18 February 2013

Bundesbank/Dombret: The year 2013 - Challenges from a financial stability perspective

Dombret spoke about the European debt crisis, the crisis in the shipping industry, price developments in the German housing market, and the repercussions for financial institutions and households.

The Member States are called upon to make headway in implementing the necessary structural reforms and consolidation measures – despite the economic and political turbulences they are experiencing. Banks – not only in crisis countries – must continue to clean up their balance sheets and further strengthen their profitability. And finally, work must also continue at the institutional level in creating a banking union, which must be approached with due caution. Here we have to put quality before speed.

Above all, it should not be forgotten that it was the measures implemented by the central banks that played a crucial role in calming the markets. These measures also bought some time for policymakers and the market players. Low interest rates and abundant supplies of liquidity are not a cure-all, however. And they certainly do not constitute a suitable therapy for tackling the crisis. Furthermore – like any emergency medicine – these measures do not come without their fair share of potential risks and side-effects.

At present, the brunt of the burden is being felt by investors who place their faith in instruments with a safe credit rating which, however, yield a low return. This is particularly true of life insurance companies who have responded to the situation by once again reducing their policyholders’ profit participation in 2012. As a supplement to building up additional reserves, this is a wise course of action in terms of securing their long-term resilience. BaFin stress tests have shown that German insurers’ resilience continues to be adequate on the whole. This suggests that there has been no hazardous widening of the gap between their obligations to pay customers a return on the one hand and declining returns on standard forms of investment on the other.

In light of the challenging financial environment, there are signs of German insurers cautiously restructuring their business policy, for example, by gearing their activities to the funding of infrastructure projects and direct lending to enterprises and households as well as to commercial and residential real estate financing. As things currently stand, the credit segment represents a relatively small chunk of insurers’ overall investment activity. However, in years to come, this area of focus is likely to gain in importance.

Following a cautious path of diversification can definitely be regarded as a positive development. Even so, I would like to draw your attention to two aspects which need to be borne in mind. First, any inroads made into new business areas need to be accompanied by a corresponding adjustment of the company in question’s risk management strategy. Second, by following this avenue, insurers are encroaching on an area of activity that has traditionally been the preserve of banks, and are increasing the competitive pressure in this field.

German banks’ profitability has proven robust up to now. Indeed, they initially benefited from falling interest rates because the higher long-term interest rate applying to granted loans is only gradually being eroded by new business, while yields on deposits have been lowered at a faster rate. As interest levels plummeted in 2009 and 2010, the banks enjoyed a corresponding increase in margins. This was true, above all, for savings banks and credit cooperatives.

The positive impact which arose from the interest rate cuts has, it seems, now dissipated. Instead, we are feeling the pinch of low interest rates and narrowed margins on the part of credit institutions. These challenges are compounded by two structural developments.

For one thing, interest expenditure is being affected. During the crisis, the market proved volatile as a provider of financing, and more and more banks “rediscovered” the classical deposit business segment. New regulatory provisions have made this line of activity additionally attractive. Nevertheless, increased competition for deposit business might lead to a further erosion of interest margins.

For another, margins are being squeezed from the income side. It has been evident for some time that enterprises with a strong credit rating fare better at securing favourable wholesale funding than banks. It makes perfect sense for enterprises to diversify their funding. The downside of this is that it simultaneously causes medium to long-term bank business to disappear. In any case, it places a strain on banks' profitability and their asset quality tends to deteriorate. We will keenly monitor the extent to which banks refrain from taking evasive action and go back to concentrating on supposedly higher-yielding investments which, however, are inclined to entail greater risk. We have good reason, for example, to observe how real estate-related lending develops in future.

In this environment, traditionally “safe” ways of investing money such as long-term savings deposits and life insurance policies are proving less profitable for households. This in itself should give them an incentive to switch to alternative forms of investment which offer potentially higher yields. The motivation to act is, however, being undermined by the uncertainty emanating from the financial crisis.

Full speech

© Deutsche Bundesbank