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Why Germany should shut down BaFin

It was an ignominious way to celebrate an 18th birthday. Only a month after BaFin came of age in May, Germany’s financial regulator was confronting a huge national embarrassment: a vast fraud that led to the collapse of payments company Wirecard. It marked the first time in history that a blue-chip Dax 30 company had failed.

Not only had BaFin failed to supervise Wirecard effectively. It had actively frustrated critics’ attempts to expose the fraud. With an unprecedented short-selling ban, it had barred a growing group of sceptical investors from betting that Wirecard’s share price would fall. And it had launched a criminal complaint against journalists at the Financial Times, who had spent years unearthing the scandal

BaFin has defended itself against criticism in the Wirecard saga by arguing that it did not have full jurisdiction over the group. But it did regulate Wirecard Bank, a crucial subsidiary. And it clearly could and should have been raising alarm bells, rather than silencing those set off by others.

Now more details have emerged about BaFin’s shortcomings in the affair. Dozens of staff had been trading Wirecard shares, some in accordance with the regulator’s disclosure rules, some in breach of them. Only two months ago did BaFin finally ban staff from investing in the companies that they regulate — leaving regulators in other jurisdictions aghast at the lax standards in place at the German watchdog. In recent months, understandable questions have been raised by parliamentarians about whether BaFin’s chief executive Felix Hufeld should stay in his job. But is it also time to abolish BaFin itself?

The Bundesanstalt für Finanzdienstleistungsaufsicht has had a troubled history. Within two years of its creation in 2002, it allowed a senior manager to embezzle millions of euros, later being lambasted in court over its “non-existent” internal controls. Five years later, it suffered a serious data breach when details of the banking sector’s troubled loans were leaked. 

Most importantly, it was for many years a weak regulator of the country’s most systemic financial institution, Deutsche Bank.

In the run-up to the 2008 financial crisis, it failed to curb Deutsche’s runaway excesses as the group piled headlong into investment banking. Deutsche became notorious with US authorities for its aggressive leverage and lax supervision. BaFin was slow to demand fresh capital injections, imperilling the bank’s survival at various points in recent years.

Regulating finance is always a challenge. But the odds are particularly stacked against BaFin. It is based in the small city of Bonn, two hours from Frankfurt, thanks to a political settlement to secure jobs in the former West German capital. The base suggests a provincialism appropriate for the supervision of domestically focused savings banks and insurers, but not for global giants.

The decision to make the European Central Bank the central supervisor for big banks has boosted quality, but it has been a further blow to BaFin, denuding it of some of its best people. The regulator also suffers from a poor-relation mentality versus the globally respected Bundesbank, which oversees the economy and monetary policy, under the wing of the ECB. The Bundesbank’s image reflects global perceptions of a strong German economy. BaFin’s reflects perceptions of a weak German banking market.

Axing it and folding regulatory responsibility into the Bundesbank and ECB looks even more logical now than a decade ago when such a move was first suggested by the government (but declined by the Bundesbank).

To do so would be to take a leaf out of the UK’s book. In the run-up to the 2008 financial crisis the UK got financial regulation catastrophically wrong and much of the banking sector collapsed. But the response to failure was effective: the government abolished the then Financial Services Authority and handed stability regulation to the less tarnished Bank of England. That eliminated gaps between their respective responsibilities and streamlined the links among economic policymaking, financial stability and supervision.

But more fundamental change is needed. The truth for policymakers everywhere, not just in Germany, is that regulation has not kept pace with rapid change in the finance industry. Payments and financial technology companies such as Wirecard are now far bigger than many banks and just as systemically important. They must be brought under the same regulatory umbrella before the next storm comes.

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