International monetary and economic cooperation have gained further significance over the past few decades. However, the increasing globalisation of trade and financial relations brings additional challenges for economic stability. For this reason, numerous international bodies and organisations are working to maintain and improve the stability of the monetary and financial system.
In a broad sense, the term “currency” denotes the constitution and organisation of a country’s entire monetary system. However, it often refers only to the monetary unit used in a given country or territory. A currency is closely tied to a country’s history and makes up part of its identity. Most countries still have their own national currency. One exception to this is the euro area, where 19 countries use a single currency.
For everyday use, currencies are represented by a non-standardised abbreviation, like the Swiss franc (CHF), or a separate currency symbol, such as the US dollar ($), the pound sterling (£), the Japanese yen (¥) and the euro (€). In international currency trade, however, all currencies are listed using a standardised three-letter code. The first two letters usually represent the country while the third letter stands for the currency (e.g. USD for the US dollar, or JPY for the Japanese yen). The euro, with its acronym EUR, is an exception.
For everyday use, currencies are represented by non-standardised abbreviations or their own currency symbols.
Owing to the fact that the currencies are different, transactions across national borders require domestic payment instruments to be exchanged for foreign ones. Such exchanges are carried out at the prevailing exchange rate. The exchange rate is the rate of exchange between two currencies, and it can be represented in two different ways. Indirect quotation shows how many units of foreign currency can be obtained for one unit of the domestic currency. Direct quotation states how much one unit of the foreign currency costs in the domestic currency. Mathematically speaking, the two quotations are the inverse of each other.
The exchange rate is the value of one currency in terms of another currency.
The technical term for a payment instruction to a country abroad in a foreign currency is “foreign exchange”. This is why we talk about a foreign exchange rate when dealing with cashless transactions involving different currencies. Foreign cash is usually exchanged at a special exchange rate (“counter rate”) based on the foreign exchange rate. Banks and bureaux de change use the exchange rate to set a buying rate for foreign currency. Their selling rate is lower. All banks and bureaux de change are free to set their own bid-ask spread. This difference is used to offset the costs of foreign currency dealing. As a rule, only banknotes are exchanged (not coins).
Foreign cash comprises foreign banknotes and foreign coins.
The institutional framework within which an exchange rate is set is referred to as an exchange rate regime. A country’s choice of exchange rate regime is determined by economic and political factors. The exchange rate regime forms part of a country’s monetary system. Pursuant to the Articles of Agreement of the International Monetary Fund (IMF), each member country has been free to choose any form of exchange arrangement it wishes since the late 1970s. Since November 1998, the IMF has published information on the exchange rate regimes used by each of its members. There are a variety of exchange rate regimes, each of which has a different degree of exchange rate flexibility. Generally speaking, a distinction needs to be drawn between fixed exchange rate regimes and flexible exchange rate regimes.
Flexible exchange rates are determined on the foreign exchange market by supply and demand. This also applies to the euro, which floats freely against major currencies (e.g. the US dollar). The euro’s exchange rate can therefore rise and fall significantly over time, with exchange rate developments largely being determined by international goods traffic and capital flows.
In a fixed rate regime, it is the central bank’s task to keep the exchange rate stable at the predetermined central rate of an “anchor currency”. To this end, the central bank buys and sells foreign currency so that it can influence the supply of, and demand for, the foreign currency. The central rate is generally accompanied by a band determining the exchange rate’s maximum permissible fluctuation margins (“intervention points”) from this central rate. Some countries still peg their exchange rates to another currency, such as the US dollar. This is intended to create more confidence in the country’s own currency.
Other countries even set themselves the stipulation that the money in domestic circulation must always be fully backed by foreign exchange reserves (known as a currency board arrangement). The aim of a currency board is for the country in question to “import” the stability of the anchor currency into its own country by curbing domestic money creation through limited inflows of foreign exchange.
Fixed exchange rates against the US dollar formed the key focus of the Bretton Woods system.
Under the Bretton Woods system, which was named after the resort in the US state of New Hampshire where the conference was held, 44 countries agreed in July 1944 on an international currency system of fixed exchange rates pegged to the US dollar as the reserve currency. The new monetary system sought to facilitate world trade and promote reconstruction after the Second World War. The system centred around the “gold standard”: the United States central banking system guaranteed to redeem the member countries’ dollar reserves at a fixed rate in gold. The other countries committed to keeping their currencies’ exchange rates within very narrow limits against the US dollar. Since the member countries’ economies developed differently, the fixed exchange rates had to be adjusted time and again. The exchange rate system finally collapsed for good in 1973. Since then, every country has been free to choose its own exchange rate regime.
The European Central Bank (ECB) calculates and publishes daily euro foreign exchange reference rates for selected currencies. These exchange rates are not intended for foreign exchange transactions. Instead, they are often used for enterprises’ annual financial statements, tax declarations, statistical reports or economic analyses.
The balance of payments is composed of several sub-accounts.
A country or currency area’s balance of payments summarises the economic transactions between residents and non-residents. Its concepts, methodology and structure are based on the IMF Balance of Payments Manual. The balance of payments is composed of several sub-accounts.
The current account (I.) comprises imports and exports of goods and services, primary income, which consists of income from investment and employment, and secondary income. The capital account (II.) contains one-off, unrequited transactions such as inheritances, gifts, or debt relief for developing countries. The financial account (III.) groups together financial transactions with non-residents, such as portfolio investment and direct investment. Transactions that cannot be broken down statistically are reported under “Net errors and emissions” (IV.), which exists because it is not always possible to assign transactions to specific items. It also reflects reporting errors and gaps. It is therefore a balancing item for the balance of payments as a whole.
In the accounting sense, the balance of payments is always balanced overall. Nevertheless, there is often talk of the “balance of payments position”. In many cases, this is only an imprecise form of expression that is often intended to refer to the balance of a sub-account, such as the current account. The term “balance of payments” is also misleading, as it does not actually refer to a balance sheet (i.e. the account balance at a particular point in time), but rather an analysis over a period of time.
The current account, which is an important part of the balance of payments, comprises trade in goods (1), services (2), primary income (3), and secondary income (4).
The most important item in the current account of the Federal Republic of Germany is trade in goods. It shows that, in 2020, Germany exported goods totalling €1,190.5 billion whilst importing goods amounting to €1,001 billion, thus generating a surplus of €189.5 billion. Measured in terms of the services generated in Germany – i.e. gross domestic product (GDP), which amounted to around €3.3 trillion in 2020 – exports of goods accounted for around 36% of GDP and imports for just under 30% of GDP.
A significant amount of Germany’s trade in goods takes place within the euro area, although this trend is declining; exports to the euro area accounted for around 36% of all German exports in 2020 after amounting to just over 40% in 2010. The corresponding share of imports was approximately 37% in 2020 and roughly 38% in 2010.
Trade in goods shows the difference between the amount of goods exported and goods imported.
The exchange of goods alone, however, does not give an overall picture of all service-related transactions with non-residents. Services, primary income and secondary income must also be taken into account. They are often also referred to as invisible current transactions.
The balance services account balance is dominated by extensive cross-border travel. As the number of foreigners visiting Germany is much lower than the number of German citizens travelling abroad, expenditure far exceeds revenue. As a result, the balance of the German services account regularly records a deficit. In 2020, however, it registered a surplus for the first time since 1971 in the order of €1.6 billion. This is largely attributable to the measures taken to contain the coronavirus pandemic, which resulted in Germany’s typically high tourism expenditure of €83 billion (2019) declining to €36 billion (2020).
The primary income sub-account documents cross-border payments arising from employment and investment, including interest and dividend payments. As Germany has built up foreign assets on account of its long-standing foreign trade surpluses and generates income from these, this sub-account regularly shows surpluses. In 2020, the balance amounted to around €92.5 billion.
Secondary income shows unrequited transactions, i.e. transactions without direct reciprocation from the counterparty. These include, for example, Germany’s contribution payments to the EU, a large portion of premium payments and all claims payments resulting from insurance policies, and remittances from foreign nationals resident in Germany who financially support their families back in their countries of origin. However, penalties and damages payments as well as lottery winnings also fall into this category. Owing to the high contribution payments it makes to the EU, Germany’s secondary income typically runs a substantial deficit. This amounted to around €51.6 billion in 2020.
In the 1990s, Germany’s current account consistently posted deficits. Following reunification, these were due, in particular, to the large backlog of goods and services then being acquired by the eastern federal states. This led to a sharp increase in imports to Germany. Since then, large surpluses have been generated owing to the German economy’s high level of competitiveness as well as a surplus of savings.
The current account balance shows the development of external assets.
A current account deficit indicates that the country concerned has consumed more goods and services than it has produced. Its imports exceed its exports. This means that it reduces its external assets or takes out loans abroad. By contrast, if a country has a current account surplus, its exports exceed its own demand for foreign goods and services. This country thus forms assets abroad. If a current account deficit is offset by a decline in the country’s foreign reserve assets, the central bank has financed the deficit by dissolving external assets (foreign reserve assets). By contrast, if the government or the economy takes out loans abroad, this import of capital covers the current account deficit. A current account balance is therefore always reflected in other items of the balance of payments, which reveal how external assets have been built up or run down.
The financial account records the financial transactions between Germany and other countries. These are also reflected in changed financial positions (e.g. deposits, securities, or equity investment).
Transaction-related changes in the Bundesbank’s foreign reserves are therefore recorded here, too. A positive capital account balance signifies a transaction-related increase, whilst a negative balance indicates a corresponding decline in net external assets. The latter may result, for example, from foreign direct investment in Germany or from foreign investment in domestic securities. Inversely, German direct investment abroad and domestic investment in foreign securities increase Germany’s external assets.
Foreign direct investment is defined as a financial relationship between a domestic enterprise and a foreign enterprise in which the direct investor holds 10% or more of the shares. It includes, in addition to participating interests in foreign firms, intra-group loans and trade credits.
German firms acquire shares in foreign enterprises or establish branches abroad in order to secure their purchasing and sales markets, for example, or set up production sites abroad to protect themselves against exchange rate fluctuations. Conversely, foreign direct investors acquire holdings in German enterprises.
Securities refer to equities, fixed-income instruments, investment fund shares and certificates. In the international capital markets, too, investments are made across borders. This can result in strong annual fluctuations in the balance of portfolio investment. While this balance was negative in 2011, at around - €34 billion (non-residents purchased more securities from domestic issuers than vice versa), it has shifted back into positive territory since 2012, amounting to €42.7 billion in 2020.
This is due to a marked increase in German investors’ demand for foreign interest-bearing securities and shares, which exceeded the rise in the acquisition of German bonds by foreign investors, who see these securities as a particularly secure form of investment.
Options and financial futures contracts are included in financial derivatives. They are used to hedge against certain risks or for speculation purposes. Employee stock options entitle employees to acquire a certain number of shares in their employer at a predetermined price, either at a specific point in time or within a certain timeframe.
Changes in the foreign reserves managed by the Bundesbank (e.g. foreign currency and gold) are recorded under the item “Reserve assets”. Other statistically recorded investment comprises loans and trade credits (where these do not constitute direct investment) as well as bank deposits and other investment. It also includes loans taken out by the government abroad or granted to other countries. In addition, domestic firms grant their foreign buyers trade credits. However, they also run up debts abroad.
A country’s reserve assets consist of securities, bank deposits in foreign currency (foreign exchange), gold reserves, and balances with the International Monetary Fund (special drawing rights). They are usually managed by the central bank.
Foreign reserves are used to settle payments that governments have to make in foreign currency. In countries with fixed exchange rate regimes, the central bank uses them to regulate their national currency. Reserve assets boost international confidence in a country’s domestic currency.
The euro area balance of payments summarises transactions made between the euro area and the rest of the world, but not transactions within the euro area.
Europe-wide interlinkages mean that the national balances of payments in the euro area partially offset each other in the aggregate balance. This is why the balances for the euro area as a whole mostly remain within narrow bounds even though individual Member States post large surpluses and deficits at times.
The financial system brings suppliers and demanders of capital together.
Hardly anyone – be it an individual, an enterprise or a government body – is likely to always receive exactly as much money as they spend. In other words, everyone is continuously accumulating or reducing financial wealth. Anyone who has excess money can invest it, making them a supplier of financial resources. At the same time, there are enterprises who invest and individuals who wish to finance major purchases. They frequently require more money than they possess. Borrowing additional funds makes them demanders of financial resources. The financial system brings lenders and borrowers together.
The financial system consists of financial intermediaries, financial markets, and financial infrastructure.
The role of the financial system is to facilitate the transfer of funds from suppliers to demanders. In a financial system, financial intermediaries – particularly banks, insurance companies and investment funds – act as brokers between the suppliers and demanders of financial resources. This takes place through the financial markets and financial infrastructure. Payment settlement and securities trading systems therefore also form part of the financial system.
Banks are a key component of the financial system. Virtually all households and enterprises use banks to execute payments via current accounts, invest money (deposits), or take out loans. Banks can create new money by granting loans. The financial system also includes financial intermediaries such as insurance companies and investment funds. In contrast to banks, they do not engage in lending, but receive funds from investors and forward these to demanders of capital – by purchasing securities, for instance.
Investors and borrowers come together in the financial markets, particularly the stock exchanges. They usually task banks or securities firms with buying and selling securities on their behalf. For investors, purchasing securities has the advantage that they can quickly be sold again – if they are traded on the stock exchange, at least. When raising capital through the sale of securities, the main focus is on issuing debt securities or bonds.
For the most part, bonds envisage fixed interest payments made at specific intervals. The market in which they are traded is called the bond market. The German government, too, draws on debt securities such as Federal bonds or Federal notes when borrowing.
Financial instruments such as securities and foreign exchange assets are traded on the financial markets.
German banks also issue large volumes of their own debt securities in order to obtain funding over the longer term. Mortgage Pfandbriefe, a particularly well-known form of bank debt securities, are used to refinance real estate loans. Shares in enterprises are traded on the equity market. Public limited companies raise equity by issuing shares. By purchasing a share, the shareholder also acquires a share in the enterprise, thereby gaining the right to share in its profits. Currencies are traded on the foreign exchange market. Trading takes place primarily between banks. A currency’s exchange rate is determined by the supply and demand for that currency.
An investment fund is not a form of investment, but rather an enterprise that invests in various assets. It sells fund shares to investors. These are securities that represent the demand for a specific part of the fund’s assets. The money received in this manner is channelled into various investments such as securities or real estate. Once fees have been deducted, the fund’s profits are passed on to its investors.
Open-end investment funds give their investors the option of redeeming the fund shares they have issued at short notice – usually every trading day. Closed-end investment funds, on the other hand, do not provide this option. Investment funds reduce the risk faced by their investors generally by investing in a range of different assets (known as diversification). Their investment activity may be focused on securities (e.g. equities and bonds) or real estate. Money market funds invest in rather short-term assets that are frequently regarded as products that compete with bank deposits.
Hedge funds are investment funds that are less stringently regulated. They are able to invest in assets that investors can use to hedge against price losses. They can also use financial instruments to follow all kinds of risky investment strategies that generate high yields but may also result in significant losses.
Exchange-traded funds (ETFs) are investment funds that track an index such as the DAX. They therefore do not actively make any investment decisions, with the result that their costs are lower than those incurred by traditional investment funds. ETF shares are traded on the stock exchange and are subject to usual market risk.
Over the past few decades, the international financial system has changed significantly. In the modern world, where capital moves freely for the most part, investors can choose from a great number of forms of investment. These days, the money deposited in a bank or an investment fund can be invested practically anywhere in the world. Internationally active banks extend loans to enterprises from all over the world and trade in securities regardless of their national origin.
Savers and investors, too, invest money abroad in order to achieve a higher yield or to diversify their risks more effectively. From an economic perspective, it makes sense to be able to transfer funds across national borders. This allows investments to be made that could not have been covered by domestic funds alone.
The causes of internationalisation in the financial markets are many and varied. For example, many countries decided to allow cross-border capital movements. Technological progress is also key, as complex financial transactions can be carried out rapidly and easily with the use of electronic systems. Here, it is largely irrelevant whether the computer system is situated in Frankfurt, New York or Tokyo. The associated boost in financial systems’ performance has increased not only the speed but also the volume of transactions considerably.
While traditional bank loans and deposits dominated international financial business in the past, trading in securities – including complex financial instruments such as derivatives, often in the form of forward transactions, swaps and options – has since gained the upper hand. They are better able than equities or bonds to meet the requirements arising from the highly interconnected global economy and new technological possibilities in securities trading.
New financing instruments and market players as well as digitalisation play an important role nowadays.
Outside of the traditional banking system, other financial market players are also increasingly taking on the role of financial intermediary, acting as a link between the supply and demand of credit. These entities are frequently subsumed under the term “shadow banks”. The term “non-bank financial intermediaries” has since come into common parlance at the international level. These include, for example, investment funds (including hedge funds and ETFs) as well as money market funds. Digitalisation, too, is helping to bring about sweeping change in the financial system. Technology-driven financial innovations (fintech) are creating new financial instruments, services and intermediaries in all areas of the financial sector. Mobile payments and internet payment methods, for instance, provide additional ways to pay, and robo-advisors offer automated investment services. These new products and providers may entail risks to financial stability in some sub-sectors, such as herding behaviour stemming from a greater degree of automation in investment decisions made by robo-advisors. To date, however, the fintech sector in Germany has remained relatively small, meaning that potential risks are limited.
Securitisation also plays a significant role. The fundamental idea is to make credit claims tradeable, including their future interest and principal payments. To this end, banks bundle credit claims and sell them to special-purpose vehicles. The special-purpose vehicle acquires the funds for the purchase by securitising claims in the form of a security, and selling this security, split into small portions, to investors. Through such transactions, banks sell credit claims to third parties, thus removing them from their balance sheet. This gives them scope for new lending.
The buyers of these asset-backed securities (ABSs) are generally found in the financial sector. They receive interest and principal payments that are drawn from the underlying loans. If a bank knows when it issues a loan that it will be able to quickly sell it on to a special-purpose vehicle, it may not pay the necessary attention to the credit assessment. This increases the risk of credit defaults.
In order to limit this risk, the issuers of asset-backed securities generally commission a rating agency to carry out a credit assessment. Particularly on account of the new and often highly complex financial instruments as well as the ever-growing number of issuers, most investors are hardly in a position to assess the risks entailed in the purchase of a complex financial instrument. By contrast, credit rating agencies specialise in analysing the creditworthiness of borrowers such as enterprises, banks and governments. They estimate how likely it is that the borrower will be able to pay interest fees and make repayments in full and on time. The credit rating awarded by the credit rating agency significantly influences the amount of interest the issuer is required to pay on the securities it issues. However, the global financial crisis revealed that even credit rating agencies are not immune to making inaccurate assessments. Investors are therefore well advised to acquaint themselves with the risks and opportunities offered by their planned investments using various different sources.
The increasing interconnectedness of the global financial system and the growing complexity of many financial products entail economic risks as well as rewards. Problems that arise in one part of the world can soon spread to other geographical regions. This became particularly apparent during the global financial crisis starting in 2007.
Financial instruments whose value is dependent on other assets (underlying assets) are called derivatives. These underlying assets may be shares, equity indices, government bonds, currencies, interest rates, or commodities. Derivatives transactions are carried out in order to protect against financial risks (referred to as hedging), but also to speculate on price changes or to take advantage of price differences between markets (known as arbitrage). As the underlying assets themselves are not purchased, derivatives require a lower capital input. Forward transactions, swaps and options are the basic kinds of derivatives. In the case of a forward or future contract, the price of a trading item that will only be delivered in the future is determined as soon as the contract is concluded. The buyer thus commits to purchasing a certain quantity of a trading item from the seller, such as a share or a foreign currency payment, at a later date at a price determined at the time the contract is concluded. The seller undertakes to deliver on the agreed terms. A swap refers to the exchange of trading items. In this vein, banks often use interest rate swaps to exchange fixed interest rates for variable interest rates in order to manage their interest rate risk. They also use swaps to shield themselves against credit risk or exchange rate risk. In the case of foreign currency swaps, in particular, the exchange may also occur with a time delay. For example, in the case of a currency swap, a delivery of euros is initially made in exchange for US dollars. After a certain amount of time, the exchange is reversed. This allows exchange rate risk to be hedged for a fixed period of time. An option transaction is a conditional forward transaction. It gives the buyer the right to purchase or sell assets at a previously agreed fixed price. The seller can exercise the option, but is not obligated to do so. Furthermore, there are various different combinations of these derivatives activities. The buyer of a swap option, which is a combination of a swap and an option, therefore obtains the right to conduct a swap in the future under predetermined terms and conditions.
Disruptions in the financial system can cause considerable real economic and social costs. For example, in the past, economic growth often contracted sharply during financial crises, resulting in extensive income losses and significant increases in unemployment. Confidence in the banking system can also be shaken during a financial crisis. This can lead to liquidity shortages at banks, which can frequently only be remedied using central bank money. Central banks therefore play a key role in resolving financial crises. Disruptions in the financial system can also impede the transmission of monetary policy and thus impair price stability.
Only a stable financial system can fulfil its macroeconomic functions.
Risks to the stability of the financial system arise from systemic risk. Systemic risk is said to exist wherever there is a danger that the financial system will no longer be able to fulfil its macroeconomic functions. One possible reason for this could be the distress of a systemically important market participant, such as a bank, insurer or financial infrastructure provider. A market participant is systemically important, for example, if it is very large (“too big to fail”) or closely interlinked with other market actors (“too connected to fail”). The ability of the financial system to function can also be jeopardised if many smaller market participants simultaneously run into difficulties – for example, because they are exposed to similar risks (“too many to fail”).
Following the global financial crisis, which began in 2007, the EU Member States implemented a large number of financial market reforms.
These are intended to help prevent future crises. A number of new institutions were also created which, in a variety of ways, contribute to safeguarding financial stability.
The financial crisis began with a banking crisis in the summer of 2007. It reached its initial peak in September 2008 with the collapse of Lehman Brothers in the United States – one of the most important investment banks in the world at the time. US banks had been granting risky mortgage loans for years amid rising real estate prices. When real estate prices in the United States dropped in 2007, many market participants questioned the value of these loans. As banks had bundled these loans, securitised them, and sold them to other market participants – including in other parts of the world – no one knew which institutions held these risks on their balance sheets. As a result, banks no longer lent each other money, enterprises were no longer adequately supplied with credit, and the economy collapsed – the financial crisis was accompanied by an economic crisis. To combat this financial and economic crisis, some countries borrowed so heavily that market participants were doubtful whether they could repay these debts. Consequently, these countries had to pay higher market interest rates on their borrowing. A sovereign debt crisis ensued, which could only be contained by means of international assistance measures for several countries.
The financial crisis showed that the international financial system needed a better regulatory framework. For this reason, policymakers decided to improve and expand both traditional “microprudential” supervision, which is geared towards the stability of individual institutions, as well as “macroprudential” oversight, which focuses on the stability of the financial system as a whole.
In 2011, three existing European supervisory committees were restructured and granted further powers: the European Banking Authority (EBA), responsible for banks, the European Securities and Markets Authority (ESMA), responsible for financial and securities markets, and the European Insurance and Occupational Pensions Authority (EIOPA), responsible for insurers and occupational pension funds.
They are consolidated under the umbrella term European Supervisory Authorities (ESAs). They are primarily committed to the task of developing EU-wide common regulatory and supervisory standards for banks, securities markets, insurers and pension funds.
Geared towards developing general rules for individual institutions, these authorities are part of microprudential supervision. The three ESAs (focusing on regulatory tasks) and the European Systemic Risk Board (focusing on oversight of the EU financial system), together with the national competent authorities and the Joint Committee of the European Supervisory Authorities, form the European System of Financial Supervision (ESFS). This system of regulatory and supervisory authorities aims to coordinate and support the work of national authorities.
The European Systemic Risk Board (ESRB), which is based in Frankfurt am Main, comprises national central bank governors and supervisors from all of the EU countries as well as representatives from the European Commission, the ESAs, and the Economic and Financial Committee of the European Union (EFC). It is responsible for the oversight of the financial system in the EU in order to help avert or mitigate systemic risks to financial stability. With its focus on the financial system as a whole, the ESRB plays a role in macroprudential oversight.
On the recommendation of the ESRB, the EU Member States have set up national authorities that are responsible for macroprudential oversight in their respective countries. Macroprudential oversight in Europe therefore also takes place at the national level. There are good reasons for this. The national competent authorities and national central banks possess specific knowledge of their own financial systems and can offer targeted responses to misalignments in their own countries. In addition, as the effects of a systemic crisis are first felt at the national level, responsibility for macroprudential policy should also rest squarely there.
The German Financial Stability Committee is responsible for macroprudential oversight in Germany.
The German Financial Stability Committee has been responsible for macroprudential oversight in Germany since 2013. It comprises the Federal Ministry of Finance (chair), the Federal Financial Supervisory Authority (BaFin) and the Deutsche Bundesbank. The Bundesbank assumes key functions within the German Financial Stability Committee and is responsible for analysing all risks that could threaten the stability of the German financial system. The Bundesbank makes proposals to the Committee regarding the issuing of warnings and recommendations and evaluates their implementation by the affected parties. Furthermore, based on the Bundesbank’s analyses, the German Financial Stability Committee can recommend the use of “hard” (binding) macroprudential tools in order to avert threats. BaFin is responsible for the deployment of these tools in Germany.
With the launch of the Single Supervisory Mechanism (SSM) as part of the banking union in November 2014, the ECB was also given additional powers in macroprudential oversight.
Although it is still primarily the respective national competent authorities that decide on macroprudential measures, the ECB can tighten these measures and order the application of certain measures. Unlike the ESRB, which has non-binding tools at its disposal in the form of warnings and recommendations, the ECB is thus able to employ binding tools. Its instructions must therefore be followed by banks. The ECB’s macroprudential powers are limited to the banking sectors of the countries participating in the SSM. It has no power to influence developments in the insurance sector, for instance.
Macroprudential tools can be broken down into “soft”, “medium” and “hard” tools depending on the legal depth of intervention and strength of binding capacity. Soft tools comprise communication from macroprudential authorities on developments relating to financial stability and emerging risks. This is accomplished in particular via regular publications, such as annual reports, but also via speeches and interviews.
Macroprudential tools with a medium depth of intervention are warnings and recommendations. Recipients of ESRB warnings and recommendations can be, in particular, the European Union as a whole, the European Commission, the governments and financial supervisory authorities of the EU Member States, and the European Supervisory Authorities. The German Financial Stability Committee can issue warnings and recommendations to all German public sector entities.
There are soft, medium and hard macroprudential tools.
Recommendations can ultimately provide for the deployment of hard (binding) macroprudential tools, which intervene directly in the business activities of financial market players. European and German legislation currently makes it possible to deploy hard macroprudential regulatory tools, especially in relation to the banking industry. The majority of these tools are designed to strengthen banks’ capital bases. They include, for example, the capital buffer for global systemically important banks, which is intended to help increase the resilience of particularly large and interconnected institutions to losses.
Supervisors can impose higher capital requirements on banks during economic upturns by imposing a countercyclical capital buffer, thus increasing their resilience. In the event of a subsequent downturn, the buffer can then be depleted again in order to cushion negative effects, such as those arising from credit defaults.
As a result of globalisation, worldwide political cooperation in monetary and financial matters has continued to gain in importance. International institutions and bodies have addressed these issues and created a framework for international cooperation.
The International Monetary Fund (IMF) is of particular significance in promoting the economic stability and cooperation of countries in the international monetary system. The IMF constantly monitors the economic and monetary policies of its 190 member countries. In its annual consultations with its member countries, it examines the economic and monetary developments in these countries and recommends specific stability-inducing economic policy measures. In addition, the IMF analyses the global economic outlook and cross-border risks in the international financial system on a semi-annual basis, with special emphasis on strengthening the resilience of economies to crises.
The IMF is the global forum for worldwide financial and monetary policy cooperation.
Member countries can access financial assistance from the IMF to help overcome difficulties in their balances of payments. For example, they can obtain the “hard” currencies they require from the IMF for a limited period of time in exchange for their own currency. For this purpose, the IMF has considerable financial resources at its disposal consisting of contributions from its member countries.
These contributions are determined according to the relative economic strength of each member country, regularly reviewed to ensure that they are appropriate, and adjusted as needed. The voting rights of the member countries in the IMF are also determined by the shares in total contributions, known as “quotas”.
The IMF generally makes its provision of financial assistance to a member country conditional on the conclusion of an economic policy adjustment programme and the implementation of pre-agreed measures aimed at overcoming the problems in that country’s balance of payments (conditionality). These could include, for example, the consolidation of the government budget, monetary and exchange rate policy measures, or market-economic reforms.
However, since 2009, countries with sound fundamentals and strong economic policies have been able to receive financial resources from the IMF as a precautionary measure, even in the absence of acute needs regarding their balance of payments and without conditionality. In this context, the IMF is currently providing Chile, Colombia, Mexico and Peru with Flexible Credit Lines (FCL). From 2010 onwards, the IMF granted large loans as part of the rescue packages for Cyprus, Greece, Ireland and Portugal. In recent years, it has granted large-scale loans to Argentina, Egypt, Pakistan and Ukraine, amongst other countries. In response to the global crisis triggered by the COVID-19 pandemic, the IMF was quick to support many of its members with extensive financial assistance – particularly by means of emergency facilities with only little economic policy conditionality. Low-income countries primarily receive financial assistance at reduced interest rates from the IMF, which it provides via a special trust fund.
Moreover, the IMF supports its member countries, if necessary, with consultancy services on technical issues relating to policy implementation, such as the compilation of statistics or the structuring of economic policy instruments and institutions, in order to strengthen the technical and administrative capacity of governments to successfully implement their economic policies.
The Federal Republic of Germany has been a member of the IMF since 1952. The Deutsche Bundesbank discharges Germany’s financial rights and obligations in the IMF. It provides the IMF with Germany’s quota resources (currently around €31.5 billion, or roughly 5.6% of the IMF’s total funds). This means that Germany has the fourth largest share in the IMF. In the event of increased financing needs, such as during a period of global crisis-like developments, the IMF may, under certain conditions, temporarily borrow additional funds from the Bundesbank and other countries or central banks by drawing on agreed credit lines.
The President of the Bundesbank is the Governor for Germany on the IMF’s Board of Governors.
The IMF’s highest decision-making body is the Board of Governors, on which all 190 member countries are represented. The Governor of the IMF for Germany is the Bundesbank President and their alternate is the Federal Minister of Finance. The Board of Governors is advised by the International Monetary and Financial Committee (IMFC), which comprises 24 members (finance ministers or central bank governors) and meets twice a year. The 24-person Executive Board is responsible for conducting the IMF’s day-to-day business. Because of its large share of voting rights and financing in the IMF, Germany is represented by its own members on the Executive Board and on the IMFC.
Since 1969, the IMF has been able to allocate special drawing rights (SDRs) to its member countries. If, in its reviews that it conducts every five years, the IMF identifies a global shortage of reserve assets, it can allocate SDRs to member countries in proportion to their quotas. If required, every member has the right to “draw” any currency it needs from the IMF in exchange for an equivalent value of its SDRs. SDRs can only be held by the IMF, the monetary authorities of the IMF member countries, and other authorised official agencies. SDRs can be used by these entities for financial transactions amongst each other. The IMF also uses SDRs as an internal unit of account in which all credit balances and loans are held. The value of SDRs is calculated daily based on a basket of the world’s major currencies. The basket weighting is reviewed every five years and adjusted if necessary. To this end, the fixed amounts of the individual currencies in the basket of currencies are determined first. By converting these into US dollar equivalents according to the current exchange rate, the IMF calculates their percentage shares in the basket of currencies, which then fluctuate over time with the exchange rates of the basket currencies.
At the 1944 Bretton Woods Conference, the International Bank for Reconstruction and Development (IBRD), or World Bank for short, was established alongside the IMF. It commenced its tasks in Washington DC in 1946. Whilst it initially used its funds to rebuild Europe, it has been focusing mainly on supporting developing countries since the late 1940s.
This task has resulted in the creation of four additional organisations: the International Development Association (IDA), the International Finance Corporation (IFC), the Multilateral Investment Guarantee Agency (MIGA), and the International Centre for Settlement of Investment Disputes (ICSID). Together with the IBRD, they are referred to as the World Bank Group. Their aim is to promote the economic development of less developed economies by providing financial and technical assistance and sharing knowledge. In common parlance, the term “World Bank” is used to denote the IBRD only. Besides the IBRD, the institution itself also includes the IDA.
The IBRD grants long-term economic development loans to developing countries and emerging market economies, and refinances these loans in the international capital markets.
The IDA grants loans to the poorest developing countries in particular at much more favourable terms: the maturities are longer and the interest rates to be paid are lower than for regular World Bank loans. Gifts are also possible in order to avoid overindebtedness. Loans from the IDA are financed predominantly using contributions from the advanced economies.
The IFC supports private sector projects in developing countries, for example by financing the establishment, modernisation and expansion of productive private enterprises.
The MIGA has the task of promoting foreign direct investment in developing countries by offering guarantees against political or legal risks associated with such investment.
The ICSID supports the implementation of arbitration proceedings for cross-border investment.
International economic and monetary policy cooperation takes place not only within the framework of international institutions but also in various informal bodies. The composition and activities of these bodies have largely evolved over time. They are named according to the number of participating countries (e.g. G20 = Group of Twenty).
The underlying idea behind these informal bodies is that a group of countries – some with similar economic interests – search for solutions to global economic problems before these issues are addressed in formal intergovernmental institutions. The informal meetings often produce outcomes that international organisations are then responsible for implementing.
The G7 has been in existence since 1976 and comprises seven major industrial economies. The finance ministers and central bank governors of the G7 regularly discuss current economic and monetary policy topics. These countries’ heads of state or government meet once a year.
The G20 consists of the most economically important industrial nations and emerging market economies.
Alongside the G7 countries, the G20 includes 12 other major countries as well as the European Union, represented by the presidency of the European Council, the European Commission and the European Central Bank. The G20 was founded in 1999 in response to the Asian financial crisis and was originally tasked first and foremost with improving dialogue between industrial countries and emerging market economies. It represents around two-thirds of the world’s population and around 85% of global gross domestic product.
The G20 meetings have gained considerably in importance since the global financial crisis of 2008. This is because crises can only be prevented effectively if as many major countries as possible agree on – and then also implement – rules for the financial markets. Moreover, economic policy dialogue has been intensified. The G20 was therefore established by its member countries as a central forum for their international economic cooperation. In addition to the meetings at the ministerial level, the heads of state or government meet once a year.
The Financial Stability Board (FSB) was established as the central coordination committee for financial sector issues by the G20 heads of state or government in the wake of the global financial crisis at their London summit in April 2009. The FSB consists of a plenary, a steering committee, four standing committees and various working groups.
The FSB works to promote the stability of the international financial system.
The membership of the FSB comprises the national authorities responsible for financial stability in the member countries as well as relevant international institutions. A country may be represented by several member authorities (up to a maximum of three) depending on the size and importance of its financial market. In Germany, these are the Deutsche Bundesbank, the Federal Ministry of Finance and the Federal Financial Supervisory Authority (BaFin). Non-member countries are involved in the FSB’s work through six regional consultative groups.
The FSB consists of representatives from central banks, finance ministries, supervisory authorities and international organisations.
The FSB is tasked with identifying any vulnerabilities in the international financial system and proposing and monitoring the implementation of any action needed to address them. Key topics include dealing with systemically important financial institutions, monitoring and regulating financial intermediaries outside the banking system, and working to reduce risks arising from derivatives markets. Another of its key tasks is promoting the internationally consistent application of standards and codes to safeguard the stability of the financial system. Furthermore, the FSB aims to coordinate regulatory and supervisory policy in financial sector issues at the international level and foster cooperation and the exchange of information among the institutions responsible for these areas.
Moreover, the members of the FSB have committed to undergo regular international peer reviews of their financial sectors and participate in the Financial Sector Assessment Program (FSAP) run by the IMF and the World Bank. Given that the FSB’s recommendations are not legally binding, political support from the G20 is crucial to the board’s success.
The Bank for International Settlements (BIS) is based in Basel and was established in 1930, making it the world’s oldest international financial institution. Membership is restricted to central banks. There are currently 60 members. The BIS has the task of promoting cooperation among central banks and facilitating international payment settlements. The BIS provides a wide range of services to central banks, particularly with regard to the management of reserve assets.
The BIS is the world’s oldest international financial institution.
The BIS plays a key role in cooperation among central banks and other bodies working in the area of finance. It works closely with various entities for which it hosts a secretariat and which, depending on their mandate, are extensively involved in formulating regulatory and supervisory responses to the financial crisis. These include, in particular, the Financial Stability Board (FSB) and the four standing committees set up by the central bank governors of the major industrial countries many years ago.
The Committee on the Global Financial System has the task of identifying and assessing possible causes of stress in the global financial markets and promoting the functional viability and stability of these markets.
The Basel Committee on Banking Supervision is committed to improving the quality of banking supervision and supervisory knowledge worldwide. It developed the “Basel standards” for bank capital and liquidity requirements, and is continuously working on further measures intended to strengthen the resilience of the banking system.
BIS committees develop requirements for a stable financial system.
The Committee on Payments and Market Infrastructures is concerned with national and international payments and securities settlement and clearing systems.
The Markets Committee is responsible, amongst other things, for government bond markets and dealing with non-standard central bank measures.