29 November 2017

Deutsche Bundesbank publishes its 2017 Financial Stability Review

Germany’s economy has been expanding for eight consecutive years now. Enterprises and households alike can borrow cheaply, and market volatility is low. However, there is a danger that low interest rates and the favourable economic conditions in Germany might cause market participants to underestimate risks. Risks have built up, in particular, during the prolonged period of low interest rates – the valuations of many investments are very high, and the share of low-interest investments on the balance sheets of banks and insurers has risen steadily.

Dr Andreas Dombret, the Bundesbank Executive Board member responsible for banking supervision, presented the Financial Stability Review by stressing: "Above all, banks need to ready themselves to weather a hike in interest rates in good time," adding that "if interest rates rise, that will bolster the stability of the German financial system in the medium term; an unexpectedly rapid and strong increase, however, could hit it hard." The resilience of banks in Germany may be good overall, he noted, but cautioned that "we nonetheless continue to have our eye on the weak profitability at many German credit institutions, whose return on equity of 2.1% in 2016 puts them at the bottom end of the spectrum in Europe. This low level of profitability could increase the incentive to take on more risk in order to generate higher returns."

An unexpectedly long period of low interest rates, he explained, will put pressure on small and medium-sized banks as well as life insurers in particular, resulting in greater incentives to take more risks.

Persistently low interest rates and upbeat economic conditions might tempt market participants to overrate their debt sustainability. The residential real estate market in particular is a highly important area for financial stability. Loans for house purchase account for half of German credit institutions’ total lending to the private sector and more than two-thirds of household debt. While the Bundesbank’s model calculations for 2016 indicate that residential real estate may be overvalued by between 15% and 30% in towns and cities, other indicators which have a bearing on risk assessment, such as credit growth and lending standards, are not showing any abnormal behaviour at present. Overall, the risks stemming from housing loans still appear to be limited.

Numerous financial market reforms have been initiated since the onset of the global financial crisis. Now it is important to evaluate whether the implemented reforms are having the desired effects, the Financial Stability Review explains. The Financial Stability Board (FSB) devised a framework for the post-implementation evaluation of reforms during Germany’s G20 presidency.

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