Close link to the real economy the bedrock of Frankfurt's financial centre
The close link between the financial sector and the real economy is the main reason Frankfurt is emerging well from the financial crisis and the bedrock on which the centre's success is built says HUBERTUS VATH. Frankfurt is now positioning itself as a centre of excellence for risk management and regulation which can be a starting point for Frankfurt to partner with, and advise, up-and-coming financial centres from Asia, South America and Eastern Europe which will lead to further growth for Frankfurt's financial centre he says.

September 2011: The 'Made in Germany' hallmark stands for quality workmanship, reliability and stability. And this applies to the services of the German financial sector just as much as for machines and cars. As the most important German financial centre, Frankfurt is host to 260 banks as well as being the location for approximately 200 branches of foreign banks. It finances the main driver of the economy - exports - as well as the expansion and internationalisation of Germany’s economy with its mainstay of medium-sized companies.
Hubertus Väth speaking at the Financial Centres International Conference in 2010.

Germany as a financial location is emerging well from the crisis, not least because Frankfurt is ranked among the exclusive club of fully integrated and comprehensively effective global leaders, according to the Global Financial Centres Index. There was never a credit squeeze here, despite all the prophecies of doom. The bedrock that made Frankfurt strong has proved itself yet again: the close link between the financial and the real economy.

The close link between the financial and the real economy
Such a close link cannot be taken for granted. In many other economic areas across the globe the financial and the real economy have become increasingly disconnected. Economists believe that this is the main reason for the last financial crisis: As soon as developments in the financial sector separate from the needs of the real economy - in other words, transactions in the financial sector become disconnected from the needs of the real economy - the players in the financial markets become increasingly self-referential.

This makes the formation of bubbles more likely, which in turn endanger the stability of the whole system when they burst, as the property bubble in the USA so clearly showed. In consequence it was those financial centres that have a strong link to the real economy which were better able to survive the crisis.

The extent to which the links between the real economy and the financial sector can vary at different financial locations is demonstrated by the following example: in the UK, GDP grew 3 per cent between the end of 2004 and the end of 2009.
Over the same period, the balance sheet total of UK banks increased by 41 per cent. Over the same period, the balance sheet total of German banks increased by a mere 12 per cent - with GDP growing 3.3 percentage points. The share of GDP accounted for by the financial economy is substantially higher in the UK than in Germany. To put it another way: in Germany a greater portion of activities in the financial market is based on assets and activities in the real economy.

A financial centre can derive major strength from its proximity to the real economy, for example as a financier for companies and nation-states. This is demonstrated by the example of bonds. Since the mid-18th century Frankfurt has been the European centre for the issue and trade in government bonds. The absolutist states on the continent satisfied their great need for credit via the Frankfurt bond market, and around the middle of the 19th century there was an increase in issues of American bonds in which Frankfurt played the leading role at that time. The banks were not only looking after the issuers but also the investors, and they developed both current-account business and custody business.

After the Second World War the establishment of the Bundesbank further strengthened Frankfurt's position in the international bond market. With policy geared very much toward stability, Bundesbank helped the Deutschmark become one of the most sought-after currencies. One consequence of the attractive status of the Deutschmark was increasing international demand for German government bonds, which made Frankfurt an even more important location.

And in the face of the current national debt crisis in Europe, German Treasury Bonds are again seen as a safe haven for investors. The fact that the German government enjoys benchmark status as an issuer is partly due to the experts in Germany's finance agency. With their issuing policy they create an optimum environment for the issue and trade in German government bonds: the necessary knowledge is embedded primarily in Frankfurt as a financial centre.

High quality stock exchange and IT infrastructure
The increasing desirability of federal government securities in the middle of the last century at the same time triggered the rapid ascent of the Frankfurt stock exchange, today one of the greatest strengths of the financial centre.

The capital flows into bonds denominated in German currency on the stock exchange boosted turnover and formed the basis for much subsequent success. Nowadays, for example, the electronic trading system Xetra from the Deutsche Boerse company is seen as one of the most reliable trading systems in the world, and one that has proved itself extremely well even in times of crisis. Even at the peak points in the crisis Deutsche Boerse was able at all times to ensure orderly trading and processing of transactions and in this way, contributed decisively to the formation of transparent prices.

Factors like market integrity and security gained enormously in importance during the crisis, with the mere efficiency of trading systems no longer the sole criterion. This is shown, for example, in terms of clearing: shifting transactions on to stock exchange infrastructures that were previously made over the counter is regarded as one of the most important challenges in the on-going stabilisation of the global financial system. With Eurex Clearing, Deutsche Boerse Group provides a system which is regarded as the most stable worldwide.

The basic requirement for such effective systems is a resilient, high-quality digital infrastructure. As a location in Frankfurt provides the efficiency needed here. 85 per cent of German data traffic and 35 per cent of all European data traffic already pass through the Frankfurt internet exchange point, the DE-CIX. The datacentre infrastructure is also top-quality: one example is the new high-power computer at the Loewe Center for Scientific Computing (Loewe CSC), which went into operation in November 2009: one of the fastest computers in Europe which, amongst other things, will carry out calculations for the CERN particle accelerator in Geneva. Thanks to these conditions, a large pilot project in cloud computing for Deutsche Bank and Goethe University was launched in Frankfurt.

Cloud computing could save on hardware costs in many places in the future, as well as reducing energy consumption and thus CO2 emissions. Furthermore, the high degree of flexibility makes cloud computing a promising technological innovation for applications in the financial sector.

The development in the IT sector shows the enormous technical complexity of the modern financial sector. The intellectual complexity of the current challenges is already well-known; both require a research and training infrastructure at the highest international level.

Frankfurt as a financial centre has long since caught up with its major competitors. As a scientific location Frankfurt is one of the leaders in the movement towards interdisciplinary research. The House of Finance (part of Geothe University) has been pursuing an interdisciplinary approach since its inception in 2008. No fewer than three institutions are now engaged in inter disciplinary financial research under its aegis: the Institute for Financial and Monetary Stability (IMFS), the Institute for Law and Finance (ILF) and the Doctoral Program in Law and Economics of Money and Finance (LEMF).

Location of choice for European institutions
These strong points make Frankfurt extremely attractive as a financial centre, particularly for institutions active in the fields of regulation and supervision.

The most prominent example of this is the European Central Bank which was established in Frankfurt in 1998. This was not least due to the high reputation for stability-oriented monetary policy enjoyed by the Bundesbank, also located in Frankfurt. The establishment of the ECB has heightened Frankfurt's position of supremacy in European bond trading.

Frankfurt's position as the issuing location in euro-denominated bonds has been further strengthened by the deteriorating position of the US dollar as international key currency, and the increasing shift toward the euro. Supported by these exogenous factors, local financial service providers as well as scientific establishments have developed considerable know-how in bond business to consolidate the established strength. The newly created European Systemic Risk Board (ESRB) is literally under the roof of the ECB. It started work on 1 January. In future this institution will probably be a central instrument of macro-prudential financial supervision.

The new European supervision for insurers and pension funds (EIOPA) should also have an equivalent high level of importance. The successor of the previous organisation, CEIOPS took up work at the beginning of January 2011, is also based in Frankfurt. The new authority will have the last word especially in cases of disagreement between national authorities and in this way it will ensure quick and efficient implementation of the right measures.

To support Frankfurt's management claim with risk management and regulation issues, Frankfurt Main Finance set up the Institute of Risk Management and Regulation (FIRM) in 2009.

This institution, so far the only one of its kind world-wide, is to provide nothing less than research and study at the top level internationally, and thus contribute decisively to strengthening the links between politics, finance and science. Research funds have already been awarded and the research itself is up and running successfully. For students, the institute offers an executive MA course which enables managers from the areas of risk management and regulation to acquire precisely the further qualification that they need.

The course first ran in summer 2010 with approximately 15 students. The institute combines the expertise of the Frankfurt School of Finance and Management and that of the House of Finance of the Goethe University: the Frankfurt School manages the teaching side, whilst the House of Finance pursues the research projects.

Centre of excellence for risk management and regulation
As a financial centre Frankfurt is now on the way to building a centre of excellence for risk management and regulation on the foundations that are already in place.

As such, the most important German financial centre is also ready to assume the roles of facilitator and catalyst for European discussions on regulation. This can be done by providing the necessary platforms for high-level exchanges, and by driving dialogue at the highest level of politics and finance– for example at the Frankfurt Finance Summit in 2011 ( Preparations for next year’s summit have already begun.

At the same time, positioning Frankfurt as the centre of excellence for risk management and regulation can be a starting point for the city as a financial centre to become an important partner and adviser for up-and-coming financial centres in Asia, South America or Eastern Europe.

For this purpose Frankfurt Main Finance has developed a model of the Frankfurt financial centre together with consulting firm Roland Berger, in order to further pursue such potential co-operations. It provides a detailed overview of the efficiency of the financial centre, starting with a general model, then looking at individual market sectors and their value-added chains, and finally at individual market players and their interactions. The result is a sort of map which enables navigation through the services provided by the financial centre and shows starting points for co-operation to partners from other financial centres. With this tool the financial centre will be able to convert contacts with foreign business partners directly into real business.

After all, we are already finding that the traditional strengths of Frankfurt as a financial centre, with its traditions as a successful financial centre over the centuries, are highly regarded abroad. This example demonstrates that to be successful in the future we do not have to be more daring or glamorous - we just have to further make use of the potential that is already there.