Claudia Buch: Challenges of contemporary central banks
Panel remarks by Ms Claudia Buch, Vice-President of the Deutsche Bundesbank, prepared for
Banka Slovenije's at the 30th anniversary conference, Ljubljana, 11 May 2022.
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Thank you very much for inviting me to speak on this panel and to celebrate Banka Slovenije's
30th anniversary. I would like to congratulate you for the excellent work you have done during the
past 30 years. Banka Slovenije has been an integral part of the Eurosystem, and we have been
cooperating closely on many projects. We very much look forward to continuing our successful
cooperation in the future!
We currently find ourselves at an important crossroads in terms of monetary policy and financial
stability. The financial system has weathered the COVID-19 pandemic relatively well - thanks to
massive policy support and greater resilience due to the financial sector reforms of the past
decade. At the same time, vulnerabilities in the financial system have increased during the
pandemic. Hence, an appropriate level of resilience in the financial sector is key: A bumpy road
lies ahead of us, uncertainty is high, and risks to both inflation and the growth outlook have
increased.
Let me start with an assessment of the residential real estate market in Germany.
House prices in Germany have increased strongly over the past decade, also mirroring global
trends. In Germany, house prices have almost doubled over the past ten years; in the euro area,
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they increased by about 40% During the pandemic, this trend has intensified. House prices are
driven by many factors, including expansionary monetary policy. Low interest rates made
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housing more affordable, which pushed up demand for real estate and house prices. Before the
pandemic, GDP growth in Germany was stable, unemployment was low, and corporate
insolvencies were on the decline. All this contributed to income and employment growth, which
are important drivers of house prices. In addition, changes in preferences due to remote working,
higher prices for construction materials in recent years, and probably also a search for yield by
investors played a part in this.
From a financial stability perspective, rising prices for real estate are a concern if they are driven
by deteriorating lending standards, credit growth and high leverage. In Germany, the growth in
loans to households for house purchase has been quite dynamic (about 7% year-on-year in Q1
2022). Household debt relative to GDP increased from 52% in 2018 - which is below the
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European average - to 57% at the end of 2021. While there has been no broad-based
deterioration of lending standards so far, debt-to-income ratios of new borrowers have increased
significantly, and debt service has been trending upwards in the last years.
The share of longer-term mortgages has increased strongly over the past decade. The
proportion of mortgages with long interest rate fixation periods of over 10 years has risen from
about 30% to 50%. This protects borrowers against the effects of rising interest rates to a certain
degree. But it also leaves the banking sector exposed to interest rate risk and short-term
increases in funding costs.
Overall, we therefore remain highly vigilant and are closely monitoring prices, lending volumes
and lending standards.
Generally, gradual and predictable increases in market interest rates would contribute to financial
stability. The profitability of financial institutions would increase, which supports the build-up of
capital buffers. A gradual increase in rates would also reduce the incentives to engage in risky
lending or investments ("search for yield"), thus slowing down the build-up of leverage and
dampening asset price surges.
By contrast, an abrupt, unexpected increase may have negative implications for financial stability.
In such a scenario, assets, including real estate, may be repriced rather quickly. Borrowers with
short-term liabilities may suddenly have to pay more for their debt. Bank profits may be squeezed
in the short term, depending on banks' reliance on interest income. Financial institutions would
be affected quite differently: German savings and cooperative banks, which account for 58% of
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lending to households and 41% of lending to corporates, do little in the way of hedging. Larger
banks, by contrast, often use derivatives to limit their exposure to interest rate risk. Hedging,
however, does not reduce the risk within the system.
Generally, during the pandemic, vulnerabilities have increased in the German financial system.
Credit has been rising. Market valuations and prices for real estate have been relatively high.
Exposure to interest rate risk has increased over time. At the same time, market participants
may underestimate macroeconomic risks going forward: Although GDP contracted by about 5%
in 2020, corporate insolvencies have actually declined during the pandemic. Future recessions
may weigh on the corporate sector more heavily. However, historical patterns in the data may be
poor predictors of potential future losses.
How can and should monetary policy take financial stability into account? Generally, monetary
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policy "gets in all of the cracks" of the economy, as Jeremy Stein argued. However, it is a blunt
tool that cannot target specific vulnerabilities. Importantly, the European Central Bank (ECB) has
the clear primary objective of maintaining price stability, and it thus needs to avoid conflicts of
interest with other policy objectives. This does not mean, of course, that it should ignore financial
stability issues.
In last year's strategy review, the ECB Governing Council thus added two important elements to
its strategy to account for the implications of house price booms. First, financial stability aspects,
including those related to real estate, are now regularly part of monetary policy discussions. This
allows the interdependence of price and financial stability to be taken into account, where
appropriate. Second, the price index used to measure inflation will include the cost of
owneroccupied housing. Thus, house prices will directly enter monetary policy considerations. Over
longer horizons, including the costs of owner-occupied housing may not change inflation
measures substantially. However, in periods of dynamic real estate price developments, the
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effect will be more significant.
Clearly, macroprudential policy is the first line of defence against risks to financial stability. In the
case of housing markets, borrower-based measures enhance the resilience of households and
the "quality" of new lending. Additionally, capital-based measures can strengthen the resilience of
banks. With these buffers, banks are then better equipped to absorb losses - that strengthens
their ability to lend even in the event of adverse shocks. Thus, sufficient capital is a safeguard for
the proper functioning of the financial system, including in stress episodes and during periods of
structural change.
In January 2022, German supervisors announced a package of macroprudential measures to
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address increasing vulnerabilities in the German financial system. The countercyclical capital
buffer was set at 0.75%, and the sectoral systemic risk buffer (on exposures secured by
residential real estate) at 2% of risk-weighted assets. Both measures will bolster banks'
resilience to adverse developments. As a complementary measure, the Federal Financial
Supervisory Authority (BaFin) called on lenders to closely monitor and address risks regarding
new mortgage loans. The intention is to foster prudent lending standards, especially concerning
loan-to-value ratios (LTVs). The German Financial Stability Committee regularly reviews all
measures.
The German example shows the importance of balancing the national and the supranational level
in addressing risks to financial stability. These risks often arise at the national level, and they
require appropriate national action. At the same time, coordinating macroprudential policy is
particularly important in Europe and in the euro area because of the high degree of financial
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integration and the common currency. Vulnerabilities in countries' financial systems often reflect
country-specific issues, including the interaction with national institutions. Therefore,
safeguarding financial stability is an important national responsibility. This holds particularly true
in a monetary union with economies that are highly integrated, but heterogeneous along
important dimensions that can significantly affect risks to financial stability. However, shocks to
domestic financial systems as well as imbalances can easily spill over across national borders
and can impair the transmission of monetary policy.
The European macroprudential policy framework has been set up to ensure that imbalances are
addressed and spillovers are taken into account. One important step in Europe was the launch of
the banking union in 2014. This harmonises banking supervision and regulation. But
macroprudential policies also need to take potentially adverse impacts on other countries into
account. Strong international institutions like the European Systemic Risk Board (ESRB), which
was established in 2010, are thus vital for monitoring and coordinating policies at the
supranational level. Therefore, the European level even has the power to top up certain domestic
policy decisions.
Hence, we have the right institutional infrastructure in place, but we also need to ensure that the
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system is working as intended. Monitoring emerging risks and addressing them appropriately is
key. It is essential to counter a potential inaction bias - both at the national and the supranational
level. Otherwise, necessary measures to safeguard the stability of financial systems will be
taken too late or not at all. To ensure that macroprudential policy can work as intended, its tools
have to be applied consistently across countries.
Let me close with a few remarks on the current economic situation.
The Russian war against Ukraine has severe geopolitical and economic implications. So far,
financial market stress has been lower than during the onset of the COVID-19 pandemic.
However, the situation in financial markets has certainly worsened: financial conditions are
tightening, risk aversion has increased, and uncertainty is high. Risks, particularly in commodity
markets and related to cyber security, require close monitoring.
Geopolitical events, climate change, and digitalisation are intensifying the ongoing structural
change in the real economy. An abrupt process of structural change may lead to losses in the
real economy and write-downs of loans. Structural change also places a burden on the financial
sector, which has to accompany the real economy through the transition.
What buffers against unexpected losses are available in the system? During the pandemic,
significant fiscal and monetary support has played an important role in protecting the balance
sheets of financial institutions. However, fiscal space is more limited than it was prior to the
outbreak of the COVID-19 pandemic, given the increase in public debt that we have seen over
the past years. In addition, monetary policy needs to address higher inflation and is in a process
of normalisation. Higher inflation puts pressure on central banks to raise interest rates to keep
inflation expectations anchored.
Appropriate buffers thus need to be available within the financial system. This requires effective
stress testing and a strong capital base - including by building up micro- and macroprudential
buffers. Additionally, to enhance the feasibility and credibility of resolution, the corresponding
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reforms should be implemented in full. It is crucial that financial institutions with unviable
business models can exit the market without jeopardising financial stability. Closing the
remaining gaps would help to fully reap the benefits of the resolution reforms.
Overall, only a resilient, well-capitalised financial system can perform its functions and benefit the
real economy and society alike. As we face a period of high uncertainty and accelerated
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structural change, this is more important than ever.
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1. I would like to thank Philip Jamaldeen, Michael Richter, Edgar Vogel and Matthias Weiss for their most helpful
contributions and comments on an earlier version of this text. All remaining errors are my own.
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2. For all data related to the German real estate and household sectors see
www.bundesbank.de/en/statistics/sets-of-indicators/system-of-indicators-for-the-german-residential-propertymarket/system-of-indicators-for-the-german-residential-property-market-795268. For euro area house prices
see sdw.ecb.europa.eu/quickview.do?SERIES_KEY=429.RESR.Q.I8._T.N._TR.TVAL.4F0.TB.N.IX. Between Q4
2011 and Q4 2021 and the growth rate was 39%.
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3. See Deutsche Bundesbank (2020). The protracted rise in residential property prices in Germany from a
macroeconomic perspective: transmission channels and fundamental determinants, Monthly Report, October.
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4. For cross-country comparisons, see sdw.ecb.europa.eu/reports.do?node=1000004952
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5. Source: Deutsche Bundesbank balance sheet statistics.
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6. See www.federalreserve.gov/newsevents/speech/stein20130207a.htm
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7. See European Central Bank (2022). Economic Bulletin. Issue 1, 2022, or ECB (2021). Inflation measurement
and its assessment in the ECB's monetary policy strategy review. Occasional Paper No 265.
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8. See German Financial Stability Committee (2022). Press release "German Financial Stability Committee
welcomes the Federal Financial Supervisory Authority's announced package of macroprudential measures". 12
January 2022 (
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9. See Buch, Claudia M., Manuel Buchholz, Katharina Knoll and Benjamin Weigert (2021). Why Macroprudential
Policy Matters in a Monetary Union. Oxford Economic Papers. 23: 1604-1633.
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10. See the panel remarks at the fifth ESRB annual conference:
www.bundesbank.de/en/press/speeches/adecade-of-macroprudential-policy-881600
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11. For further details, see Financial Stability Board (2021). Evaluation of the Effects of Too-Big-to-Fail Reforms:
Final Report. March 2021.