance lines was particularly encouraging. On the other hand, the occupational health insurance and private long-term care insurance lines contracted.
In the non-life insurance business, premium income grew by 4.8 percent to €5,788 million, with most of this growth being generated from vehicle insurance and corporate liability insurance business.
Premium income from the inward reinsurance business rose by 15.1 percent to €2,341 million. The business in Europe performed well on the whole, with particularly strong growth in the United Kingdom. Business was also encouraging in Asia, whereas other regions registered a decrease in premiums.
Gains and losses on investments held by insurance companies and other insurance company gains and losses declined by 62.0 percent to a net gain of €1,342 million (2017: net gain of €3,531 million). At the end of the year under review, the level of longterm interest rates was slightly below the corresponding level at the end of the previous year. At the same time, the significant widening of spreads on interest-bearing securities had an adverse impact on this item during the year under review. Equities markets relevant to R+V did worse during the course of 2018 than they had in the prior year. In 2018, movements in exchange rates between the euro and various currencies were noticeably more favorable overall than in the previous year.
Overall, these trends in the reporting year essentially resulted in a €1,695 million deterioration in unrealized gains and losses to a net loss of €1,297 million (2017: net gain of €398 million), a €1,195 million deterioration in the contribution to earnings from the derecognition of investments to a loss of €21 million (2017: gain of €1,174 million), and a fall of €121 million in current income and expense to income of €2,346 million (2017: income of €2,467 million). On the other hand, foreign exchange gains and losses improved significantly, by €838 million, to a net gain of €181 million (2017: net loss of €657 million) and the balance of depreciation, amortization, impairment losses, and reversals of impairment losses improved by €91 million to a net expense of €50 million (2017: net expense of €141 million).
Owing to the inclusion of provisions for premium refunds (particularly in the life insurance and health insurance business) and claims by policyholders in the fund-linked life insurance business, the change in the level of gains and losses on investments held by insurance companies also affected the ‘insurance benefit payments’ line item presented below.
Net insurance benefit payments decreased by 7.2 percent from €15,312 million in 2017 to €14,208 million in 2018. At the companies offering personal insurance, the changes in insurance benefit payments were in line with the change in premium income and in gains and losses on investments held by insurance companies and other insurance company gains and losses. An amount of €305 million (2017: €827 million) was added to the supplementary change-in-discountrate reserve. The ‘corridor method’ for calculating the supplementary change-in-discount-rate reserve was introduced in accordance with the German Regulation for Amending the Regulation on the Principles Underlying the Calculation of the Premium Reserve (DeckRV), which came into force on October 23, 2018. This method changed the procedure for determining the reference discount rate in order to restrict excessive changes under the previous rules. The corridor method was applied retrospectively for the whole of 2018 for those R+V Group companies offering personal insurance that were affected.
The non-life insurance business had to absorb expenses arising from storms Friederike and Burglind of around €90 million and from storms Wilma and Yvonne of around €50 million during the reporting year. Overall, the level of natural peril losses was within the anticipated claims budget.
In the inward reinsurance business, the net claims ratio was considerably lower than in the previous year. Notable natural disaster events included the Camp Fire in California, Typhoons Jebi and Trami in Japan, and Hurricane Michael in Florida, which together gave rise to a total expense of €149 million.
Insurance business operating expenses went up by 4.9 percent to €2,721 million (2017: €2,595 million) in the course of ordinary business activities in all divisions, with a particularly sharp rise in the nonlife and inward reinsurance segments.
As a result of the factors described above, profit before taxes for the reporting year fell by €382 million to €413 million (2017: €795 million).
Human Resources Report and Sustainability Report
Human Resources Report
The financial sector faces huge challenges as a result of far-reaching changes in its environment. The transformation into a digital world, a shift in customers’ expectations, and the transition to an information society with the postulate ‘life-long learning’ all place new demands on employees and managers, including in the Cooperative Financial Network. Moreover, there have been changes among employees across all age groups about what they expect from their immediate working environment.
It is increasingly recognized that the digital transformation can only be effective if the implementation of new technologies is accompanied by a fundamental cultural shift at the individual banks. This cultural evolution starts with the broad-based use of digital media but also encompasses internal communications and necessitates both a revised approach to management and increased flexibility in terms of working hours and location. From a human resources perspective, banking of the future at the cooperative banks will require employees and managers to be well-versed in the use of digital applications, to be open to the opportunities of digitalization, and to practice a measured risk culture when it comes to dealing with these new areas. A high level of willingness to embrace change at every level and having the necessary organizational structures in place are crucial if the individual bank is to successfully equip itself for the future.
In this process, the cooperative banks are supported by a comprehensive range of products and services from the cooperative associations, academies, and service providers. Specially designed professional development activities are available for employees, managers, and members of boards of managing directors that help to equip them for this upcoming transformation.
Human resources activities at the level of the individual cooperative banks also need to change. The focus is not only on improving the efficiency of human resources work by deploying suitable IT tools but also on sharing the work more widely with HR service providers within the Cooperative Financial Network and, in particular, on increasing the HR expertise of staff in the department. For this reason, the Bundesverband der Deutschen Volksbanken und Raiffeisenbanken e.V. (BVR) [National Association of German Cooperative Banks] launched a project relating to human resources work of the future in 2018. The objectives of the project are as follows:
Formulation of a new strategic blueprint for future human resources work so that the cooperative banks can continue to cater to the changing requirements faced by their workforce
Incorporation of the products and services of the cooperative HR service providers into this strategic blueprint for future human resources work
If a cooperative bank’s workforce is to be a key factor in the information society, then human resources activities will also take on a fundamental role by making an invaluable contribution to the institution’s efforts to equip itself for the future.
Another vital factor for the future is the ability of individual cooperative banks to recruit and retain well qualified young people. The ‘next’ initiative for trainees has been enhanced in order to provide the member institutions with effective support in this process. In 2018, five trainees were again selected for the ‘next’ ambassador team to act as authentic proponents of the local cooperative banks’ traineeship programs. The career websites were also revised in 2018, while the hashtag @wirsindnext (‘we are next’) has been launched for use on social media. Two new digital platforms enable contact between all trainees and with trainers and marketing managers across Germany. At the next Drehmoment (‘next turning point’) event, trainees from across Germany met with experts in banking, training, education, and work for the first time, participating in workshops to gain fresh motivation and develop ideas for the future. The popularity of the local cooperative banks as a trainer and employer was confirmed when they were included in the Trendence institute’s 2018/2019 ranking of the most sought-after employers for school-leavers for the 13th time in succession.
Although a traineeship in banking continues to be highly regarded as an entry-level qualification, significant changes are taking place. The ratio of trainees to other employees fell slightly, although it remains at a high level compared with other sectors. At the end of the year, the ratio stood at 6.3 percent (December 31, 2017: 6.8 percent; see chart on page XX). The decrease is partly due to the lack of suitably qualified applicants and forward-looking HR planning. The reorganization of the workforce was also reflected in the number of employees, which decreased slightly in the reporting year to 176,583 (December 31, 2017: 179,598; see chart on page XX).
Currently, around 90 percent of all traineeships in the cooperative banks are banking traineeships. In view of the digital revolution, however, HR planning is increasingly focusing on other occupations too. This includes traineeships in dialog marketing, IT and, since August 2018, a traineeship in the newly recognized occupation ‘e-commerce’. The proportion of employees with a degree rose from 8.0 percent to 8.4 percent in 2018 (see chart on page XX). For the seventh time in a row, the local cooperative banks were ranked among ‘Germany’s top 100 employers’ by the trendence Absolventenbarometer. This survey asked around 14,000 students approaching their final exams about their ideal employer and their career goals.
Number of employees*
* Volksbanken Raiffeisenbanken Cooperative Financial Network.
Years of service*
* Cooperative banks and DZ BANK AG
Ratio of trainees to other employees*
* Cooperative banks and DZ BANK AG
Proportion of employees with a degree*
* Cooperative banks and DZ BANK AG
For many years, the idea of sustainability has been a guiding light for politicians, businesspeople, and environmentalists. One of the most widely used definitions of the term sustainability is the one developed by the United Nations in 1987: “Sustainable development is development that meets the needs of the present generation without compromising the ability of future generations to meet their own needs.” According to this definition, sustainable development refers both to the present and to the future. The Cooperative Financial Network promotes sustainable development from an economic, social, and environmental perspective.
Owners: achieving more together
The identity principle is what makes the cooperative different from all other types of company structure. Its members are also its owners and customers. More than half of its customers have proactively decided to become a member. The cooperative banks have 18.6 million members across Germany. The cooperative banking remit to provide development finance entails collaboration in a spirit of partnership aimed at mutual benefit. It also defines the ethical business context: According to section 1 of the German Cooperative Act (GenG), the nature of the business has to be oriented to the long-term success of its members. Partnership, self-responsibility, and helping people to help themselves are thus part of the cooperative DNA.
Cooperative advocacy, along with the annual general meeting or general assembly of representatives and the supervisory board (whose members are businesspeople from the region), ensures opportunities for involvement in the democratic process and encourages dialog within society on economic, social, and environmental issues. At the same time, the local cooperative banks learn from the collaboration with their cooperative governing bodies, adopt business innovations, and embrace changing requirements in order to put their business models on an efficient footing for the future in line with market needs.
In accordance with their remit to provide development finance, the cooperative banks independently align the nature of their business to the long-term success of their members and customers, taking a grass-roots democracy approach. A responsible business policy with a strong focus on members and on the common good is thus an integral element of their corporate strategy. For more than 170 years, they have been supporting, encouraging, and advising local people and companies through their financial services and playing a vital role for the real economy through responsible lending. They operate and do business on the basis of mutuality: Each cooperative bank belongs to its members, who benefit from the strength and solidarity of a powerful community. Moreover, an annual dividend enables members to share directly in the business success of the cooperative banks.
The local cooperative banks have always adhered to the principle of sustainability and pass on their economic success to the regions in which they operate.
They play a proactive role in the economic, social, and cultural development of their local area. They effectively expand their cooperative network structure through donations, sponsorship, and the voluntary activities of their employees in the community. At the same time, the remit to provide development finance defines the sustainable value creation process at the core of their day-to-day business. The combination of commercial viability and corporate responsibility underpins their regional strength, which they continually develop and expand.
In the challenging times created by the digital transformation and social change, the cooperative movement’s strengths of customer proximity and regional roots are needed more than ever before. The cooperative banks are updating their values-based business model for the future, in dialog with their members and for their benefit.
Corporate social responsibility (CSR)
Every year, the BVR conducts a survey of all member institutions in order to record the Germanywide CSR data of the Cooperative Financial Network. This provides tangible proof of how the many differentengagementactivitiesintheregionscombine to create a force to be reckoned with at national level and highlights the particular contribution that the cooperative banks make to society (CSR reports of the local cooperative banks). The entities of the DZ BANK Group have also established various products, concepts, and processes that are based on environmental, social, and ethical criteria.
The latest figures for 2018 show that the Volksbanken Raiffeisenbanken Cooperative Financial Network is constantly stepping up its activities as a corporate citizen. The local cooperative banks and their specialized institutions provided financial assistance totaling €145.2 million to people in Germany. Donations from the Volksbanken Raiffeisenbanken and other cooperative banks reached €97.7 million and local communities benefited from sponsorship worth €36.7 million; income from charitable foundations added a further €10.8 million. This ever stronger commitment, not just in 2018 but also in the years before, reflects the healthy financial results of the Cooperative Financial Network. This shows that good financial performance is not an end in itself but leads to more being done for local needs.
Furthermore, the foundation assets of the Volksbanken Raiffeisenbanken Cooperative Financial Network amounted to €318 million at the end of 2018. This sum has been rising steadily for years. This total volume of foundation assets has more than doubled in recent years. To put that into context, the equivalent amount at the end of 2009 was only €125 million. Support for charitable foundations is a particularly sustainable form of social engagement. Reflecting the sustainability and long-term orientation of the 875 cooperative banks’ business philosophy, this commitment to charitable foundations represents a very durable way of backing local projects.
Combined Opportunity and Risk Report
The following 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 individual institutions as a secondary element. In this context, risk management at the level of the protection scheme is mainly focused on preventing individual institutions from getting into difficulties.
Risk reporting covers all entities in the scope of consolidation for the purposes of commercial law. The scope of consolidation for the consolidated financial statements therefore goes beyond the companies consolidated for regulatory purposes and is not limited to the members of the protection scheme.
Risk management in a decentralized organization
The BVR protection scheme and BVR Institutssicherung GmbH 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, form the backbone of risk management in the Cooperative Financial Network.
Institutional protection scheme of the Cooperative Financial Network
BVR protection scheme (BVR-SE)
BVR-SE is Germany’s and the world’s oldest deposit guarantee fund for banks and is financed entirely without government support. Since its creation in the 1930s in the wake of the global economic and banking crisis, it has always ensured that all affiliated banks have been able to meet their financial obligations, particularly with regard to the deposits of retail customers. BVR-SE is regulated and monitored by the Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin) [German Federal Financial Supervisory Authority].
Since the German Deposit Insurance Act (EinSiG) came into effect on July 3, 2015, when it became necessary to establish a legally recognized deposit insurance scheme, BVR-SE has been continued as an additional voluntary bank-protection scheme in accordance with section 2 (2) and section 61 EinSiG.
The main and unchanged aims of BVR-SE are to ensure stability 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 Financial Network. So that it can provide the necessary support in securing these aims, BVR-SE has access to a guarantee fund that is funded by contributions from the member banks. If necessary, the institutions will also support each other with additional funding (guarantee obligations).
In 2018, BVR-SE met, without qualification, all its responsibilities as a bank-protection scheme in accordance with the articles of association. A total of 885 institutions of the Cooperative Financial Network belonged to BVR-SE as at December 31, 2018 (December 31, 2017: 926 members). The decrease stemmed solely from mergers within the Cooperative Financial Network.
BVR Institutssicherung GmbH (BVR-ISG)
BVR-ISG is an officially recognized deposit guarantee scheme and, since July 1, 2015, has been operating an institutional protection scheme within the meaning of article 113 (7) of Regulation (EU) No. 575/2013 for CRR credit institutions that has been approved by the regulator. 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 its member institutions. 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 requirements regarding deposit protection for customers.
Together, BVR-ISG and BVR-SE form the Cooperative Financial Network’s dual protection scheme. The members of the BVR-ISG protection scheme are those CRR credit institutions that also belong to the BVR and are affiliated to BVR-SE. As at December 31, 2018, the membership comprised 883 CRR credit institutions (December 31, 2017: 924), which is all of the banks in the Cooperative Financial Network that are authorized in Germany by BaFin.
Under section 50 (1) EinSiG, BVR-ISG is subject to supervision by BaFin and to monitoring by the Bundesrechnungshof (BRH) [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 BVR-SE. Dual employment contracts and a service agreement are in place so that BVR-ISG’s
day-to-day business operations can be carried out by the BVR employees who perform the corresponding functions for BVR-SE. Given the long-established successful operation of BVR-SE, 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.
The focus of the activities of BVR-ISG in 2018 was on fulfilling its responsibilities as defined by law, the articles of association, and regulatory requirements. The activities centered on the risk-based collection of contributions, which is compliant with the relevant guidance of the European Banking Authority (EBA), the management of funds, extensive operational stress tests, and preparations for the IPS recovery plan in accordance with the Minimum Requirements for the Design of Recovery Plans (MaSan). BVR-ISG can look back on a highly successful year, having not had to take any action to protect depositors or banks or pay any compensation in accordance with section 145 of the German Bank Recovery and Resolution Act (SAG) at any time in 2018.
Risk identification and analysis
The Cooperative Financial Network is a decentralized organization made up of legally independent institutions that are linked – through BVR-SE – by their liability. This decentralized element is in contrast with banking groups that have a parent company at the top of a hierarchical structure. Consequently, the power to make business decisions lies with each individual institution and its independent Board of Managing Directors and Supervisory Board. This decentralized structure determines the focus of risk management for BVR-SE. The focus is above all on overall analysis of the financial risk carriers – i.e. the institutions – rather than on isolated analysis of individual risk types and their scope. 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.
BVR-SE has 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 BVR-SE’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. Rating a bank in accordance with the classification system provides the basis for determining the risk-adjusted guarantee fund contributions of BVR-SE and is also the starting point for preventive management.
The results of the classification are supplemented by further analysis and data, 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 is predominantly based on information from the institutions’ accounting and reporting systems. 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, BVR-SE prepares special analyses on specific issues and specific risks, such as determining the impact of sustained low interest rates.
In accordance with its risk-oriented mode of operation, BVR-SE performs individual bank analyses on institutions of major financial significance to the protection scheme as a whole. 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 BVR-SE’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).
Classification process and contributions to the BVR 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 the nine credit rating categories, which range 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. BVR-SE receives this data electronically from the regional auditing association responsible for the individual bank.
All institutions covered by BVR-SE are included in the classification system. Only a small number of institutions are not included, notably those that are rated separately by an external rating company, e.g. DZ BANK AG and its subsidiaries as well as Münchener Hypothekenbank eG.
The classification process in 2018 was based on an analysis of data from the 2017 financial statements. There was another year-on-year improvement in the class distribution that was attributable to a further small boost to the risk position, a virtually unchanged level of net assets, and a slightly poorer financial performance across the network as a whole. Adjusted for non-recurring items, net interest income went down only slightly, whereas net fee and commission income rose and the cost/income ratio held more or less steady. Loss allowances for loans and advances were exceptionally low, as had been the case in previous years. There was a slight drop in the proportion of unsecured lending classed as loans with a high probability of default or as non-performing loans (NPLs).
The net profit generated was used to strengthen the financial position, in particular Tier 1 capital.
For the institutions that are also members of BVRISG, the 2018 rate for contributions to the guarantee fund of the protection scheme was set at 0.036 percent of the assessment basis (unchanged on 2017), taking account of any individual discounts or surcharges resulting from the classification. For the other member institutions, the contribution rate was 0.0828 percent of the assessment basis.
Risk management and monitoring
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.
The results of the classification process provide the basis for BVR-SE’s systematic preventive management. Preventive management is used whenever a bank is classified as B– or lower on the basis of its annual financial statements. In addition, other key figures and data have increasingly been used over the past few years so that any anomalies at institutions can be identified at an early stage. In 2018, this data included multi-year planning information from the banks’ reporting systems, all of which was made available to BVR-SE.
Before the prevention phase, the monitoring of conspicuous institutions is playing an ever more significant role in the early analysis of institutions. In 2018, 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 BVR-SE’s work away from restructuring and toward end-to-end preventive management that also includes monitoring.
As before, the work of BVR-SE in restructuring member institutions is 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 future viability while accommodating the interests of all members of the Cooperative Financial Network.
The ‘Manual for future-proof bank management – guidelines for reorganizing and restructuring cooperative banks’, which was revised in 2017, forms the basis for providing restructuring assistance and carrying out restructuring measures. The principles documented in the manual provide affected banks with guidance on re-establishing competitive structures, e.g. through recovery, and describe concepts for restoring their fundamental profitability. The aim is for the banks to complete this restructuring phase within no more than five years. BVR-SE’s manual is also specifically aimed at banks undergoing preventive measures and any institutions that have themselves identified the need for reorganization.
BVR-SE 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 2018. Costs were therefore incurred solely in connection with legacy cases, where risks already covered had become acute or loss allowances were recognized in BVR-SE’s annual financial statements. As BVR-SE also focused on dealing with and finalizing legacy cases in 2018, the level of restructuring activity fell to an almost immaterial level in the reporting year. The total restructuring amounts in need of protection were not only significantly lower than expected, they were also – on a net basis – again far smaller than the repayments under debtor warrant obligations and other guarantee release obligations. This meant that the capital base of the dual cooperative institutional protection scheme (comprising BVR-SE and BVR-ISG) was strengthened once again in 2018 and, as planned, the statutory guarantee fund resources at its disposal could be expanded yet again.
Outlook for the BVR protection scheme and BVR Institutssicherung GmbH
In financial terms, BVR-SE expects the cooperative banks’ performance to be unchanged or to weaken slightly in 2019. At present, there is no sign of any scenarios that might present a material threat to the stability of BVR-SE. Particularly in view of the slowing German economy, however, an increase in the level of support and assistance provided by BVR-SE cannot – for the first time in five years – be ruled out in 2019. In light of this potential adverse development, BVR-SE plans to strengthen its guarantee fund capital in the next few years.
Against this backdrop, the BVR Association Council decided in November 2018 to increase the contribution rate for 2019. The rate for contribution to BVRSE’s guarantee fund was set at 0.05 percent of the assessment basis for the institutions that are also members of the BVR-ISG protection scheme (2017: 0.036 percent). For the other member institutions, the contribution rate was raised from 0.0828 percent to 0.0924 percent of the assessment basis.
This year, BVR-ISG again faces the task of implementing regulatory requirements, such as preparing recovery plans within the meaning of sections 12 to 20 SAG. It is also likely that new disclosure requirements will arise as a result of indirect and sectoral supervision by the ECB, in particular broader and stricter requirements at the level of the Cooperative Financial Network. BVR-SE expects yet more issues to emerge in this regard, involving international institutions such as the European Single Resolution Board (SRB), the EBA, and the European Commission. Such issues could affect BVR-SE and/or BVR-ISG. The EBA is due to carry out extensive activities in connection with the regular review of the EU Deposit Guarantee Schemes Directive (DGSD), which was scheduled for 2019 back in 2014. BVR-ISG will be supporting these activities by participating in a number of the EBA task force’s working groups.
Regulatory capital management
The consolidated financial statements of the Cooperative Financial Network provide a comprehensive overview of the main capital ratios, particularly the consolidated regulatory capital ratios. These capital ratios are calculated in accordance with the provisions of the CRR using the extended aggregated calculation pursuant to article 49 (3) CRR in conjunction with article 113 (7) CRR. Information concerning the regulatory capital ratios relates to the reporting date of December 31, 2018 and does not include the retention of the profits reported in the 2018 annual financial statements. Profit is retained after the individual institution’s relevant committees have given their approval. This retention of profits will significantly strengthen the capital base still further in 2019.
The Tier 1 capital ratio improved to 13.6 percent (December 31, 2017: 13.4 percent). If the reserves pursuant to section 340f of the German Commercial Code (HGB) are classified as Tier 1 capital, the Tier 1 capital ratio was unchanged year on year at 15.6 percent. The Cooperative Financial Network’s regulatory total capital ratio was 15.8 percent as at December 31, 2018 (December 31, 2017: 16.0 percent). Overall, regulatory own funds increased by €4.0 billion to €101.7 billion. The rise in own funds was largely attributable to the retention of profits from 2017 by the cooperative banks, which was reflected in the ratios as at December 31. The Cooperative Financial Network’s capital is predominantly held by the cooperative banks.
The total risk exposure as at December 31, 2018 amounted to €642.4 billion (December 31, 2017: €611.5 billion). This 5.1 percent increase was driven by growth in the customer lending business, in both the retail and the corporate banking segments.
BVR-SE analyzes the regulatory capital ratios of each member bank on an ongoing basis. The institutions themselves are responsible for fulfilling the regulatory requirements at all times, including in respect of bank-specific SREP surcharges (e.g. for interest-rate risk, other material risks, and/or stress test results). As shown by the chart on page XX, the
capital adequacy of the individual institutions in the Cooperative Financial Network was at a healthy level as at the reporting date of December 31, 2018. This had also been the case as at December 31, 2017.
The Cooperative Financial Network has healthy capital adequacy thanks to equity of €107.7 billion (December 31, 2017: €104.4 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 calculated for the Cooperative Financial Network on a pro forma basis, came to 6.9 percent as at December 31, 2018 (December 31, 2017: 6.8 percent). This is further proof of the above-average capital adequacy of the Cooperative Financial Network. The ratio is calculated for the Cooperative Financial Network by applying the requirements (adjusted appropriately) of article 429 CRR. This 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 Cooperative Financial Network. The risk exposures were determined by aggregating the individual leverage ratio submissions of all the member banks and adjusting them for material internal exposures within the joint liability scheme. This approach factors in the zero weighting given to internal exposures within the network, which will be implemented for the member institutions when CRR II is introduced. If the reserves pursuant to section 340f HGB are classified as Tier 1 capital and the pertinent CRR I provisions are applied in full, the leverage ratio was 7.8 percent (December 31, 2017: 7.7 percent). The leverage ratio total exposure increased by 4.2 percent year on year, rising to €1,269.8 billion.
Economic capital management
Risk capital management is a core task at each individual institution. Pursuant to the Minimum Requirements for Risk Management (MaRisk), it must be structured according to the complexity, scope of
business activities, and size of the bank. The banks receive procedural support through the VR Control concepts and VR Control software.
Risk capital management is influenced by two factors: firstly the business necessity of optimally allocating risk capital to various risk categories while taking account of risk/reward considerations and, secondly, the new requirements of the Internal Capital Adequacy Assessment Process (ICAAP). The BVR drew up the necessary integrated concept in the VR Control update project, and it will be made available to the banks in 2019.
At a business management level, the interest-rate and credit risk categories – usually the main risk categories for the cooperative banks – are included in the optimization calculation. According to the basic concept of capital market theory, where there are given risk/return figures in each class and each correlation, combinations can be found that ensure an optimum ratio in the overall portfolio at overall bank level.
Alongside these business considerations, the banking regulator has supplemented risk measurement in Pillar I with its own Supervisory Review and Evaluation Process (SREP) and worked out a system of bank-specific surcharges for interest-rate risk and other material risks as well as a stress scenario surcharge. The surcharges were again at a manageable level for the banks in 2018, and the surcharges for other material risks fell sharply compared with 2017.
The proportionality of the individual institutions is taken into account when managing risk-bearing capacity in connection with risk capital management. The German banking regulator has comprehensively redrafted the 2011 prudential paper on the supervisory assessment of bank-internal capital adequacy concepts and, with the aim of harmonization, adapted it to the principle of significant institutions (SIs). The new concept for risk-bearing capacity consists of both a normative perspective (capital planning) and an economic perspective that is based on complete risk modelling from a value-based perspective.
This new concept means a change of method for the institutions, because more than 99 percent of them previously took a going-concern approach using HGB results. To help them with this change, the BVR has – as part of its remit to act as a catalyst and provide technical guidance – put in place various support services designed to equip the banks to tackle
the challenges that they will face going forward. Cooperative banks, auditing associations, the computing center, and DZ BANK were involved in drawing up the concept. Alongside the project, an impact analysis was conducted at a number of banks. It confirmed their resilience, including under the new approach.
The new concept provides the basis for the necessary IT-based implementation support and should enable the banks to carry out the required calculations using their existing IT tools. Full implementation of the new guidelines will take some time and, after the banks’ experts have studied them in detail, there will be an initial trial phase before the banks switch to the new calculation. The banking regulator specifically stated in an annex to the guidelines that there is a time-limited option to continue with the old going concern model during transition to the new concept.
Credit ratings of the Cooperative Financial Network
The high credit ratings of the Cooperative Financial Network remained stable and unchanged in 2018. Credit rating agencies Standard & Poor’s and FitchRatings have each given the Cooperative Financial Network a rating of AA–. The credit ratings are based on the economic strength of the Cooperative Financial Network. This can be seen from the individual ratings, which are all at an identical level. The rating agencies point to the consistently successful business model focused on retail and corporate banking as the reason for their positive assessment. The funding of the business model is based on customer deposits, so it is structurally secured for the long term. Liquidity is ensured at all times 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 in terms of quantity and quality. The rating agencies recognize the ability and note the 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. BVR-SE 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.
Distribution of total capital ratios in the Cooperative Financial Network*
Proportion of institutions (percent)
Total capital ratio up to … percent
* As at December 31, 2018
Credit risk, market risk, liquidity risk, and operational risks
Credit risk in the customer business is the most important risk category in the cooperative banks. To assess the creditworthiness of individual borrowers, the cooperative banks use the relevant segment-specific VR rating systems, which are validated centrally on an ongoing basis in accordance with high market standards. The vast majority of the banks, particularly when analyzing risk-bearing capacity, use portfolio models to measure risk at portfolio level. These models are also constantly reviewed at both overall model level and parameter level.
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 risk-conscious lending policy. The cooperative banks are conservative in their lending decisions. Their knowledge of customers plays a central role, as does the capacity of customers to meet their obligations. 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 significant growth in its lending business in 2018. Loans and advances to customers increased by 4.3 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 2018. On average across all 401 municipal and rural administrative districts, prices for purchasing residential properties for own use rose by 5.9 percent (2017: 5.4 percent). The price rises were geographically well distributed in 2018, with increases in both urban and rural areas.
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, the construction sector, and further processing companies. Because of their regional roots, the local cooperative banks have also 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.
Loss allowances decreased to €151 million in 2018 (2017: €576 million). This yearon-year fall was due to the reduced recognition of loss allowances for legacy exposures in ship and offshore financing. Loss allowances remained low at 0.02 percent of the volume of loans and advances to customers and banks (total volume: €813,716 million). As at December 31, 2018, the Cooperative Financial Network’s NPL ratio (non-performing loans as a proportion of the total lending volume) stood at 1.7 percent (December 31, 2017: 2.0 percent). This encouraging decrease in the NPL ratio was attributable to contraction of the volume of NPLs and a rise in the total lending volume. 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 persistently low interest rates, the Cooperative Financial Network’s net interest income reduced by 1.4 percent
in 2018. 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. There is also still the risk that funding costs will rise when interest rates in the financial markets start to climb again.
Along with credit risk, interest-rate risk – a category of market risk – plays an important role for most of the cooperative banks. The cooperative banks regularly measure and limit this risk with regard to their risk-bearing capacity. A distinction is made between interest-margin risk and valuation risk. Interest-margin risk is the risk of net interest income falling short of the expected or budgeted figure. Valuation risk is influenced by unexpected price volatility during the holding period. For the purpose of determining the shortfalls/volatility, parcIT provides generic interest-rate scenarios (VR interest-rate scenarios) centrally that are derived from time series. They contain not only parallel shifts but also rotations of the yield curve. 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 came into force in 2018. The EBA published its new ‘Guidelines on the management of interest-rate risk arising from non-trading book activities’ in 2018, which came into force on June 30, 2019. They introduce an early-warning indicator, for which there is a six-month transitional period. 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 II, 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. Circular 9/2018 (BA) is being redrafted this year and will take account of the aforementioned new requirements set out in the EBA guidelines.
BVR-SE monitors the appropriateness of the member institutions’ level of interest-rate risk, for example by using simulations to calculate net interest income. These simulations show that the local cooperative banks will continue to generate an adequate level of income going forward, not least as a result of the control mechanisms that they have in place.
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 94 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 BVR-SE and BVR-ISG, which particularly aim to safeguard deposits.
The cooperative banks transfer surplus liquidity from their customer deposits to the central institution, DZ BANK. On the one hand, this gives DZ BANK indirect access to a stable source of funding based on retail deposits. On the other, cooperative banks requiring liquidity can obtain it from their central institution. DZ BANK thus pools the liquidity surpluses of the individual institutions and is able to balance out the structural differences in the individual cooperative banks’ liquidity levels. In its role as the cooperative central institution, DZ BANK ensures cash pooling within the network of cooperative banks and specialized service providers.
Each cooperative bank manages its own liquidity and the accompanying risk. In doing so, they make sure that they comply with the regulatory liquidity coverage ratio (LCR) and net stable funding ratio
(NSFR). They have business management tools at their disposal that enable the bank-specific parameterization of the funding matrices using the banks’ own behavior-based assumptions and the calculation of a transaction-based liquidity price that can then be factored into their contribution costing as appropriate. The individual cooperative banks are thus able to establish and manage an appropriate level of liquidity adequacy.
With the BVR taking a leading role, the necessary plans were drawn up and then signed off by the relevant committees in 2018. A systemic rollout to support the concept is taking place in 2019.
The degree to which a bank is able to guarantee its ability to meet its payment obligations in the short term is measured using the LCR. Banks are required to maintain a sufficiently high level of liquidity. As at December 31, 2018, the median LCR of all cooperative institutions was 165.7 percent (December 31, 2017: 161.3 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 method is 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.
Opportunities and opportunity management
Customer membership is a distinctive feature of the cooperative banks’ business model and one that is ideally suited to conveying the values of the cooperative idea. It offers the cooperative banks the opportunity to distinguish themselves from rival banking groups. The cooperative banks’ distinctive characteristics are reflected in their continued ability to reach a wide range of customers. Strong customer retention results in measurable economic benefits, e.g. income growth for the cooperative banks and the protection of their market share.
Even in the digital age, the business model of the cooperative banks puts people and their wishes and objectives first. In the years ahead, the digitalization initiative launched by the Cooperative Financial Network in the retail and corporate banking businesses will enable it to proactively adapt to the changes in the competitive environment resulting from the digital revolution. The aim is to forge ahead with digitalizing the cooperative banks’ products and services and offer all of the touchpoints that customers want (local branches as well as online and mobile banking).
Measures derived from the KundenFokus (customer focus) project have been implemented and there has been capital expenditure in connection with the digitalization initiative. This allows the Cooperative Financial Network to take account of the changes in customer behavior and to adjust and strengthen the overall business model accordingly. The focus is on the comprehensive omnichannel presence and thus the implementation of efficient processes at all levels. Nonetheless, personal contact remains a key component of the customer relationship, alongside high-quality advice and the possibility for customers to choose how they would like to communicate with their bank. The Cooperative Financial Network is therefore establishing efficient customer touchpoints and giving its members integrated access to all information and services through all the relevant channels – whether in branch or via digital media.
Digitalization, with its increasing influence on members’ behavior, also offers the banks potential to improve their cost structure in the medium term. By marketing new digital payment services, such as contactless payments, paydirekt, and Kwitt, and implementing an online inquiry process for all of the main products, banks are able to address customer needs and attract new customers. This also enables them to target young, tech-savvy customers and members.
Consumer spending is expected to be boosted further by the positive trends in employment and disposable income. This will stabilize demand for banking products and services. Given the current low level of interest rates, the cooperative banks will continue tapping into potential in the real estate business. Should there be a sustained rise in interest rates, opportunities will open up in connection with the sale of interest-bearing financial products.
Real economy and banking industry
Germany’s economy has been turning noticeably gloomier since summer 2018. This is due not only to the more challenging global economic conditions but also to two one-off factors. Firstly, introduction of the new Worldwide Harmonised Light Vehicles Test Procedure (WLTP) resulted in a backlog of new car registrations. Secondly, the exceptionally dry summer led to low water levels in Germany’s rivers and canals, causing disruptions for ship transport. The disappearance of these one-off factors should enable the overall economy to pick up again in the first half of 2019. The BVR’s model-based estimates show that the economy is unlikely to slip into recession. However, economic growth is expected to remain muted for the time being. This can be seen from important sentiment indicators, such as the ifo Business Climate Index, which have not staged much of a recovery from their downturn last year, despite the brightening situation at the start of 2019.
In its latest economic main scenario (dated June 2019), the BVR predicts that, adjusted for inflation, GDP will rise by 0.8 percent in 2019. Growth is therefore expected to be significantly weaker than in 2018. As was the case last year, rising consumer spending and capital expenditure will remain the main growth drivers. These two types of spending will be underpinned by factors such as the continued increase in employment, (in many cases) rapidly rising income levels, the sustained health of the construction industry, and expansionary fiscal policy measures introduced by the German government. However, foreign trade is likely to hold back the increase in GDP, as exports will probably grow at a slower rate than imports. Consumer prices are predicted to rise by 1.4 percent.
As at June 2019, the downside risks for the economy are considerably greater than the prospects of an upturn. The risks primarily emanate from the global situation and are predominantly political in nature. If, for example, the US government imposes new tariffs on vehicles imported from the EU, there is likely to be a severe impact on German foreign trade. It is also unclear whether the weakness of the German automotive industry, which took a heavy toll on the country’s economic growth in the second half of 2018, was solely caused by the one-off effect of introducing the WLTP. Structural factors were
possibly at play too, and their effect could be compounded during the forecast period. Furthermore, the dispute between the United States and China flared up again in spring 2019, with new punitive tariffs and other trade restrictions being imposed. The dispute could escalate further, triggering a significant slowdown in the global economy. It is also conceivable that the weakness that is emerging in the United States and China turns out to be much more pronounced than assumed in the baseline scenario. The Iran dispute might lead to far higher oil prices and weigh down on the economy. Another significant source of uncertainty is the direction of economic policy in Italy. The country’s size and very high government debt, as well as the ongoing risks in its banking sector, pose a real danger to the economic growth and financial stability of the eurozone as a whole. Moreover, the risk of a no-deal ‘hard’ Brexit is higher than it has ever been. If one or more of these downside risks were to materialize, demand for German exports would fall, which in turn would take its toll on capital expenditure and consumer spending in Germany. The country’s economy might then stop growing and could even slip into a recession.
The European Central Bank has adjusted its forward guidance and, after its council meeting on June 6, 2019, announced that it expected the key interest rate to remain at its current level until at least the middle of 2020. A new program of targeted longerterm refinancing operations, which was announced in March 2019 and will start in September 2019, has put monetary policy on an expansionary footing again. At the beginning of the second half of June, ECB President Mario Draghi raised the prospect of further loosening measures in the event that inflation does not remain close to the monetary policy target. Consequently, and given that German government bonds remain in demand as a safe haven, yields on Bunds with long maturities will probably remain very low by historical standards.
A number of the macroeconomic scenarios outlined above also affect the outlook for the banking industry. As well as the absence of interest-rate rises in 2019, the main factors at play are the potential political arrangements for Brexit, the negative impact of Italy’s economic policy on Italian government
bonds, and uncertainties surrounding the tariffs to be imposed by the US government and by China. The ongoing difficulties in respect of income from interest-earning business will continue to be affected by the level of interest rates in the eurozone, which is not appropriate to the economic conditions, and margins will again be significantly squeezed over the course of 2019. These difficulties are still being mitigated at present by the low number of insolvencies among companies and individuals across Germany and by the country’s sustained economic upturn, albeit at a diminishing rate. From the current perspective, no significant increase in the need to recognize loss allowances for loans and advances is expected in 2019. The extent of fair value gains and losses in the securities portfolio depends heavily on possible market turmoil, which is also significantly influenced by the aforementioned political risks.
In 2019, banks are continuing to address this still-growing pressure on earnings and the highly adverse impact of regulatory requirements by taking steps to improve their efficiency with the aim of reducing costs. There will continue to be mergers for economic reasons, and reviews of the appropriateness of the branch networks remain on the agenda. The main driver here continues to be changing customer behavior, with people increasingly accessing banking products online. Advancing digitalization will also further reduce the number of employees needed in the financial sector.
As before, however, the banks will attempt to hold their position against competitors by aiming for an even greater focus on customer requirements, for example by expanding their digital offering in the context of omnichannel banking. Competition with fintechs and bigtechs will continue to intensify, especially given the forays into the market observed in Germany.
A very rapid rise in interest rates poses a genuine threat for the banking industry, even though banks have generally strengthened their capital adequacy. The European sovereign debt crisis and uncertainties in foreign policy and foreign trade could still have a negative impact. Although the short-term effects currently seem modest, the longer-term risks of these uncertainties for international trade and cross-border investment should not, from the current perspective, be underestimated. Levels of fee and commission income will be heavily influenced by potential shifts in market share between traditional competitors and fintechs/bigtechs.
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 higher capital requirements and changes to regulatory systems – and implement structural change to adapt to competitive conditions.
In addition to the new regulatory environment, new competitors with approaches based on the use of data and technology are presenting the financial sector with the challenge of scrutinizing its existing business models, adapting them as required, and substantially improving its efficiency by digitalizing business processes and IT processes. The resulting capital investment is initially likely to lead to substantial costs before the anticipated profitability gains can be realized.
Moreover, the outlook for the Cooperative Financial Network shows that the environment of low interest rates will continue to dominate business performance and that the aforementioned challenges will have an adverse impact.
The expected growth in parts of the global economy should provide a boost for the financial performance of the Cooperative Financial Network. It is important, however, not to forget the negative factors for global economic growth resulting not only from Brexit but also from possible trade restrictions. These factors could also depress the heavily export-oriented German economy.
These challenges may thus limit the growth of the Cooperative Financial Network’s income and thus its latitude for accumulating capital in 2019. Nevertheless, the Cooperative Financial Network is expected to generate a satisfactory level of earnings overall this year by exploiting market opportunities in its core business areas and, at the same time, actively managing costs. This should enable it to further strengthen its reserves.
Net interest income, particularly in the Retail Customers and SMEs operating segment, will remain under pressure in 2019, primarily as a consequence of the persistently low interest rates.
The Cooperative Financial Network anticipates that net fee and commission income will hold steady in 2019. 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 2019, gains and losses on trading activities, which are particularly influenced by those of the Central Institution and Major Corporate Customers operating segment, are expected to be at a much better level than in 2018.
Customer-driven capital markets business may again provide impetus in 2019. The main prerequisite for a steady level of net gains under gains and losses on trading activities continues to be a stable financial and capital markets environment.
Net gains under gains and losses on investments in 2019 are predicted to make a modest contribution to profit before taxes because the non-recurring items recognized in 2018 will not be repeated.
Loss allowances will probably return to their normal level in 2019 and should be in line with the lending portfolio and the planned volume of new business. The low number of insolvencies among companies and individuals across Germany and the continuation of a moderate economic upturn indicate that there is no significant increase in risk factors. Nonetheless, uncertain political and macroeconomic developments could have a detrimental impact on loss allowances.
Other gains and losses on valuation of financial instruments are expected to follow a positive trend in 2019. 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 rise in 2019. Based on the prediction of steady gains and losses on investments held by insurance companies, it is currently assumed that a further increase in gross premiums in the different divisions will lead to a higher level of net income from insurance business overall. Exceptional events in financial a nd capital markets, changes in underwriting practices, or potential changes in the regulatory requirements faced by insurers may adversely affect the level of net income expected to be earned from insurance business.
Administrative expenses are projected to rise again slightly in 2019. This is primarily due to expenses in connection with the digitalization initiative that will only pay off in the years ahead in the form of productivity increases. Provided that costs continue to be tightly managed and given that income is expected to rise, the cost/income ratio will probably improve.
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.