“Solvency II” and “Basel III” could give rise to substantial risks to the financing of German companies, should the mutually reinforcing effects of these regulatory reforms in the insurance and banking sector not be taken into account.
“They will tend to increase the costs of securing outside capital. Germany’s SMEs (small and medium-sized companies) will also feel the effects of this,” said Martin Zeil, Bavaria’s economics minister, on the occasion of the release of a comprehensive appraisal authored by the Munich-based Professor Christoph Kaserer and commissioned by the Munich Financial Center Initiative (fpmi).
“The reciprocal effects of these reforms of the insurance and banking industries have received far too little attention. One reason has been, no doubt, the lack of robust figures,” criticized Zeil, pointing out that the appraisal provided new findings in this area.
“One indisputable fact is that the insurers constitute a major source of the banks’ financing. Should the new rules cause the insurers to alter their investment practices, this will ramify upon the banks – and thus upon Germany’s SMEs,” points out the minister.
The appraisal reveals that Germany’s insurers hold Euro 1.4 trillion in assets committed on the long-term basis – some half of the country’s total. The insurers are thus the country’s greatest collectors of capital. As such, they play a major role in supplying the refinancing needed by Germany’s banks, and thus, indirectly, in furnishing the financing required by the country’s corporate sector. The insurers also directly provide capital to this non-financial sector.
A professor of business administration, financial management and capital markets at Munich’s Technische Universität, Kaserer emphasized that the share of Germany’s corporate and real estate financing accruing from insurers comes to 38%. Kaserer also proved that insurers hold 12% of the volume – corresponding to some Euro 550 billion – of refinancing provided to the banking sector from outside sources. This percentage rises to 24% and to 41% for unsecured bank bonds and loans and German covered mortgage bonds respectively. With a share of 20% of the instruments in circulation, the insurers also constitute a highly important group of investors in the area of hybrid capital – subordinate loans and profit participation rights.
The appraisal foresees the pending Basel III rules’ triggering of a considerable need for refinancing on the part of commercial banks and Landesbanken. This need will probably be met by increasing the issuing of unsecured bank loans. Proprietary valuations of risk, Solvency II and Germany’s Bank Restructuring Act could combine to cause at the same time the country’s insurers to withraw from this market – with concomitant effects on it and on hybrid capital.
The peril of the insurers’ reducing their purchases of bank bonds is very real, states the appraisal, which sees the new regulations as giving insurers incentives to start avoiding long-term corporate bonds. “Should banks’ refinancing costs increase, the costs of securing credit will also rise. This could also affect Germany’s SMEs, as they depend upon such credit, and as they can hardly switch to other forms of financing,” notes Zeil.
fpmi basically welcomes the introductions of Basel III and Solvency II. The two bodies of rules will reduce the financial sector’s risks and will increase its transparency of operation. To counter any potential problems, fpmi – in accordance with the appraisal – suggests precluding negative reciprocal effects issuing from Solvency II and Basel III.
A further thrust of the Initiative’s approach is to augment Solvency II’s orientation towards the long-term nature of the insurance business. The principle of the regulation has to fit this business model. This would secure the future of the guarantee models used by Germany’s life insurers and corporate pension plans. These models have been especially successful. Germany’s life insurance industry has entered into 94 million contracts – these have a premium volume of more than Euro 90 billion – with policyholders, making it by far the country’s most important form of private old-age provision. Guarantee-based corporate pension plans are also highly important to Ger-many’s SMEs.
fpmi views the risks issuing from Solvency II, Basel III and other simultaneous projects of regulation as requiring the EU Commission to undertake a detailed investigation of the reciprocal effects of these individual measures. The results of this investigation should be incorporated into their rules, believes the Initiative.
“Before the reforms are implemented, studies of their potential effects have to be carried out. A focus has to be the financing procured by the non-financial sector. I will employ this appraisal in my advocacy in Berlin and Brussels of such an emphasis. I am confident that Germany’s banking sector and each of the three pillars comprising it will continue to represent a secure source of attractive corporate financing in the future. We have to now take the steps necessary to achieve this goal,” emphasizes Zeil.