Principles

The following description of the risk management system is based on the structure and functional principles of the Cooperative Financial Network’s institutional protection scheme at a primary level, but also takes into account the risk management of the individual institutions as a secondary element. In this context, risk management at the level of the protection scheme is mainly focused on preventing individual institutions from getting into difficulties.

Risk reporting covers all entities that are consolidated for the purposes of commercial law in the consolidated financial statements. This scope of consolidation for the consolidated financial statements therefore goes beyond the companies consolidated for regulatory purposes and is not limited to the members of the protection scheme.

The BVR protection scheme and BVR Institutssicherung GmbH ensure the stability of the entire Cooperative Financial Network and confidence in the creditworthiness of all its members. Both schemes together, and each in its respective functions and area of responsibility, form the backbone of risk management in the Cooperative Financial Network.

Institutional protection scheme of the Cooperative Financial Network

BVR protection scheme (BVR-SE)
BVR-SE is Germany’s and the world’s oldest deposit guarantee fund for banks and is financed entirely without government support. Right from its inception, this system has always ensured that all banks covered by the scheme have been able to meet their financial obligations – especially toward retail customers holding deposits. BVR-SE is regulated and monitored by the Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin) [German Federal Financial Supervisory Authority].

Since the German Deposit Insurance Act (EinSiG) came into effect on July 3, 2015, when it became necessary to establish a legally recognized deposit insurance scheme, BVR-SE has been continued as an additional voluntary bank-protection scheme in accordance with section 2 (2) and section 61 EinSiG.

The main responsibilities of BVR-SE are to ensure stability by averting imminent financial difficulties or eliminating any such existing problems at the affiliated institutions and to prevent any negative impact on confidence in the Cooperative Financial Network. So that it can provide the necessary support in securing these aims, BVR-SE has access to a guarantee fund that is funded by contributions from the member banks. If necessary, the institutions will also support each other with additional funding (guarantee obligations).

As can be seen from its annual report, BVR-SE was able to fulfill the responsibilities set out in its articles of association – especially its responsibilities as a bank-protection scheme – in 2021. A total of 781 institutions of the Cooperative Financial Network belonged to BVR-SE as at December 31, 2021 (December 31, 2020: 824 members). The decrease stemmed solely from mergers within the Cooperative Financial Network.

BVR Institutssicherung GmbH (BVR-ISG)
BVR-ISG is an officially recognized deposit guarantee scheme and, since July 1, 2015, has been operating an institutional protection scheme within the meaning of article 113 (7) of Regulation (EU) No. 575/2013 for CRR credit institutions that has been approved by the regulator. By operating the institutional protection scheme, BVR-ISG satisfies its responsibility under its articles of association to avert or eliminate imminent or existing financial difficulties in its member institutions.

To this end, BVR-ISG will initiate any preventive or restructuring action, as required. Where, in accordance with section 10 EinSiG, BaFin identifies a compensation event in relation to a CRR credit institution that is a member of the BVR-ISG protection scheme, BVR-ISG will compensate the customers of the credit institution concerned in accordance with sections 5 to 16 EinSiG. BVR-ISG thus fulfills the statutory requirements regarding deposit protection for customers.

Together, BVR-ISG and BVR-SE form the Cooperative Financial Network’s dual protection scheme. The members of the BVR-ISG protection scheme are those CRR credit institutions that also belong to the BVR and are affiliated to BVR-SE. As at December 31, 2021, the membership comprised 779 CRR credit institutions (December 31, 2020: 822), which is all of the banks in the Cooperative Financial Network that are authorized in Germany by BaFin.

Under section 50 (1) EinSiG, BVR-ISG is subject to supervision by BaFin and to monitoring by the Bundesrechnungshof (BRH) [German Federal Court of Audit] with regard to its responsibilities to compensate depositors in accordance with sections 5 to 16 EinSiG and with regard to funding and target funding levels in accordance with sections 17 to 19 EinSiG.

To the extent possible under EinSiG, BVR-ISG’s organizational and decision-making structures match the organizational and decision-making structures of BVR-SE. A service agreement is in place so that BVR-ISG’s day-to-day business operations can be carried out by the BVR employees who perform the relevant functions for BVR-SE. This includes monitoring and assessing risks for all CRR credit institutions that are members of BVR-ISG.

The focus of the activities of BVR-ISG in 2021 was on fulfilling its responsibilities as defined by law, the articles of association, and regulatory requirements. These activities centered on the risk-based collection of contributions, which is compliant with the relevant guidance of the European Banking Authority (EBA), the management of funds, extensive operational stress tests, and introduction of the IPS recovery plan in accordance with the Minimum Requirements for the Design of Recovery Plans (MaSan). BVR-ISG can look back on a highly successful year, having not had to take any action to protect depositors or banks or pay any compensation in accordance with section 145 of the German Bank Recovery and Resolution Act (SAG) at any time in 2021.

Risk identification and analysis

Basic structures
The Cooperative Financial Network is a decentralized organization made up of legally independent institutions that are linked – through the dual protection scheme – by their mutual liability. This decentralized element is in contrast with banking groups that have a parent company at the top of a hierarchical structure. Consequently, the power to make business decisions lies with each individual institution and its independent Board of Managing Directors and Supervisory Board. This decentralized structure determines the focus of risk management for the dual protection scheme. The focus is above all on overall analysis of the financial risk carriers – i.e. the institutions – rather than on isolated analysis of individual risk types and their scope. This fundamental methodological approach ensures that, in establishing that each individual institution’s financial position and risk position are appropriate and its financial performance is adequate, the entire system – i.e. the entire Cooperative Financial Network – as a unit can be considered to be on a sound economic footing.

The dual protection scheme has appropriate systems for identifying and classifying risks and for monitoring the risks of all its members and of the institutional protection scheme as a whole. Risks are rated on the basis of BVR-SE’s classification system, which has been in use since 2003. The aim of this rating process, which is based on the annual financial statements, is to obtain an all-round, transparent view of the financial position, financial performance, and risk position of all members. Rating a bank in accordance with the classification system provides the basis for determining the risk-adjusted guarantee fund contributions of BVR-SE and is also the starting point for preventive management.

The results of the classification are supplemented by further analysis and data, in particular evaluations of the data collected as part of an annual comparative analysis. This is a data pool that the BVR compiles from data collected from its member institutions and is predominantly based on information from the institutions’ accounting and reporting systems. The data from the annual comparative analysis forms the basis for analyses that use key risk indicators to identify and examine particular abnormalities. In addition, BVR-SE prepares special analyses on specific issues and specific risks, such as examining the impact of sustained low interest rates, the risks to investments in securities resulting from the war in Ukraine, and the effects of the upcoming interest-rate rises.

In accordance with its risk-oriented mode of operation, BVR-SE performs individual bank analyses on institutions of major financial significance to the protection scheme as a whole. This includes applying the concept used to analyze large banks. It thus takes into account the risks resulting from the size category of the affiliated institutions.

To assess BVR-SE’s risk-bearing capacity, probabilities of default are determined on the basis of various stress scenarios and Monte Carlo simulations are used to calculate the possible restructuring amounts. This involves carrying out scenario-specific classifications on the basis of different assumptions (e.g. interest-rate changes, declining credit ratings in the customer lending business).

Classification process and contributions to BVR-SE
The classification system uses eight key figures relating to financial position, financial performance, and risk position to assign the banks to one of the nine credit rating categories, which range from A++ to D. The classification system is based on quantitative key figures, most of the data for which is taken from the banks’ audited annual financial statements and audit reports. BVR-SE receives this data electronically from the regional auditing association responsible for the individual bank.

Generally, all institutions covered by BVR-SE are included in the classification system. Only a small number of institutions are not included, notably those – such as DZ BANK AG and its subsidiaries as well as Münchener Hypothekenbank eG – that are rated separately by an external rating company.

The classification process in 2021 was based on an analysis of data from the 2020 financial statements, which revealed that the classification results were weaker than those from the previous year. The deterioration was primarily due to gains and losses on securities, which fell back to a normal level following a sharp improvement in the previous year. This particularly affected any key figures for financial performance that include net profit. In absolute terms, income in the core business remained static and did not keep pace with the increase in the volume of business. Net interest income, for example, was virtually unchanged in absolute terms, while there was a further rise in net fee and commission income. The cost/income ratio rose a little owing to slightly higher administrative expenses. By contrast, operating profit held more or less steady. Loss allowances for loans and advances increased but were still at a low level by historical comparison. This is because the effects are gradually starting to be felt of the new rules on recognizing general loan loss allowances in accordance with accounting guidance statement 7, which has been issued by the banking committee of the Institut der Wirtschaftsprüfer in Deutschland e.V. (IDW) [Institute of Public Auditors in Germany] and is required to be applied from 2022 onward. The key figures for financial position declined slightly because the sum of the asset items grew at a slower rate than the total increase in the volume of business. The key figures for the risk position improved slightly owing to decreases in unsecured lending classed as weaker loans. Overall, the aforementioned effects resulted in reductions in the points awarded and thus to a poorer overall distribution of the classification results.

Classification of the BVR-ISG contributions
The contributions from the CRR credit institutions that are members of BVR-ISG are calculated on a risk-oriented basis in accordance with the BVR-ISG rules on contributions. The risk-weighted contribution is measured using the annual classification results and following a defined procedure. The main structural elements and the details of the calculation methodology are drawn from the EBA’s guidelines (EBA/2015/10), in accordance with which deposit guarantee schemes and institutional protection schemes are required to collect risk-related contributions.

Risk management and monitoring

Preventive management
The aim of preventive management is to identify and counteract adverse economic trends in the cooperative banks at an early stage, thereby helping to prevent the need for supporting measures. An analysis is carried out of data and other information from all banks in order to identify banks with potential issues. Necessary measures to stabilize and improve business performance are then agreed with the senior management of these banks in the course of supplementary discussions.

The results of the classification process provide an important basis for BVR-SE’s systematic preventive management. A bank is brought into the scope of this preventive management approach no later than when it is classified as B– or lower on the basis of its annual financial statements. Building on the classification results, other key figures were added in previous years (e.g. from the banks’ reporting systems and from the stress tests that the supervisory authority now regularly conducts even for domestic, not systemically important banks) so that any anomalies at institutions can be identified at an early stage. In 2021, this data included multi-year planning information from the banks’ reporting systems, all of which was made available to BVR-SE, and – for the first time – the key figures that the banks are required to disclose in respect of the IPS recovery plan on the basis of the German Regulation on the Minimum Requirements for the Design of Recovery Plans for Institutions (MaSanV).

Before the prevention phase, the monitoring of conspicuous institutions is playing an ever more significant role in the early analysis of institutions. In 2021, the monitoring program once again also reached out to institutions that were not showing any particular indications of risk but that could potentially represent a major risk simply because of the size of their balance sheet. This underpins the long-term trend of shifting the focus of BVR-SE’s work away from restructuring and toward end-to-end preventive management that also includes monitoring.

Restructuring management
As before, the work of BVR-SE in restructuring member institutions is aimed at ensuring that these institutions’ annual financial statements are able to receive an unqualified auditors’ opinion, which it does by providing restructuring assistance. The next stage is to contractually agree the measures required in order to ensure that the bank’s business regains its future viability while accommodating the interests of all members of the Cooperative Financial Network.

The ‘Manual for future-proof bank management – guidelines for reorganizing and restructuring cooperative banks’ forms the basis for providing restructuring assistance and carrying out restructuring measures. The principles documented in the manual provide affected banks with guidance on re-establishing competitive structures, e.g. through recovery, and describe concepts for restoring their fundamental profitability. The aim is for the banks to complete this restructuring phase within no more than five years. BVR-SE’s manual is also specifically aimed at banks undergoing preventive measures and any institutions that have themselves identified the need for reorganization. The manual also includes a dedicated section setting out detailed procedures for restructuring measures that need to be carried out in close consultation with the bank undergoing restructuring and the relevant cooperative auditors’ association with statutory responsibility. This section of the manual addresses different potential target institutions separately and can be applied specifically to each individual case.

There was a continued absence of any uptick in recovery activities by BVR-SE in 2021. In particular, costs were not incurred as a result of COVID-19-related effects. Only very minor costs were incurred for legacy cases where risks already covered had materialized or for which loss allowances were recognized in BVR-SE’s annual financial statements. These legacy cases are being progressively reduced. The total restructuring amounts in need of protection resulting from such legacy cases were significantly lower than expected and there were only a few isolated repayments under debtor warrant obligations and other guarantee release obligations.

The overall business performance meant that the capital base of the dual cooperative institutional protection scheme was strengthened once more in 2021 and the statutory guarantee fund resources at its disposal were able to be increased again as planned.

Outlook for the BVR protection scheme and BVR Institutssicherung GmbH

The main influences on the financial performance of the cooperative institutional protection scheme in 2022 will be the ongoing war in Ukraine – and its impact on the German and wider European economy – and the return to rising market interest rates. These may result in risks and costs, for example due to new restructuring cases. At the time of preparation of the consolidated financial statements and management report, however, these risks and costs had not materialized/been incurred.

This year, BVR-ISG is again focusing on implementing regulatory requirements. For the first time, the IPS recovery plan will be managed on a regular, full-year cycle. The MaSanV requirements, which have been incorporated into the IPS recovery plan specified by BVR-ISG, must be fulfilled at individual institution level. BVR-ISG produces and maintains centralized documents and resources to help the institutions with this. The EBA is again due to carry out activities in connection with the regular review of the EU Deposit Guarantee Schemes Directive, which was initiated in 2019 (e.g. the assessment of contributions). BVR-ISG will be supporting these activities by participating in a number of the EBA task force’s working groups.

Regulatory capital management

The consolidated financial statements of the Cooperative Financial Network provide a comprehensive overview of the main capital ratios, particularly the consolidated regulatory capital ratios. These capital ratios are fundamentally calculated in accordance with the provisions of the CRR using the extended aggregated calculation pursuant to article 49 (3) CRR in conjunction with article 113 (7) CRR. Information concerning the regulatory capital ratios relates to the reporting date of December 31, 2021 and does not include the retention of the profits reported in the 2021 annual financial statements. Profit is retained after the individual institution’s relevant committees have given their approval. This retention of profits will further strengthen the capital base in 2022.

The Tier 1 capital ratio held largely steady at 15.2 percent (December 31, 2020: 15.3 percent). As expected, the Cooperative Financial Network’s regulatory total capital ratio declined to 15.8 percent as at December 31, 2021 owing to phase-out rules (December 31, 2020: 16.3 percent). Overall, regulatory own funds increased by €4.3 billion to €119.7 billion. The rise in own funds was largely attributable to the retention of profits from 2020 by the cooperative banks, which was reflected in the ratios as at December 31, 2021. The Cooperative Financial Network’s capital is predominantly held by the cooperative banks.

The total risk exposure as at December 31, 2021 amounted to €757.7 billion (December 31, 2020: €706.8 billion). This 7.2 percent increase was driven by growth in both the retail and the corporate customer lending business.

BVR-SE analyzes the regulatory capital ratios of each member bank on an ongoing basis. The institutions themselves are responsible for fulfilling the regulatory requirements at all times, including in respect of bank-specific SREP surcharges. As shown by the chart on pages 54/55, the capital adequacy of the individual institutions in the Cooperative Financial Network was at a healthy level as at the reporting date of December 31, 2021. This had also been the case as at December 31, 2020.

The Cooperative Financial Network has healthy capital adequacy thanks to equity of €129.5 billion (December 31, 2020: €121.7 billion). It has continually boosted its level of capital in recent years by retaining profit. This trend substantiates the Cooperative Financial Network’s sustainable business model with its broad diversification of sources of risk and income.

The Cooperative Financial Network’s consolidated leverage ratio pursuant to the CRR came to 8.0 percent as at December 31, 2021 (December 31, 2020: 8.0 percent). This is further proof of the healthy capital adequacy of the Cooperative Financial Network. The ratio is calculated for the Cooperative Financial Network in accordance with the provisions of article 429 CRR. It is based on Tier 1 capital as determined in the extended aggregated calculation in accordance with article 49 (3) CRR. The risk exposures are determined by aggregating the individual leverage ratio submissions of all the member banks and adjusting them for material internal exposures within the joint liability scheme. The leverage ratio total exposure measure increased by 5.8 percent year on year to reach €1,430.3 billion.

Economic capital management

Risk capital management is a core task at each individual institution. Pursuant to the Minimum Requirements for Risk Management (MaRisk), it must be structured according to the complexity, scope of business activities, and size of the bank. The German banking regulator comprehensively revised the previous approach used for the supervisory assessment of bank-internal capital adequacy concepts and, with the aim of harmonization, adapted it to the principle of significant institutions (SIs). The new concept for risk-bearing capacity consists of both a normative perspective (capital planning for a three-year period) and an economic perspective that is based on complete risk modelling of all material risks from a value-based perspective. Immaterial risks that, in aggregate, can be classed as a material risk must also be reflected in risk-bearing capacity.

Alongside these business considerations, the banking regulator has supplemented risk measurement in Pillar 1 with its own Supervisory Review and Evaluation Process (SREP) and worked out a system of bank-specific surcharges for interest-rate risk in the banking book on the one hand and for other material risks on the other, as well as a stress scenario surcharge that reflects the banking regulator’s expectation that this risk amount will be backed by common equity Tier 1 capital in the medium term. The surcharges for the individual cooperative banks were once again met in 2021.

Starting with the disclosure pursuant to the German Financial and Internal Capital Adequacy Information Regulation (FinaRisikoV) as at the reporting date of December 31, 2020, all institutions have had to submit their capital planning to the banking supervisor in the form of an expected scenario and an adverse scenario. The disclosure of capital planning constitutes the normative perspective for institutions that have begun to use the new procedure to disclose their risk-bearing capacity. The own funds that would be required in the event of the scenarios materializing are compared with the eligible capital that is available. In view of the growing lending business, resulting in a rise in risk-weighted assets (RWAs) across all of the main exposure classes, the task of managing the capital ratios and own funds in order to prevent shortfalls is becoming increasingly important. The BVR will work out how to support the institutions with this task in 2022. Specifically, it plans to establish ways in which the cooperative banks can reduce their capital requirement and strengthen their capital adequacy. This new concept means a change of method for the institutions, because more than 99 percent of them previously applied a going-concern approach using HGB results. Switching to the new risk-bearing capacity method needs to be completed by the end of 2022. From 2023, the banking supervisor wants the risk-bearing capacity disclosures to be submitted in accordance with the new approach. In the meantime, all of the banks are switching over their relevant processes, supported by consultancy and IT services from the associations, Atruvia, and parcIT.

Credit ratings of the Cooperative Financial Network

The Cooperative Financial Network has been awarded a credit rating of AA– from Fitch and of A+ from Standard & Poor’s, in both cases with a stable outlook. Standard & Poor’s changed the credit rating from AA– to A+ in 2021. The agencies point to the consistently successful business model focused on retail and corporate banking as the reason for the current credit ratings. Capital adequacy is also judged to be above average in terms of quantity and quality. The rating agencies recognize the Cooperative Financial Network’s ability to build up capital from its own resources by retaining profits. The granular credit structure and high proportion of mortgages in the retail business are the hallmarks of the overall high level of quality in the customer lending business. Funding is secured by the use of customer deposits. Liquidity is ensured by means of an extensive and highly diversified portfolio of marketable securities, combined with the cash pooling that takes place within the Cooperative Financial Network. The dual protection scheme is seen by the rating agencies as an important connecting link and a crucial element of the risk management system of the Cooperative Financial Network.

Credit risk

Credit risk is the risk of losses that may arise as a result of the default or deterioration in the creditworthiness of a borrower, issuer, counterparty, or equity investment. As at December 31, 2021, the credit risk-weighted assets of the Cooperative Financial Network amounted to €689.1 billion (December 31, 2020: €640.2 billion), which equated to 90.9 percent of total risk-weighted assets (December 31, 2020: 90.6 percent). This means that credit risk is the most significant risk category for the cooperative banks in the normative perspective for risk-bearing capacity.

To assess the creditworthiness of individual borrowers in the customer business, the banks use segment-specific rating systems that are validated centrally on an ongoing basis in accordance with market standards. These rating systems are also subject to continual further development in order to ensure that all relevant segments of the customer lending business are covered. The vast majority of the banks, particularly when analyzing risk-bearing capacity, use portfolio models to measure risk at portfolio level. These models are also constantly validated at both overall model level and parameter level.

The primary cooperatives have been stepping up their recording of loss data since 2020, recognizing proceeds from a sizeable number of full property recoveries. parcIT supplements this with recovery data for real estate drawn from vdpExpertise’s extensive data pool, which goes back many years. Overall, this base data enables loss given default (LGD) ratios to be estimated, including in respect of the stress test for less significant institutions (LSI).

The Cooperative Financial Network’s strategy focuses on the profit-oriented assumption of risk, while taking its level of equity into consideration and pursuing a risk-conscious lending policy. The cooperative banks are conservative in their lending decisions. Their knowledge of customers plays a central role, as does the capacity of customers to meet their obligations. Overall, the Cooperative Financial Network’s customer lending business has a granular credit structure and a high proportion of mortgages. The granularity and extensive regional diversification of the Cooperative Financial Network’s business activities limit the formation of risk clusters.

The Cooperative Financial Network continued to register significant growth in its lending business in 2021. Loans and advances to customers increased by 6.0 percent year on year (2020: 5.4 percent). Once again, long-term home finance was a key growth driver. Home finance lending by the cooperative banks benefited from the favorable economic conditions. The combination of low interest rates, a healthy level of employment, and rising household incomes fueled strong demand for real estate loans. In 2021, this trend was again overshadowed by concerns about rising risks as a result of the fallout from the COVID-19 crisis. In many sectors offering face-to-face services, businesses had to close temporarily due to a number of lockdowns and therefore made use of government support and of loans from Germany’s KfW development bank. Nonetheless, credit risk remained at a moderate level in all sectors in 2021. An analysis of the changes in the banks’ credit ratings and of defaults among all their corporate and retail customers shows that default rates in the corporate customer lending business remained at the low level recorded in 2020. Overall, corporate customers’ credit balances increased during the reporting year. Credit balances in the retail customer lending business are returning to pre-crisis levels. The monthly analyses have been facilitating the early identification of crisis-driven changes to the risk situation in the corporate and retail customer lending businesses since the outbreak of the pandemic.

Following a fall of 4.6 percent in 2020, GDP bounced back with an increase of 2.9 percent in 2021. Nevertheless, the COVID-19 pandemic took a heavy toll on the hospitality, tourism, and retail sectors. Emergency support measures and further lending programs helped to stabilize the economic situation, particularly in the sectors hit hardest by the pandemic.

Residential real estate prices in Germany continued to rise rapidly in 2021. According to data from the Verband deutscher Pfandbriefbanken (vdp) [Association of German Pfandbrief Banks], prices for owner-occupied housing went up by 11.3 percent. This is the biggest jump since the start of the German housing market’s upturn ten years ago. Prices increased in both urban and rural areas. In addition to continued high demand for residential properties, the increase in prices was driven by higher costs for the materials used to construct new homes.

To help the member institutions to monitor the regional markets, the BVR teamed up with vdpResearch GmbH to develop a concept for measuring market volatility in individual postal code areas: BVR real-estate market monitoring. The measurements from this monitoring provide additional regional information to complement the market volatility concept of Deutsche Kreditwirtschaft (DK) [German Banking Industry Committee]. This enables the cooperative banks to determine the geographical areas forming their relevant markets and better comply with regulatory requirements.

The growth in the local cooperative banks’ corporate banking business was predominantly driven by lending to companies in the construction, service, and financial services sectors. Because of their regional roots, the local cooperative banks have also established a strong foothold in the renewable energies market and provide financial support to companies in relation to projects for increased energy efficiency and for power generation from renewable sources.

In 2021, loss allowances amounted to a net reversal of €0.3 billion (2020: net addition of €2.4 billion), predominantly due to individual reversals of the loss allowances recognized in 2020 in connection with COVID-19. The level of loss allowances was also influenced by the still historically low level of company insolvencies. The Cooperative Financial Network’s NPL ratio (non-performing loans as a proportion of the total lending volume) decreased again slightly to stand at 1.3 percent as at December 31, 2021 (December 31, 2020: 1.5 percent). This fall in the NPL ratio was attributable to the increase in the total lending volume and a simultaneous reduction in the volume of NPLs. In summary, the cooperative banks operate a healthy lending business overall.

Market risk

Market risk is the risk of losses that could arise from adverse changes in market prices or in factors that influence prices. Market risks are generally grouped into the following categories: equity risk, interest-rate risk, and currency/commodity risk. As at December 31, 2021, the market risk-weighted assets of the Cooperative Financial Network amounted to €14.5 billion (December 31, 2020: €13.1 billion), which equated to 1.9 percent of total risk-weighted assets (December 31, 2020: 1.9 percent).

Along with credit risk, interest-rate risk – a category of market risk – plays an important role for most of the cooperative banks. The cooperative banks regularly measure and limit this risk with regard to their risk-bearing capacity. Currently, under the going-concern approach to risk-bearing capacity that is still applied, a distinction is made between interest-margin risk and valuation risk. Interest-margin risk is the risk of net interest income falling short of the expected or budgeted figure. Valuation risk is influenced by the unexpected volatility of market parameters during the holding period. For the purposes of determining and managing periodic interest-rate risks, parcIT regularly provides non-portfolio-specific interest-rate scenarios (VR interest-rate scenarios), which contain not only upward and downward shifts but also rotations of the yield curve. The moderate interest-rate movements during the year were adequately covered by the VR interest-rate scenarios used to manage interest-rate risk. In addition, the regulatory interest-rate scenarios specified in BaFin Circular 06/2019 (BA) for the Swiss franc, Danish krone, euro, pound sterling, Japanese yen, and US dollar were provided centrally by parcIT.

Interest-rate risk has a significant influence on the banks’ financial performance. The persistently low interest rates caused the Cooperative Financial Network’s net interest income in 2021 to decline slightly, by 0.2 percent, compared with the previous year. As in prior years, the largest proportion of net interest income was generated from the net interest margin contribution in the customer business, primarily the customer lending business.

At consolidated level, there was a rise in market risk in 2021. This was mainly due to increased spread risk and heightened volatility. The switch to the new approach to risk-bearing capacity with effect from 2023 will make it necessary to also measure, and set limits for, asset-specific market risk under the economic perspective. In 2022, parcIT intends to validate and enhance the existing historical simulation method used to measure market risk (particularly interest-rate risk). This will be carried out on the basis of criteria specified by the banks that use the method, such as in relation to model assumptions, the degree of coverage of product catalogs, sensitivities, and the different steering committees affected by the methodology. Now that interest rates have started rising, we anticipate a significant increase in market risk over the course of 2022.

Liquidity risk

Liquidity risk refers to the risk that a bank becomes unable to meet its payment obligations. In accordance with the cooperative principle of subsidiarity, each cooperative bank is in charge of its own liquidity and risk management. Compliance with the liquidity coverage ratio (LCR) and net stable funding ratio (NSFR), which are Pillar 1 regulatory key figures, is mandatory. The business management tools that are available enable the individual cooperative banks to define and manage their own bank-specific internal liquidity adequacy assessment process (ILAAP).

A temporary process for closely monitoring the liquidity situation of the entire Cooperative Financial Network had been introduced in response to the COVID-19 crisis in 2020. In the year under review, it was possible to revert to the usual observation and reporting modalities.

The degree to which a bank is able to guarantee its ability to meet its payment obligations in the short term is measured using the LCR. Banks are required to maintain a sufficiently high level of liquidity as measured by this key figure. As at December 31, 2021, the median LCR of all cooperative institutions was 160.1 percent (December 31, 2020: 177.6 percent).

For many years, the Cooperative Financial Network has had a reliable liquidity structure that is deemed crisis-resistant. The loan to deposit ratio of the Cooperative Financial Network is 95.8 percent (December 31, 2020: 95.0 percent). The basis for this lies in the diversifying, risk-mitigating effect created by the stable business structure of the banks, which tends to be divided into small units, and, in particular, in the institutions’ traditional method of obtaining funding through customer deposits. Customers therefore recognize and reward the effectiveness of the institutional protection provided by BVR-SE and BVR-ISG, which particularly aim to safeguard deposits.

The liquidity of the Cooperative Financial Network is characterized by the strong portfolio of deposits from retail and corporate customers. This deposit portfolio has an extremely granular structure and is growing steadily. The liquidity is invested using the Cooperative Financial Network’s internal market system at DZ BANK. As the central institution, DZ BANK is responsible for offsetting liquidity peaks that arise by pooling excess liquidity from individual cooperative banks and balancing out differences in their liquidity levels. Information about the liquidity situation of the individual banks is shared with DZ BANK on an ongoing basis, ensuring that it always has a clear picture of the overall situation.

Operational risk

Based on the definition used by the banking regulator, operational risk is the risk of losses arising from inadequate or failed internal processes, personnel, or systems, or from external events. As at December 31, 2021, the risk-weighted assets of the Cooperative Financial Network attributable to operational risk amounted to €50.9 billion (December 31, 2020: €50.5 billion), which equated to 6.7 percent of total risk-weighted assets (December 31, 2020: 7.1 percent).

The systems and internal processes implemented by the cooperative banks aim to reduce operational risks. A variety of measures are taken to address operational risk, including procedural instructions, an internal control system (ICS), separation of functions, the use of standardized contract templates that have been reviewed by a legal expert, and the appointment of security, compliance, data protection, and anti-money-laundering officers. In addition, business continuity plans for failure of technical equipment and unexpected staff absences are in place.

Internal control processes ensure that material operational risks are identified, analyzed, and assessed on a regular basis. The institutions can use guidelines to conduct a systematic risk assessment in keeping with market standards. The institutions record any loss events in their own database. Based on the outcome of the loss event analysis, internal procedures are adjusted and preventive safeguards implemented as necessary.

Operational risk is measured in consideration of the business model of the individual institution. The dominant methods are quantification by means of a plausible lump sum or based on historical loss event data, sometimes supplemented by value-at-risk (VaR) approaches.

Customer membership is a distinctive feature of the cooperative banks’ business model and one that is ideally suited to conveying the values of the cooperative idea. It offers the cooperative banks the opportunity to distinguish themselves from rival banking groups. The cooperative banks’ distinctive characteristics are reflected in their continued ability to reach a wide range of customers. Strong customer retention results in measurable economic benefits, e.g. income growth for the cooperative banks and the protection of their market share. The cooperative principle has received a boost as a result of the coronavirus pandemic and greater regionalization, creating new opportunities for the cooperative banks to strengthen their competitive position.

The return to rising interest rates, a market-driven trend that emerged in autumn 2021, is now discernible at the main central banks too and we believe that this will create new opportunities over the next few years. The increase in interest rates for home finance in recent months will serve to stabilize the institutions’ net interest income. However, the actual effect will depend on the extent to which risks materialize as a result of the geopolitical environment and the return to rising interest rates.

Even in the digital age, the business model of the cooperative banks puts people and their wishes and objectives first. In the years ahead, the digitalization initiative launched by the Cooperative Financial Network in the retail and corporate banking businesses will enable it to proactively adapt to the changes in the competitive environment resulting from the digital revolution. The aim is to forge ahead with digitalizing the cooperative banks’ products and services and offer all of the touchpoints that customers want (local branches as well as online and mobile banking).

The implementation of measures derived from the KundenFokus (customer focus) project continued and there has been capital expenditure in connection with the digitalization initiative. This allows the Cooperative Financial Network to take account of the changes in customer behavior and to adjust and strengthen the overall business model accordingly. The focus is on the comprehensive omnichannel presence and thus the implementation of efficient processes at all levels. Nonetheless, personal contact remains a key component of the customer relationship, alongside high-quality advice and the possibility for customers to choose how they would like to communicate with their bank. The Cooperative Financial Network is therefore establishing a variety of different customer touchpoints and giving its members integrated access to all information and services through all the relevant channels, whether in branch or via digital media.

Digitalization, with its increasing influence on members’ behavior, also offers the banks potential to improve their cost structure in the medium term. By marketing new digital payment services and implementing an online inquiry process for all of the main products, banks are able to address customer needs and attract new customers. This also enables them to target young, tech-savvy customers and members.

Customer membership is a distinctive feature of the cooperative banks’ business model and one that is ideally suited to conveying the values of the cooperative idea. It offers the cooperative banks the opportunity to distinguish themselves from rival banking groups. The cooperative banks’ distinctive characteristics are reflected in their continued ability to reach a wide range of customers. Strong customer retention results in measurable economic benefits, e.g. income growth for the cooperative banks and the protection of their market share. The cooperative principle has received a boost as a result of the coronavirus pandemic and greater regionalization, creating new opportunities for the cooperative banks to strengthen their competitive position.

The return to rising interest rates, a market-driven trend that emerged in autumn 2021, is now discernible at the main central banks too and we believe that this will create new opportunities over the next few years. The increase in interest rates for home finance in recent months will serve to stabilize the institutions’ net interest income. However, the actual effect will depend on the extent to which risks materialize as a result of the geopolitical environment and the return to rising interest rates.

Even in the digital age, the business model of the cooperative banks puts people and their wishes and objectives first. In the years ahead, the digitalization initiative launched by the Cooperative Financial Network in the retail and corporate banking businesses will enable it to proactively adapt to the changes in the competitive environment resulting from the digital revolution. The aim is to forge ahead with digitalizing the cooperative banks’ products and services and offer all of the touchpoints that customers want (local branches as well as online and mobile banking).

The implementation of measures derived from the KundenFokus (customer focus) project continued and there has been capital expenditure in connection with the digitalization initiative. This allows the Cooperative Financial Network to take account of the changes in customer behavior and to adjust and strengthen the overall business model accordingly. The focus is on the comprehensive omnichannel presence and thus the implementation of efficient processes at all levels. Nonetheless, personal contact remains a key component of the customer relationship, alongside high-quality advice and the possibility for customers to choose how they would like to communicate with their bank. The Cooperative Financial Network is therefore establishing a variety of different customer touchpoints and giving its members integrated access to all information and services through all the relevant channels, whether in branch or via digital media.

Digitalization, with its increasing influence on members’ behavior, also offers the banks potential to improve their cost structure in the medium term. By marketing new digital payment services and implementing an online inquiry process for all of the main products, banks are able to address customer needs and attract new customers. This also enables them to target young, tech-savvy customers and members.