Bundesbank: German Banks Coping Well With Higher Interest Rates, But Story Not Over Yet

23 November 2023

By David Barwick – FRANKFURT (Econostream) – Germany’s financial system has handled higher borrowing costs well, but a riskier and more uncertain environment underscores the need for a resilient financial sector, the German Bundesbank said on Thursday in releasing its 2023 financial stability review.

‘So far, the German financial system has coped well with the rise in interest rates over the last year, but the effects of this rise have not yet fully materialised’, the Bundesbank said. ‘Structural change in the economy is also likely to further increase credit risk.’

Notwithstanding the short-term benefits to banks of higher interest rates, which have been a boon to sector profits, interest margins could face pressure further out, the Bundesbank said, given that the rate hikes have yet to be fully passed on to depositors.

Weak credit demand makes it hard for banks to generate more revenue from interest payments, and higher credit risk has led to tightened lending standard, the Bundesbank noted.

‘In addition, banks have reduced a considerable volume of hidden reserves in order to cushion market price losses on their assets’, the German central bank said. ‘At the same time, hidden losses have increased among banks and insurers.’

The negative effect of higher borrowing costs on property prices has increased risk in commercial real estate especially, the Bundesbank said. In the case of residential real estate, the medium-term outlook is less risky, since robust job markets and the prevalence of fixed-term rates on related lending constitute somewhat of a cushion, according to the review.

‘The German economy is exposed to pressure for structural change, which has further intensified as a result of the uncertain geopolitical situation and the climate crisis’, the Bundesbank said. ‘Credit risk is likely to occur in the medium term, especially for highly indebted enterprises that need to adjust considerably to the new framework conditions.’

According to a Bundesbank analysis, the negative effect of higher carbon prices on valuations of claims against carbon-intensive industries should be limited and not present a solvency threat.

‘An orderly ecological transformation, a predictable energy transition and transparency about its consequences would also spare the financial sector even larger losses going forward’, the Bundesbank said.

The German central bank determined that, given the importance of financial sector resilience, the January 2022 package of macroprudential measures remained appropriate. Only a handful of relatively small banks were unable to meet the standards without needing to raise fresh capital, the Bundesbank said.

‘Negative effects on lending or interest rates have not been observed’, the Bundesbank said. ‘Only if there was a risk of a credit crunch due to high losses would it be appropriate to release the buffers. In such a period of stress, banks could use capital buffers and other capital reserves to absorb losses. A deterioration in the economic outlook is not a sufficient condition for releasing the buffers.’