Stay firmly on the path of reform

Berlin, 15 March 2006 - Not checked against delivery

Klaus-Peter Müller
President of the Association of German Banks and Chairman of the Board of Managing Directors, Commerzbank AG

Press conference following the meeting of the Board of Directors of the Association of German Banks

Introduction

Ladies and gentlemen – next week the new German government will have been in office for four months. It is generally recognised that it has made a good start. This is not to say, however, that citizens consider that everything needing to be tackled in Germany, particularly in home affairs, is already on the right track. On the contrary: nine out of ten Germans, according to a survey commissioned by the Association of German Banks early this year, believe that the reforms agreed to date will not be sufficient to solve the problems facing the country.

People in Germany expect their politicians to vigorously continue pursuing the reform agenda. This applies not only, but naturally above all, to the Federal government. And it is certainly true that there are high expectations of the “grand coalition”. After all, the CDU/CSU and SPD made a clear commitment in their coalition agreement to a policy of reform. Now – or at the very latest after the elections to the state parliaments in Baden-Württemberg, Rhineland-Palatinate and Saxony-Anhalt – it is time to work through the list of pressing issues. Step by step, yet swiftly and steadily.

Economic and fiscal policy agenda

And the list is a long one. Right at the top is the federalism reform
– the “mother of all reforms”, if you like. The point here is for Germany to disentangle itself from all the constraints we have imposed on ourselves over time with our complex network of legislative powers and also with the financial relationship between the federal government, the states and local authorities.

The likely changes to Germany’s Basic (constitutional) Law should take us a step forward. True, the end of the legislative process is once again open, but the coalition government should soon reach agreement. Even if the reforms currently envisaged will take us to the halfway mark at best, they will meet important prerequisites for more growth and employment. Instead of continuing to tinker with the package, we should now look forward. Because we still have to face the task of reforming Germany’s “financial constitution”.

Mixed financing, combined federal and state taxes, and of course the revenue equalisation scheme between the federal government and the states – these factors, too, hamper the states and the federal government in exercising responsibility for their affairs. They prevent federal competition to find the best solutions in economic and fiscal policy. As long as we fail to reorganise this whole area, considerable potential for growth, innovation and ultimately employment will – as the FDP rightly points out – remain unexploited.

What is more, reforming the financial constitution offers an opportunity to free companies in Germany from a burden that is virtually unknown in the international arena – namely trade tax. It could be replaced with a more appropriate form of local government finance that, unlike today, should be based on several pillars. On the one hand a local commercial tax in the form of a right for local authorities to levy a surcharge on income and corporation tax. And on the other hand a reorganised property tax together with an increased share for local authorities of VAT or, if necessary, income tax. Funding of this kind would eliminate the damaging effects on the economy of trade tax and guarantee local authorities stable tax revenue.

If it proved possible to put local government funding on a new, more secure basis in this way, we would at the same time remove a significant obstacle to another very important reform: the reform of company taxation.

Allow me to first clear up a common misunderstanding: company taxation reform is not a gift to the business community. On the contrary: it is a precondition for higher economic growth and more jobs. So it is also, not to say above all, in the interests of workers.

Economists and academics are unanimous in their view that the necessary growth can only be achieved – even if this is something not all policymakers want to admit – with appropriate net tax relief. There is no other way to achieve an internationally competitive tax rate. So company taxation reform should not be shackled from the outset with the dogma of revenue neutrality. Furthermore, in the past tax relief was often paid for in another form by businesses themselves, and was sometimes even overcompensated.

Sound blueprints for a reform of company taxation have already been drawn up by the Stiftung Marktwirtschaft (an economic policy think-tank) and the council of experts known as the Sachverständigenrat. And time is pressing: if the reform is to enter into force as planned on 1 January 2008, the reform must be agreed on by next summer at the latest. This is because companies need sufficient time to prepare for the new tax rules. So it is important for the German government to keep its promise to examine these proposals without delay and publish the main points of a draft bill by summer this year.

There is also a need to reform the taxation of investment income. The government of the state of Hesse published a sound proposal last year. Like the Sachverständigenrat, the Zentraler Kreditausschuss (ZKA) – a joint committee of Germany’s leading banking associations – and the rest of the business community, Hesse is in favour of a moderate, flat withholding tax on interest, dividends and private capital gains. This would be a transparent and practical solution both for tax authorities and for investors and banks. We welcome the fact that the government has taken on board legitimate reservations about their original plans and that the idea of introducing a capital gains tax in isolation as early as 2007 has been shelved. A new regime is now to take effect from 1 January 2008 alongside the company tax reform.

A withholding tax would have another big advantage: it would render time-consuming and costly bureaucratic controls superfluous. The practice of allowing authorities automated access to information on customers’ accounts, which is controversial for a whole host of reasons, would be obsolete – at least in the area of taxation. It goes without saying that the banks will continue to contribute constructively to all measures aimed at combating terrorism.

It should nevertheless be recognised that there has been an increasing tendency in recent years to use the business community – particularly the banks – to carry out, free of charge, tasks which are the inherent responsibility of the state.

This is a dangerous development not least because bureaucratic burdens are already excessive and have over the years become a real locational disadvantage for companies in Germany seeking to compete in the international marketplace.

To reverse this trend we need less regulation and, where regulation is indispensable, better regulation. The new government has already adopted this reform project. In future, the costs to business of state regulation are to be calculated during the legislative process by means of a standard cost model and all alternatives to legislation are to be examined. The government’s commitment to deregulation may be gauged by its plans to set up a standards monitoring committee direct in the Federal Chancellor’s Office. That is a good sign, an encouraging sign. Naturally, it is now important for deeds to follow.

There is already an indication of positive development in the economy. The German economy has had a lively start to 2006, though it admittedly continues to benefit from the world economic boom. The Association of German Banks forecasts 1½% growth for this year. But a glance at 2007 shows that the recovery remains fragile. Policymakers would therefore do well to take account of 2007, too, in their calculations.

First of all, the planned three percentage point increase in VAT is likely to put the brakes on domestic demand. And second, we must be prepared for the fact that the world economic boom will not continue indefinitely, but is likely to cool down further – and in an environment, moreover, of rising interest rates.

Fiscal policy therefore also moves between these two poles, between hopes and fears, when considering the economic prospects. This applies, too, if Brussels is brought into the equation. ECOFIN decided yesterday to step up the excessive deficit procedure against Germany. Serious efforts will need to be made if the deficit is really to be brought down to 2.5% next year as promised in the German Stability Programme.

It must be clearly understood in this context that a sound consolidation strategy should be built first and foremost on cutting public spending. We believe raising taxes to consolidate the budget is the wrong approach because of the implications for the economy and for growth. The envisaged increase in VAT of three percentage points at the beginning of 2007 is therefore not an inevitable response to the excessive deficit procedure. Rather, it is the result of inadequate efforts to cut spending in previous years.

The federal budget for this year will also clearly overshoot the borrowing limit prescribed by our constitution. This is another task which has merely been postponed – and it remains a challenging one. To comply with Article 115 of the Basic Law next year, the federal government will have to reduce its new indebtedness by almost half.

It could not be clearer, ladies and gentlemen: policymakers must lose no more time and face up to their key task – strengthening growth. Only if overdue structural reforms are set in motion before the end of this year will Germany be adequately prepared to meet the challenges of 2007.

Banking policy agenda

Structural reform is a prerequisite for growth in Germany. This applies, too, to Germany’s position as a financial centre. The International Monetary Fund recently reiterated yet again that reforming the German banking system – and, specifically, privatising German public savings banks – would make an important contribution to economic growth.

The government’s coalition agreement also sends out an important message in this context by underlining that a competitive financial centre is “one of the major prerequisites for economic growth and more employment”. No previous government has laid such emphasis on this issue.

So it is all the more disappointing to find policymakers now sending out signals which are inconsistent with the aim of strengthening Germany’s position as a financial centre. Certainly, this cannot be achieved without regulation. But when regulating capital markets in Germany, as at international level, a sense of proportion must prevail. Nor is it helpful for some election campaigners to attempt to revive the notorious “capitalism debate”.

It is also difficult to understand why the German government, in contrast to the commitment made in the coalition agreement, no longer intends to implement EU rules “as is” after all. This applies, for example, to the Anti-Discrimination Directive. There will apparently once again be “gold-plating” when the directive is transposed into national law. This would be a fresh competitive disadvantage for Germany in the European financial market, a self-inflicted wound – and thus utterly wrong.

The right approach, by contrast, is to provide impetus for the future of Germany as a financial centre. I am thinking, for example, of real estate investment trusts (REITs), which the government plans to introduce from 1 January 2007. An initiative known as Initiative Finanzstandort Deutschland (IFD) has put forward a concrete model for these vehicles. The only real remaining obstacles to the rapid launch of REITs in Germany are a few tax aspects. The Federal Ministry of Finance has promised to clarify these shortly so that the market for REITs in Germany can be opened up. Otherwise, there is a danger of other financial centres once again getting ahead of us. REITs have operated successfully in the US and French markets for some time, and the UK is planning their introduction on 1 January 2007.

A concern has been raised in connection with REITs that tenants in flats transferred to trusts of this kind would – assuming this actually occurred at all – face adverse consequences. This concern is unfounded. Regulations protecting tenants in Germany will continue to apply unchanged, even if the property is held in a listed REIT.

Open property funds have proved their quality over many years notwithstanding the disruption we have recently seen in a few isolated instances. REITs will be a welcome addition on the market.

An issue for the future is a possible role for property in private provision for old age. After the phasing out of subsidies for home owners, it is worth considering including owner-occupied residential property in the options eligible for so-called “Riester” incentives. It would, however, need to be ensured that property was not once again given preferential treatment over other forms of investment.

Banking supervision is another issue addressed in the coalition agreement that is of interest to the financial markets. The government intends to evaluate the work of the Federal Financial Supervisory Authority (BaFin) and, if necessary, press for changes in the organisation and working methods of both BaFin and the Bundesbank. Let me say this: a strong regulator is vital to the competitiveness of a financial centre. The structure established in 2002 and the division of responsibilities between BaFin and the Bundesbank have proved their worth, and are also regarded as exemplary at international level. True, optimising supervision is a permanent task. Yet we see no reason for fundamental criticism. BaFin must continue to exercise its monitoring role in a way which does not cause competitive distortions to the detriment of German banks. Its activities must be guided by the principle of the least possible interference in the freedom to do business. This involves assuming that the banks will comply with the rules and regulations governing them even without complete and continuous control. In short: we are in favour of supervision in which a sense of proportion plays a strong role.

Lawmakers must also allow fair competition in the sale of Bankgesellschaft Berlin. To guarantee the necessary legal certainty, it must be made clear either by amending Section 40 of the German Banking Act or by some other means that any acquirer of Bankgesellschaft can – if it so wishes – continue to use the name “Sparkasse”. Only if this is possible can the sale of Bankgesellschaft be considered “non-discriminatory”, as required by the European Commission.

We welcome in this context the announcement by Internal Market Commissioner Charlie McCreevy that he intends to decide shortly how the Treaty infringement procedure against Germany – suspended since 2003 – will proceed and look into the public banks’ monopoly on the use of Sparkasse that is enshrined in Section 40. This is not about interference in the system of ownership. It is actually about strengthening the ownership rights of local authorities. These include the right, when selling a publicly owned savings bank, to sell the name Sparkasse along with it. This is the only way to avoid selling the bank below its value. This applies particularly to the Bankgesellschaft Berlin case. What is more, “free” (i.e. private) Sparkassen such as those in Hamburg, Bremen or Lübeck, which are permitted to use the name Sparkasse under an exemption to the rule in Section 40, demonstrate that public ownership is no prerequisite for the ability to carry out the responsibilities of a savings bank. This is underscored by savings banks in other European countries which have been successfully privatised or turned into co-operatives.

The announcement of an amendment to the Savings Bank Act in Hesse has sparked a political debate. I would like to make one thing quite clear: there is no foundation whatsoever to allegations that the private banks want to bring legal action against the act. What would be the basis for such action? Not even a draft bill has been published as yet.

Based on the information available to date, the planned legislation certainly falls short of the private banks’ expectations concerning the modernisation of the German market. Nevertheless, the envisaged formation of nominal capital is an important first step in the right direction. I do not understand what is supposed to be wrong with creating nominal capital. The point at issue is this: how long is a municipal treasurer supposed to wait for a reasonable return on the capital tied up in a local Sparkasse while at the same time closing kindergartens and public swimming baths due to a lack of funds? It is estimated that Germany’s public savings banks hold capital worth some 50 billion euros. Citizens have a right to see a return on this capital in their communities which is in line with market rates.

Ladies and gentlemen, the banks face further challenges this year with direct implications for their business. I should like to mention just two of them today: the new Basel II capital adequacy rules and the Single Euro Payments Area, the SEPA.

The recent decision to amend the German Banking Act marks an important first step by the government to implement the new rules in Germany. It is now important for the planned Solvency Ordinance and the Ordinance governing large exposures and loans to be adopted at the same time as the Banking Act.

In the interests of a level playing field for all banks in Europe, it is also important that the Capital Requirements Directive, which implements Basel II, is transposed in all member states simultaneously and in full. What is happening on Basel II in the US is most unfortunate. A very late political debate appears to be under way on the introduction of Basel II. It would be welcome if America got back into step with Europe and did not back away from the goal, jointly set in summer 2004, of subscribing to a single international standard.

When implementing the rules on intra-group exposures (IGEs) in the German Banking Act, the government should ensure that the directive’s criteria for granting zero weighting apply equally and in full to all categories of banks. If unwarranted preferential treatment were given to banks belonging to a joint liability scheme, Germany would run the risk of failing to comply with European law – with all the consequences this would entail. Moreover, any departure from the criteria set out in the European directive – criteria which are indispensable from a competition and risk perspective – would not be conducive to the stability of the financial markets.

A key role in establishing a true European single market for financial services will also be played by the Single Euro Payments Area. The Commission recently published a consultation paper in which it was critical of what has been achieved to date by the European banking industry. Let there be no misunderstanding: Germany’s private banks have a clear commitment to SEPA. We fully support the Commission’s objective of creating a single market for payments in the EU. But the Commission should not prescribe in excessive detail how this objective is to be achieved. The private banks continue to set great store by intensive dialogue with the Commission. We are confident that an acceptable solution can be found for both sides, and thus ultimately for customers as well.

Conclusion

Ladies and gentlemen, the World Cup kicks off in 86 days time. Like all sports fans I, too, am anxious to see how the German team will perform. Compared to our national football team, the German government has “played” better so far. The important thing now is for efforts not to slacken and to stay on course. There is still plenty to do. What really matters is what gets published in the Federal Law Gazette. At the end of the day, to quote a football saying which applies equally well to reforms: “It’s the result that counts!”

Thank you for your attention!