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 2022. A total of 744 institutions of the Cooperative Financial Network belonged to BVR-SE as at December 31, 2022 (December 31, 2021: 781 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, 2022, the membership comprised 742 CRR credit institutions (December 31, 2021: 779), 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. These include monitoring and assessing risks for all CRR credit institutions that are members of BVR-ISG.

The activities of BVR-ISG in 2022 related to the fulfillment of 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 Regulation on the Minimum Requirements for the Design of Recovery Plans for Institutions (MaSanV). 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 2022.

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 effects of interest-rate rises and risks arising on securities investments in 2022.

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).

BVR-SE classification process
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 that are rated separately by an external rating company, e.g. DZ BANK AG and its subsidiaries as well as Münchener Hypothekenbank eG.

The classification process in 2022 was based on an analysis of data from the 2021 financial statements, which revealed that the distribution of the classification results was virtually unchanged. The stability of the classifications in 2021 was attributable to the different divisions and key figures as follows. Net assets held steady, albeit with a small decrease. Both the risk-weighted total risk exposure and the volume of business recognized on the balance sheet saw slightly stronger growth than the underlying items of capital. By contrast, the risk situation in respect of the two unsecured loan ratios improved slightly. Financial performance also contributed to the positive trend as the earnings generated in 2021 showed a slight improvement. The administrative expenses ratio was primarily affected by the increase in net fee and commission income, while the risk expenses ratio reflects smaller net additions to specific loan loss allowances.

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 the available data and other information in order to identify institutions with potential issues. Necessary measures to stabilize and improve business performance are then agreed with the senior management of the 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. For some years now, other key figures are added that build on the classification results (e.g. key figures 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 2022, this data included the multi-year planning, the banks’ regular reporting, the key figures used in the IPS recovery plan, and the statutory ad hoc disclosures required pursuant to section 24 (1) no. 4 of the German Banking Act (KWG). As a result of Russia’s invasion of Ukraine and the subsequent turmoil and tensions in the money markets and capital markets, many banks had to recognize write-downs on their securities portfolios, or they avoided such write-downs using appropriate accounting methods. Analyzing this situation formed a major part of BVR-SE’s preventive monitoring activities.

Before the prevention phase, the monitoring of conspicuous institutions plays a significant role in the early analysis of institutions. The particular effect in this area of BVR-SE’s work in 2022 is described above. In addition, but of lesser significance, the monitoring program also reached out once again in 2022 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 substantially strengthened the long-term trend in the focus of BVR-SE’s work, shifting 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 primarily aimed at ensuring that these institutions’ annual financial statements are able to receive an unqualified auditors’ opinion, so that regulatory measures against member institutions can be avoided. 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. BVR-SE’s statutes provide the legal basis for all of its actions.

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 in accordance with BVR-SE’s statutes 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.

Despite the highly challenging economic conditions, there was a continued absence of any uptick in recovery activities by BVR-SE in 2022. In particular, there was no negative impact on BVR-SE’s resources resulting from valuation effects in the institutions’ securities portfolios. Only very minor costs were incurred for legacy cases where risks already covered had materialized or for which a loss allowance had been 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 not adversely affected by support measures in 2022 and the statutory guarantee fund resources at its disposal were able to be increased again as planned.

Outlook for BVR-SE and BVR-ISG

The main influences on the financial performance of the cooperative institutional protection scheme in 2023 will be the ongoing war in Ukraine – and its impact on the German and the wider European economy – and the ECB’s future decisions on interest rates. The slowdown in construction activity and the rise in finance costs for consumer and commercial borrowing also represent a challenge for business performance and financial performance. Taken together, 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. The focus will be on the IPS recovery plan, specifically implementation of the MaSanV requirements in regular operations. This will involve BVR-ISG maintaining and updating the key documents and resources for its member institutions. 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. BVR-ISG will be supporting these activities by participating in a number of the EBA task force’s working groups. A crucial element of this work is the revised assessment of contributions that will be coming into force after July 3, 2024, i.e. after the accumulation period for deposit protection.

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 CRR provisions 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, 2022 and does not include the retention of the profits reported in the 2022 annual financial statements. Profit is retained after the individual institution’s relevant committees have given their approval. This retention of profits will further strengthen capital in 2023.

The Tier 1 capital ratio held largely steady at 15.1 percent (December 31, 2021: 15.2 percent). The Cooperative Financial Network’s regulatory total capital ratio was also more or less unchanged at 15.7 percent (December 31, 2021: 15.8 percent).

Overall, regulatory own funds increased by €1.8 billion to €121.7 billion (December 31, 2021: €119.9 billion). This growth was influenced by the rise in own funds resulting from the retention of the profits reported in the 2021 financial statements and by negative effects that were attributable to generally temporary, interest-rate-related impairment in the securities portfolio and to the impact of phasing out some components of Tier 2 capital. The Cooperative Financial Network’s capital is predominantly held by the cooperative banks and their members.

The total risk exposure as at December 31, 2022 amounted to €775.8 billion (December 31, 2021: €757.7 billion). This 2.4 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 page 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, 2022. This had also been the case as at December 31, 2021.

The Cooperative Financial Network has healthy capital adequacy thanks to equity of €127.5 billion (December 31, 2021: €129.5 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 7.4 percent as at December 31, 2022 (December 31, 2021: 8.0 percent). This is continued proof of the healthy capital adequacy of the Cooperative Financial Network. The decline in the leverage ratio was attributable to the expiry of special arrangements that the supervisory authority had allowed the institutions to apply during the coronavirus pandemic. Since March 31, 2022, exposures to central banks have no longer been excluded from the calculation of the total exposure measure in accordance with article 429a (1) (n) CRR. The leverage 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 10.6 percent year on year, rising to €1,581.3 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 European banking supervisor’s principle of significant institutions (SIs). The concept for risk-bearing capacity consists of both a normative and an economic perspective. The latter is based on complete risk modeling of all material risks from a value-based perspective, in which immaterial risks that, in aggregate, can be classed as a material risk must also be reflected in risk-bearing capacity.

The year under review saw a rapid surge in inflation triggered by the supply price shock in the fossil energy markets. The central banks reverted from their previously very expansionary monetary policy and quickly hiked interest rates by some way. All these risk factors have a direct or delayed, indirect impact on various risk drivers, which made it necessary to analyze how they might affect counterparty risk, market risk, and liquidity risk. The effects on various capital variables and on profitability in the context of capital management therefore had to be examined.

Many institutions used scenario analysis to do so. parcIT, the center of excellence for such matters in the Cooperative Financial Network, developed the necessary parameters for an adverse scenario and a stress scenario, making them available to the cooperative banks. In accordance with the regulatory requirements, the banks must review their capital and earnings situation as part of their internal process for ensuring risk-bearing capacity (internal capital adequacy assessment process, ICAAP). This includes using stress tests covering all types of risk that show the impact on the main risk categories.

Across the banks, it is clear that diversification and hedging are among the possible ways of reducing concentrations of credit risk. In addition, bank-wide cash flows can be managed in order to avoid or mitigate the negative effects on assets that could potentially be produced by interest-rate movements. From an economic perspective, maintaining risk-bearing capacity is based on the efficient allocation of the bank’s risk capital across the various risk types: counterparty risk, market risk (including real estate price risk), liquidity risk, and operational risk. This is because this approach enables assets to be increased on the back of a positive performance in the individual risk categories and at overall bank level. The normative perspective is designed to ensure the regulatory capital adequacy of the institutions in the Cooperative Financial Network. The BVR has provided the cooperative banks with guidance on sustainable measures for strengthening their capital base. A particularly important measure is the consideration of the cost of equity when pricing the lending business.

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. 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, 2022, the credit risk-weighted assets of the Cooperative Financial Network amounted to €707.2 billion (December 31, 2021: €689.0 billion), which equated to 91.2 percent of total risk-weighted assets (December 31, 2021: 90.9 percent). This means that credit risk is the most significant risk category for the cooperative banks’ risk-bearing capacity in the normative perspective.

To assess the creditworthiness of individual borrowers in the customer business, the banks use segment-specific rating systems that are validated 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 credit-portfolio models to measure risk at portfolio level. These models are also validated at both overall model level and parameter level.

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 knowledge of the institutions in the Cooperative Financial Network about their customers plays a central role in lending, as does the capacity of customers to meet their obligations. Overall, the Cooperative Financial Network’s customer lending business has a predominantly granular credit structure and a high proportion of mortgage loans. The granularity and extensive regional diversification of the Cooperative Financial Network’s business activities limit the formation of risk clusters.

The price shock triggered by the war in Ukraine, for example in the gas markets, raised credible concerns that there would be significantly more production outages in the short and medium term. The manufacturing sector was faced with sometimes substantially more expensive products, which greatly squeezed companies’ profits. There were also fears of a fall in profits in downstream sectors. Some consumers suffered a sharp drop in disposable income as a result of higher energy costs for heating and hot water combined with elevated inflation. This in turn will have an adverse impact on the allocation of credit ratings as rating migrations and defaults will be more likely in the future. There is also a risk of falling property prices, and thus lower carrying amounts for collateral. Finally, liquidity management may also be affected if dwindling account balances lead to reduced liquidity coverage potential.

Suitable stress scenarios were developed for the cooperative banks in order to analyze the effects on the different metrics in the normative and economic perspectives of risk-bearing capacity. The scenarios showed the banks the economic impact of the aforementioned shock. Using the extensive measurement methods available, the banks were able to quantify this impact for themselves. The assumed default probabilities are based on historical analysis. Increases in write-downs in the real estate market were also simulated. Encouragingly, the economic situation looks set to ease, which means that the scenarios described above have not materialized so far, partly thanks to significant government intervention. However, energy price levels and their impact will still have to be monitored going forward.

The Cooperative Financial Network continued to register significant growth in its lending business in 2022. Loans and advances to customers increased by 5.9 percent year on year (2021: 6.0 percent). Once again, long-term home finance was a key growth driver. The lending volume continued to increase thanks to strong demand for owner-occupied housing in the first half of 2022. Demand for mortgages declined in the second half of the year owing to the rise in lending rates and high construction costs, although this had only a minimum impact on lending growth for the year as a whole.

According to data from the Verband deutscher Pfandbriefbanken (vdp) [Association of German Pfandbrief Banks], prices for owner-occupied housing went up by 9.0 percent in the year under review (2021: 11.3 percent). However, the rapid increase in prices only continued until mid-2022, with the second half of the year seeing a fall in prices. Rising finance costs and high inflation thus appear to have brought the long-standing upswing in the German housing market to an end in 2022.

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 member institutions 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 service and construction 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. The DZ BANK Group’s lending business was primarily focused on entities within the Cooperative Financial Network and on real estate finance in the reporting year.

The expense for loss allowances amounted to €1.4 billion in 2022 (2021: net reversal of €0.3 billion) and was mainly attributable to the addition required for parameter-based loss allowances as a result of the gloomier economic conditions. The Cooperative Financial Network’s NPL ratio (non-performing loans as a proportion of the total lending volume) decreased again slightly to stand at 1.2 percent as at December 31, 2022 (December 31, 2021: 1.3 percent). This fall in the NPL ratio was attributable to the increase in the total lending volume and an almost unchanged volume of NPLs. In summary, the institutions in the Cooperative Financial Network 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, currency risk, and commodity risk.

As at December 31, 2022, the risk-weighted assets of the Cooperative Financial Network for market risk amounted to €13.2 billion (December 31, 2021: €14.5 billion), which equated to 1.7 percent of total risk-weighted assets (December 31, 2021: 1.9 percent).

Interest-rate risk has a significant influence on the banks’ financial performance. Net interest income in the Cooperative Financial Network rose sharply in 2022, jumping by 12.7 percent year on year. As in previous years, the largest proportion of net interest income was generated from net interest margin contributions in the customer business, primarily the customer lending business.

The reporting year was dominated by elevated inflation and a shift in central bank policy. At the same time, other segments of the financial markets experienced volatility too. One of the most important types of market risk is interest-rate risk because it not only directly affects returns on own-account investments in securities but also has an impact on the customer lending and deposit-taking businesses.

Due to the switch to the new approach to risk-bearing capacity with effect from 2023, the cooperative banks that previously applied the old going-concern approach will now have to measure and manage their market risk using the value-at-risk (VaR) model, as already used by the institutions in the DZ BANK Group and by Münchener Hypothekenbank eG. To this end, parcIT has developed a new process based on the historical simulation method. The institutions are also required to use planning scenarios and adverse stress scenarios to produce capital plans that take account of the relevant interest-rate scenarios.

Liquidity risk

In the Cooperative Financial Network, liquidity risk is managed with the aim of ensuring that a bank can meet its payment obligations at all times. 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 determine and manage their internal liquidity risk individually.

The reporting year was influenced by the combined effect of a number of crisis components. The resulting movements in the money markets and capital markets made liquidity management more challenging. Monitoring of the LCR at consolidated level, which indicates the Cooperative Financial Network’s ability to meet its payment obligations in the short term, revealed a temporary reduction in mid-2022. By December 31, 2022, the median LCR of all cooperative institutions had recovered to 158.5 percent and was thus down only slightly year on year (December 31, 2021: 160.1 percent). Furthermore, the ratio was well above the mandatory minimum level of 100 percent at all times. Once again, the Cooperative Financial Network’s decentralized liquidity management proved fundamentally resilient during the crisis conditions of 2022.

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 96.8 percent (December 31, 2021: 95.8 percent). The basis for this lies in the diversifying, risk-mitigating effect created by the stable and granular business structure of the cooperative banks 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. Excess 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 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, 2022, the risk-weighted assets of the Cooperative Financial Network attributable to operational risk amounted to €51.9 billion (December 31, 2021: €50.9 billion), which equated to 6.7 percent of total risk-weighted assets (December 31, 2021: 6.7 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 IT 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 method is quantification in the form of a lump sum, although value-at-risk (VaR) approaches are sometimes used too.

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 and product suppliers in the Cooperative Financial Network the opportunity to distinguish themselves from rival banking groups. The extensive branch network allows the institutions in the Cooperative Financial Network to stand out from online banks, ensuring they can continue to reach a wide range of customers. Strong customer retention results in measurable economic benefits, e.g. income growth for the institutions in the Cooperative Financial Network and protection of their market share. In our view, the cooperative principle has received a boost – particularly since the coronavirus pandemic and as a result of greater regionalization – that creates new opportunities for the cooperative banks to strengthen their competitive position.

Sustainability has always been enshrined in the DNA of the cooperative banks and is part of their corporate identity. Financial success and socially responsible business are inextricably linked for the cooperative banks and are always geared toward working together to support the common good. In its sustainability guidelines, the Cooperative Financial Network has made a commitment to the Paris climate goals and the UN’s global sustainable development goals (SDGs). It has also set itself the objective of playing a significant role in creating sustainable forms of employment in the regions and a climate-friendly economy.

Even in the digital age, the business model of the institutions in the Cooperative Financial Network puts people and their wishes and objectives first. In the years ahead, various activities – mainly through the central IT service provider Atruvia for retail and corporate banking business but also for the back-office functions of the cooperative banks – will enable the Cooperative Financial Network 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 to offer all of the touchpoints that customers want (local branches as well as online and hybrid 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 and follow-up activities. 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, implementing an online inquiry process for all of the main products, and offering digital membership, banks are able to address customer needs and attract new customers. This also enables them to target young, tech-savvy customers and members. The BVR believes that, by establishing the new specialist units Truuco (a smart data company) and Amberra (a company focused on updating the cooperative business models), it has created the structures that will allow it to create highly tailored recommendations for customers based on smart data and to also provide ecosystem offerings that go beyond banking products in the traditional sense.

In view of current interest rates, we believe that the institutions have good potential for generating income in the lending business in the next few years. This can be seen from the rise in interest rates on home finance, which are already helping to stabilize net interest income, even if the absolute volume of new business declines. The introduction of new products that enable customers to benefit from rising interest rates and the capital markets may also have a positive effect on the financial performance of the institutions in the Cooperative Financial Network and help them to secure market share in an increasingly competitive environment. However, the actual impact depends on the materialization of risks as a result of these higher interest rates, in particular with regard to the level and speed of changes in interest rates on liability-side products and – based on the implications for lending demand and credit risk – the geopolitical situation this year.