Andreas Dombret: Interest rate reversal in the United States and German
banks
Introductory statement by Dr Andreas Dombret, Member of the Executive Board of the
Deutsche Bundesbank, at the annual meeting of the Verein für Socialpolitik, Münster,
17 September 2015.
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Ladies and gentlemen
The British rock band The Alan Parsons Project charted in 1978 with a single entitled "What
goes up ...", the first two lines of which read as follows: "What goes up, must come down /
What must rise, must fall". These words of wisdom are also worth heeding in the financial
markets - indeed, they're the secret of any successful trader. But interestingly, the precise
opposite also holds true in the financial markets. So, we could equally say: "Interest rates
that fall, must rise again."
But for now, the euro area is still in the midst of a protracted spell of very low interest rates. It
goes without saying that this low-interest-rate environment is making itself felt on banks -
particularly on those whose business models are very reliant on interest income. So it's not
surprising that many a German credit institution is struggling with weak earnings. That's a
topic which has been on the agenda for quite some time now. Incidentally, we will be getting
a better idea of how German banks are coping with the currently low level of interest rates
next week - on 18 September, to be precise, when the Bundesbank and BaFin will be
releasing the findings of a joint survey on the low-interest-rate environment.
What can banks do? In a nutshell, banks should act on the meagre state of their earnings at
present by reflecting on their business models and tapping fresh sources of income. While
The Alan Parsons Project might have a point, living off ever-diminishing resources and
simply sitting tight until interest rates reverse isn't what I would consider the right course of
action. That's because interest rates in the euro area are likely to remain very low for some
time to come - the low rate of inflation, the modest economic outlook and the ECB's forward
guidance suggest as much.
The picture is a different one across the pond. For all extents and purposes, the United
States already began edging towards the monetary policy exit back in May 2013. That was
when the US Federal Reserve announced its plans to "taper" its bond purchase programme.
So a possible interest rate hike would represent a return to conventional monetary policy
terrain. And it is not so much the timing of the interest rate move that matters as the
subsequent interest rate path which the Fed follows.
What would a return to normal policy rate conditions in the United States mean for the euro
area and for Germany's banks? Since 2013 we have observed that policy divergence
between the United States and the euro area has had two knock-on effects. First, the
differential between US and euro-area interest rates has widened; second, the euro
exchange rate has dwindled. This trend gained traction early this year when the Eurosystem
announced the large-scale purchase of government bonds. That increased the spread
between US Treasuries and German Bunds and sent the euro plummeting against the dollar.
So German banks need to remember that even if the Fed raises its policy rates, the spell of
low interest rates in the euro area looks set to continue. Remember what I said just a few
minutes ago - sitting tight and hoping for the best simply isn't an option. And as far as
possible exchange rate volatility is concerned, banks might theoretically be exposed to
currency risk. Two factors play a role here. The first is banks' funding gap in dollars. That gap
measures the excess of a bank's US dollar assets over its US dollar liabilities. The bigger
this overhang, the more exposed the bank is to exchange rate risk. The second factor is the
mismatch between the maturities of assets and liabilities denominated in US dollars. This
maturity mismatch measures both exchange rate risk and interest rate risk.
At the onset of the global financial crisis in 2008, both the funding gap and the maturity
mismatch of German banks were very large indeed. When the forex markets dried up and
German banks got cut off from US dollar funding, the central banks had to step in and lend a
helping hand. Since then, the ECB, to name but one, has been providing swap facilities, but
the take-up now is virtually non-existent.
German banks have reduced their vulnerability since those days, slashing their funding gap
by downsizing their stock of US dollar assets. What remains substantial, though, is the scale
of the maturity mismatch of their US dollar investments. However, the actual risk exposure
here is relatively small, because German banks these days are much better hedged against
currency risk than they were just a few years ago.
All in all, then, the expected interest rate reversal in the United States is unlikely to impact
strongly on German banks - and it's not as if the move is coming entirely out of the blue. And
that's a point worth noting, because there are three qualities that are crucial for any exit from
an accommodative monetary policy - transparency, predictability and communication. We
are unlikely to see a turnaround in euro-area interest rates in the near future. In closing, I
would like to quote again from The Alan Parsons Project: "Someday, you'll know where you
are".
Thank you for your attention.