Capital Markets and Portfolio Investment

As an EU member state with a well-developed financial sector, Germany welcomes foreign portfolio investment and has an effective regulatory system. Germany has a very open economy, routinely ranking among the top countries in the world for exports and inward and outward foreign direct investment. As a member of the Eurozone, Germany does not have sole national authority over international payments, which are a shared task of the European Central Bank and the national central banks of the 19 member states, including the German Central Bank (Bundesbank). A European framework for national security screening of foreign investments, which entered into force in April 2019, provides a basis under European law to restrict capital movements into Germany on the basis of threats to national security. Global investors see Germany as a safe place to invest, as the real economy – up until the COVID-19 crisis– continued to outperform other EU countries.German sovereign bonds continue to retain their “safe haven” status.

Listed companies and market participants in Germany must comply with the Securities Trading Act, which bans insider trading and market manipulation. Compliance is monitored by the Federal Financial Supervisory Authority (BaFin) while oversight of stock exchanges is the responsibility of the state governments in Germany (with BaFin taking on any international responsibility). Investment fund management in Germany is regulated by the Capital Investment Code (KAGB), which entered into force on July 22, 2013. The KAGB represents the implementation of additional financial market regulatory reforms, committed to in the aftermath of the global financial crisis. The law went beyond the minimum requirements of the relevant EU directives and represents a comprehensive overhaul of all existing investment-related regulations in Germany with the aim of creating a system of rules to protect investors while also maintaining systemic financial stability.

Money and Banking System

Although corporate financing via capital markets is on the rise, Germany’s financial system remains mostly bank-based. Bank loans are still the predominant form of funding for firms, particularly the small- and medium-sized enterprises that comprise Germany’s “Mittelstand,” or mid-sized industrial market leaders. Credit is available at market-determined rates to both domestic and foreign investors, and a variety of credit instruments are available. Legal, regulatory and accounting systems are generally transparent and consistent with international banking norms. Germany has a universal banking system regulated by federal authorities, and there have been no reports of a shortage of credit in the German economy. After 2010, Germany banned some forms of speculative trading, most importantly “naked short selling.” In 2013, Germany passed a law requiring banks to separate riskier activities such as proprietary trading into a legally separate, fully capitalized unit that has no guarantee or access to financing from the deposit-taking part of the bank. Since the creation of the European single supervisory mechanism (SSM) in November 2014, the European Central Bank directly supervises 21 banks located in Germany (as of January 2021) among them four subsidiaries of foreign banks.

Germany supports a global financial transaction tax and is pursuing the introduction of such a tax along with other EU member states.

Germany has a modern and open banking sector that is characterized by a highly diversified and decentralized, small-scale structure. As a result, it is extremely competitive, profit margins notably in the retail sector are low and the banking sector considered “over-banked” and in need of consolidation. The country’s “three-pillar” banking system consists of private commercial banks, cooperative banks, and public banks (savings banks/Sparkassen and the regional state-owned banks/Landesbanken). This structure has remained unchanged despite marked consolidation within each “pillar” since the financial crisis in 2008/9. The number of state banks (Landesbanken) dropped from 12 to 5, that of savings banks from 446 in 2007 to 374 at the end of 2019 and the number of cooperative banks has dropped from 1,234 to 814. Two of the five large private sector banks have exited the market (Dresdner, Postbank). The balance sheet total of German banks dropped from 304 percent of GDP in 2007 to about 265 percent of end-2019 GDP with banking sector assets worth €9.1 trillion. Market shares in corporate finance of the banking groups remained largely unchanged (all figures for end of 2019): Credit institutions 27 percent (domestic 17 percent, foreign banks 10 percent), savings banks 31 percent, state banks 10 percent, credit cooperative banks 21 percent, promotional banks 6 percent.

The private bank sector is dominated by globally active banks Deutsche Bank (Germany’s largest bank by balance sheet total) and Commerzbank (fourth largest bank), with balance sheets of €1.3 trillion and €466.6 billion respectively (2019 figures). Commerzbank received €18 billion in financial assistance from the federal government in 2009, for which the government took a 25 percent stake in the bank (now reduced to 15.6 percent). Merger talks between Deutsche Bank and Commerzbank failed in 2019. The second largest of the top ten German banks is DZ Bank, the central institution of the Cooperative Finance Group (after its merger with WGZ Bank in July 2016), followed by German branches of large international banks (UniCredit Bank or HVB, ING-Diba), development banks (KfW Group, NRW.Bank), and state banks (LBBW, Bayern LB, Helaba, NordLB).

German banks’ profitability deteriorated in the years prior to the COVID-19 crisis due to the prevailing low and negative interest rate environment that narrowed margins on new loans irrespective of debtors’ credit worthiness, poor trading results and new competitors from the fintech sector, and low cost efficiency. In 2018, according to the latest data by the Deutsche Bundesbank (Germany’s central bank), German credit institutions reported a pre-tax profit of €18.9 billion or 0.23 percent of total assets. Their net interest income remained below its long-term average to €87.2 billion despite dynamic credit growth (19 percent since end-2014 until end-2019 in retail and 23 percent in corporate loans) on ongoing cost-reduction efforts. Thanks to continued favorable domestic economic conditions, their risk provisioning has been at an all time low. Their average return on equity before tax in 2018 slipped to 3.74 percent (after tax: 2.4 percent) (with savings banks generating a higher return, big banks a lower return, and Landesbanken a –2.45 percent return). Both return on equity and return on assets were at their lowest level since 2010.

Brexit promptedsome banking activities to relocate from the United Kingdom to the EU, with many foreign banks (notably U.S. and Japanese banks) choosing Frankfurt as their new EU headquarters. Their Core Tier 1 equity capital ratios improved as did their liquidity ratios, but no German large bank has been able to organically raise its capital for the past decade.

In 2020, the insolvency of financial services provider WireCard revealed certain weaknesses in German banking supervision. WireCard, which many viewed as a promising innovative format for the processing of credit card transactions, managed to conceal inadequate equity from supervisory authorities while also inflating its actual turnover. The Wirecard insolvency led to the replacement of the head of banking supervisory authority BaFin and triggered both an ongoing overhaul of the German banking supervision and a continuing parliamentary investigation.

It remains unclear how the COVID-19 crisis will affect the German banking sector. Prior to the pandemic, the bleaker German economic outlook prompted a greater need for value adjustment and write-downs in lending business. German banks’ ratio of non-performing loans was low going into the crisis (1.24 percent). In March 2020, the German government provided large-scale asset guarantees to banks (in certain instances covering 100 percent of the credit risk) via the German government owned KfW bank to avoid a credit crunch. So far, German banks have come through the crisis unscathed thanks to extensive liquidity assistance from the ECB, moratoria and fiscal support for the economy. Nevertheless, 25 German banks were downgraded in 2020 and many more were put on negative watch, though CDS spreads for the two largest private banks have fallen dramatically since the height of the crisis in March 2020 and are currently around pre-COVID levels. The second and third COVID-waves, however, are likely to take a toll on credit institutions and 2021 could prove to be the toughest test for banks since the 2008/9 global financial crisis. According to the Bundesbank, loan defaults by German banks could quadruple to 0.8 percent of the loan portfolio (or €13 billion). The Bundesbank’s focus in particular is on aircraft loans. According to Bloomberg’s calculations, the major German regional banks have lent €15 billion for aircraft financing. At Deka alone, the asset manager of the savings banks, the ratio of non-performing loans in aircraft financing is at a relatively high 7.7 percent.

Foreign Exchange and Remittances

Foreign Exchange

As a member of the Eurozone, Germany uses the euro as its currency, along with 18 other EU countries. The Eurozone has no restrictions on the transfer or conversion of its currency, and the exchange rate is freely determined in the foreign exchange market.

The Deutsche Bundesbank is the independent central bank of the Federal Republic of Germany. It has been a part of the Eurosystem since 1999, sharing responsibility with the other national central banks and the European Central Bank (ECB) for the single currency, and thus has no scope to manipulate the bloc’s exchange rate. Germany’s persistently high current account surplus – the world’s second largest in 2020 at USD 261 billion (6.9 percent of GDP) – has shrunk for the fifth year in a row. Despite the decrease, the persistence of Germany’s surplus remains a matter of international controversy. German policymakers view the large surplus as the result of market forces rather than active government policies, while the European Commission (EC) and IMF have called on authorities to rebalance towards domestic sources of economic growth by expanding public investment, using available fiscal space, and other policy choices that boost domestic demand.

Germany is a member of the Financial Action Task Force (FATF) and is committed to further strengthening its national system for the prevention, detection and suppression of money laundering and terrorist financing. Federal law is enforced by regional state prosecutors. Investigations are conducted by the Federal and State Offices of Criminal Investigations (BKA/LKA). The administrative authority for imposing anti-money laundering requirements on financial institutions is the Federal Financial Supervisory Authority (BaFin).

The Financial Intelligence Unit (FIU) – located at the General Customs Directorate in the Federal Ministry of Finance – is the national central authority for receiving, collecting and analyzing reports of suspicious financial transactions that may be related to money laundering or terrorist financing. On January 1, 2020, legislation to implement the 5th EU Money Laundering Directive and the European Funds Transfers Regulation (Geldtransfer-Verordnung) entered into force. The Act amends the German Money Laundering Act (Geldwäschegesetz – GwG) and a number of further laws. It provides, inter alia, the FIU and prosecutors with expanded access to data. On March 9, 2021 the Bundestag passed an anti-money laundering law seeking to improve Germany’s criminal legal framework for combating money laundering while simultaneously implementing the EU’s 6th Money Laundering Directive (EU 2018/1673 – hereafter “the Directive”). The Directive lays down minimum rules on the definition of criminal offenses and sanctions to combat money laundering. The law goes beyond the minimum standard set out in the Directive by broadening the definition of activities that could be prosecuted as money laundering offenses. Previously, the money laundering section in the German Criminal Code was designed to criminalize acts in connection with a list of serious “predicate offenses,” the underlying crime generating illicit funds, e.g., drug trafficking. The new law dispenses with the previously defined list, allowing any crime to be considered as a “predicate offense” to money laundering (the “All- Crimes Approach”). This is a paradigm shift in German criminal law, and implements an additional priority laid out in Germany’s “Strategy to Combat Money Laundering and Terrorist Financing” adopted in 2019.

The number of suspected money laundering and terrorist financing cases rose sharply in 2019 from 77.000 suspicious activity reports (SARs) to 114.914 according to the 2019 annual report of FIU (a new record and 12-fold that of 2009). The vast majority (98 percent) of suspicious transaction reports were filed by German banks and other financial institutions in order to avoid legal risks after a court ruling that held anti-money laundering (AML) officers personally liable, thus including many “false positives”. At the same time, the activities resulted in just 156 criminal charges, 133 indictments and only 54 verdicts.

In its annual report 2018, the FIU noted an “extreme vulnerability” in Germany’s real estate market to money laundering activities. Transparency International found that about €30 billion in illicit funds were funneled into German real estate in 2017. The results of the first concerted action by supervisory authorities of the German federal states in the automotive industry in 2019, for example, were sobering: only 15 percent of car dealers had implemented AML provisions, the rest had deficiencies, showing the “need for further sensitization.” The report also noted a slight upward trend in the number of SARs related to crypto assets. Around 760 SARs cited “anomalies in connection with cryptocurrencies”, as reporting noted, especially the forwarding of funds to trading platforms abroad for the exchange of funds into cryptocurrencies. However, the FIU itself has come under criticism. Financial institutions deplore the quality of its staff and the effectiveness of its work. The Institute of Public Auditors in Germany (IDW) criticizes that the precautions taken to prevent money laundering in high-risk industries outside the financial sector are monitored much less intensively. A review of the FIU scheduled for 2020 has been postponed due to the pandemic.

There is no difficulty in obtaining foreign exchange.

Remittance Policies

There are no restrictions or delays on investment remittances or the inflow or outflow of profits.

Germany is the largest remittance-sending country in the EU, making up almost 18% of all outbound personal remittances of the EU-27 (Eurostat). Migrants in Germany posted USD 25.1 billion (0.6 percent of GDP) abroad in 2019 (World Bank). Remittance flows into Germany amounted to around USD 16.5 billion in 2019, approximately 0.4 percent of Germany’s GDP.

The issue of remittances played a role during the German G20 Presidency in 2017. During its presidency, Germany passed an updated version of its “G20 National Remittance Plan.” The document states that Germany’s focus will remain on “consumer protection, linking remittances to financial inclusion, creating enabling regulatory frameworks and generating research and data on diaspora and remittances dynamics.” The 2017 “G20 National Remittance Plan” can be found at https://www.gpfi.org/publications/2017-g20-national-remittance-plans-overview 

Sovereign Wealth Funds

The German government does not currently have a sovereign wealth fund or an asset management bureau.

* Source for Host Country Data: Federal Statistical Office, www.destatis.de; Bundesbank, www.bundesbank.de