Frankfurt am Main, 27-11-2015 — /EuropaWire/ — Exceptionally low interest rates remain a salient feature of the financial system setting in Germany. They reflect the global low real economic growth and expansionary monetary policy stance. Speaking at a press conference to unveil the Bundesbank’s Financial Stability Review 2015, Deputy President Professor Claudia Buch said:
“The longer interest rates stay low, the more incentive market participants have to incur increased risk.” She added that, were risk premiums to fall to an exceptionally low level, this could potentially endanger financial stability.
“We have to tackle these challenges in order to maintain the stability of the financial system,” Professor Buch explained. Otherwise, the attendant build-up of risks to financial stability might prompt monetary policymakers to put off the warranted normalisation measures for far too long – the precise effect of which would be to cause further risks to accumulate.
The impact of the low-interest-rate environment on the German banking system’s earnings and stability has been limited so far.
“Institutions have strengthened their resilience in the past few years,” said Dr Andreas Dombret, the Bundesbank Executive Board member in charge of banking supervision.
“Banks have further increased their capital and reduced their leverage.” The tier 1 capital ratio of the German banking system as a whole rose by 0.6 percentage point between June 2014 and June 2015, and currently stands at 15.6%, he noted. To fulfil the minimum leverage ratio requirement under the Basel III regime, eight of the major German banks would now have to raise a combined total of less than €1 billion of additional tier 1 capital. The corresponding figure at the end of 2013 was around €18.5 billion. Dr Dombret pointed out that an ongoing low-interest-rate environment would primarily affect small and medium-sized institutions, which might respond to falling interest income by taking greater risks. He cautioned:
“It remains important in the current market setting for German institutions to cut their costs further and to reduce their dependency on interest-rate business over the medium term”.
The danger that a protracted period of low interest rates poses to insurance companies is that their earnings might no longer suffice to cover their contractual commitments. Deputy President Claudia Buch warned:
Persistently low interest rates would jeopardise the resilience of many insurers. Although the Life Insurance Reform Act Lebensversicherungsreformgesetz, which came into force in August 2014, will curb the outflow of funds from insurance companies, and thereby strengthening their capital base, Bundesbank analyses indicate that this relief cannot offset the impact of the further drop in interest rates. But insurers still have time to make the necessary adjustments. Professor Buch concluded that life insurers are therefore facing the ongoing challenge of further boosting their resilience.
The weight of the shadow banking industry in the German financial system has increased, with mutual funds being a particularly fast-growing segment. However, this is not an unregulated part of the financial system.
“Key metrics currently do not indicate an increase in risk in the shadow banking industry,”Professor Buch said, though she added that the size of some individual mutual funds could make them systemically important.
“Not least for that reason we will continue to keep a close eye on the shadow banking sector and potential risks in the future.”
The current risks to financial stability emanating from the real estate market are rated by the Bundesbank as low, despite the continuing price dynamic in individual segments. The Bundesbank’s Financial Stability Review notes that the growth in mortgage lending is still moderate by historical standards. While the risk of a price correction accompanied by mass mortgage defaults is fairly small at the moment, developments still need to be monitored intensively. As an additional initiative, the German Financial Stability Committee recommended the Federal Government in June 2015 to create the legal basis to equip policymakers with macroprudential instruments capable of regulating real estate financing.
“We could then nip any unwelcome developments in the bud,” Professor Buch explained.
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SOURCE: Deutsche Bundesbank