Prof. Dr. Claudia M. Buch
Vice-President
of the Deutsche Bundesbank
Statement at the presentation of the
Deutsche Bundesbank's 2022
Financial Stability Review
Frankfurt/Main
24 November 2022
Seite 1 von 18
Deutsche Bundesbank, Directorate General Communications
Wilhelm-Epstein-Strasse 14, 60431 Frankfurt am Main, Germany, Tel.: +49 (0)69 9566 33511, Fax: +49 (0)69 9566 33077
presse@bundesbank.de, www.bundesbank.de
Reproduction permitted only if source is stated.
Ladies and gentlemen,
Together with my colleague, Joachim Wuermeling, I wish to warmly welcome
you to the presentation of the Bundesbank's Financial Stability Review this
year.
At first glance, the key messages in this report might look a lot like those
from last year: the German financial system is vulnerable to macroeconomic
risks, and sufficient resilience is needed to preserve the stability of the
system.
But there have been decisive changes, too.
First, the macro-financial environment has deteriorated substantially. One
year ago, we were expecting the economy to experience a robust upturn.
Interest rates and inflation were low. Today, risks to the real economy and
inflation have increased significantly. Vulnerabilities can become injuries that
can be healed only with some difficulty later on.
Second, risks we had warned about in the past years have already
materialised in some cases. For example, market valuations have fallen
substantially, causing financial institutions to sustain losses accordingly. The
financial system has been able to cope with these losses so far. But to make
sure things stay this way, all stakeholders have to step up to the plate - first
and foremost the financial institutions themselves. That's a point the
European Systemic Risk Board (ESRB) made just recently. It was its first
general warning.1
What is clear: We need a resilient financial system that functions even during
periods of stress and can support structural change in the real economy.
Banks need to be able to absorb losses without external assistance.
Otherwise, there is the risk of a credit crunch that would exacerbate a crisis
in the real economy.
So what does the risk situation look like?
Chart 1
It's plain to see that the risks to economic activity are clearly tilted to the
downside. A slight recession has been forecast for 2023.2 To gauge the
future stability of the financial system, we look particularly closely at very
negative developments. Above all, an intensified energy crisis would be a
considerable drag on the real economy (chart 1). Gas rationing would be a
problem since money cannnot make up for a gas shortage. And there are
other risks as well. The International Monetary Fund stresses risks to global
growth and financial stability in its recent reports.3 That's not good news, for
a German economy that is highly interconnected internationally.
Chart 2
Germany's strong dependence on imported energy and the rise in energy
prices also mean a decline in real incomes. Roughly 95% of German gas
consumption alone comes from imports. The stoppage of Russian deliveries
in particular has caused gas and energy prices to soar (chart 2) - and that
surge in prices will only recede gradually. This means we are having to pay
more for our imports than we are getting for our exports - the terms of trade
have fallen by more than 10% this year.4 It's a situation not unlike the oil
price shock in the 1970s.
These higher energy costs can only be redistributed domestically.
Enterprises and households therefore face a heavier financial burden, and
credit risks will rise in the future.
The higher nominal interest rates represent a further cost factor. By and
large, rising interest income is good news for banks whose revenues are
heavily reliant on maturity transformation. The flip side of this, though, is
greater risk, because higher interest rates place an additional strain on
borrowers. Furthermore, higher interest rates have depressed securities
prices - banks have been forced to recognise impairments and have already
depleted almost all their unrealised reserves.
Chart 3
That said, expectations about future price developments are relevant for the
incentives to carry on taking out debt. So far, nominal interest rates have
risen more slowly than expected inflation. This means that real interest rates
are still negative on average - and financing conditions are correspondingly
favourable.
Chart 4
Demand in the residential real estate market has weakened To take out a
mortgage loan today, you need to pay interest of more than 3%, up from
1.3% a year ago. More and more households are expecting that real estate
prices will not rise any further.5 On balance, house prices are still rising,
albeit at a slower pace (chart 4). That said, there are no signs of a severe
slump in real estate prices or of overvaluations receding.6
♦♦♦
All in all, then, the macroeconomic risks have risen and the financial system
remains vulnerable to these risks. For at the end of the day, a financial
system is a network of financial contracts - contracts written on the basis of
assumptions about the future. Many of these assumptions will probably turn
out to be overoptimistic: the financial situation of enterprises has
deteriorated, insolvencies in the corporate sector are likely to rise, and
households have lost purchasing power. These factors are weighing on the
financial system.
Chart 5
Lending developments provide indications of how well the financial system
can cope with these burdens.
Overall, lending is continuing to grow, but at a slowing pace. However, there
is no credit crunch. Many enterprises have drawn down credit lines to
prevent liquidity bottlenecks and ready themselves for mounting energy
prices. Overall, lending to enterprises grew quite significantly - buoyed in
part by government measures. Households, by contrast, have borrowed
substantially less to finance real estate (chart 5) due to higher interest rates,
lower real incomes and elevated uncertainty. Banks have become more
cautious about lending - no doubt in a reflection of the upturn in risk.
Chart 6
The upturn in the financial cycle is weakening overall, then, but
vulnerabilities in the loan portfolios remain high (chart 6).
Chart 7
Tension emerged in the financial system this year because energy suppliers
had to provide additional collateral for derivatives trading (chart 7). Since the
global financial crisis, derivatives have increasingly been traded through
central counterparties (CCPs) as a way of mitigating risks in the financial
system. Energy derivatives trading in Germany takes place at the energy
exchange in Leipzig. After the outbreak of Russia's war against Ukraine,
energy prices spiked very sharply and abruptly, and volatility rose
considerably. Accordingly, central counterparties asked for more collateral.
That collateral needs to be provided first by the clearing members, which are
primarily banks. These clearing members have passed on the increased
requirements to their customers - i.e. to the energy firms that had entered
into the derivatives transactions. The firms were not always able to post that
collateral without external assistance - government credit lines via the KfW
Group stabilised the market.
This development shows that extreme and highly unexpected periods of
market stress might make fiscal intervention necessary as a way of
supporting the real economy. The financial sector also benefits indirectly.
What it doesn't mean, though, is that the financial sector can count on the
government: in the end, the financial system needs to be able to absorb
losses on its own. It would also be wrong to blame the CCP mechanism for
the tensions at the energy exchange. Adequately collateralised derivatives
transactions are a good protection against contagion risks and are positive
for the financial system.
Even though the situation at the energy exchanges has eased, an
intensification of the energy crisis is a possible risk scenario for the financial
system. The Financial Stability Review analyses a scenario in which energy
exports from Russia to the EU come to a complete halt, energy prices
remain high and real GDP declines significantly next year. That scenario
would result in all financial institutions - banks, insurers, investment funds -
experiencing a sharp increase in losses.
Chart 8
Mounting losses could lead to a tightening of the supply of credit. This is
because mounting losses mean write-downs on banks' capital, and shrinking
capital ratios. How banks respond depends on their capital buffers (chart 8).
If banks use their buffers, this stabilises lending. If they try to maintain their
capital ratios, loans would decline more sharply. The prudential framework
offers banks headroom here, as they are allowed to fall short of the
macroprudential buffer requirements for a time. Then, however, supervisory
consequences such as restrictions on distributions in the form of bonuses or
dividends take hold. When banks consider this matter, they will undoubtedly
assess whether falling short of the buffer requirements would be seen by the
markets as a negative signal.
This example goes to show that the better capitalised banks are, the lower
the probability that negative real economic developments will be amplified
within the financial system.
An intensification of the energy crisis is just one potential negative scenario
that could occur; it does not represent a forecast of future developments. At
the current juncture, nobody can foresee how the energy markets will
develop. An abrupt interest rate hike in the markets would put many
borrowers and financial institutions under pressure. Cyberattacks could
exacerbate the situation still further.
♦♦♦
The financial system's resilience is crucial in determining whether increased
risks are amplified by the financial system. First, let's look at who the banks
serve as customers: households and firms.
Chart 9
Residential real estate loans are a key factor in the financial resilience of
households. In recent years, debt levels have risen (chart 9).7 At the same
time, residential real estate loans have mainly been taken out by higher-
income households. Households are initially shielded from interest rate risk
by relatively long interest rate fixation periods. But that interest rate risk is
then present in the financial system and makes banks more vulnerable to an
interest rate rise.
Chart 10
Corporate debt levels have also risen over the past few years. In terms of
financial metrics, enterprises' debt sustainability still looks to be fairly sound.
For energy-intensive enterprises, the debt overhang ratio is marginally higher
and the interest coverage ratio is slightly lower (chart 10). Increased costs
will reduce firms' financial headroom going forward. This could pose a
problem for banks, as quite highly leveraged enterprises comprise a
relatively high share of the loan portfolios. Losses could therefore increase in
the event of adverse developments.
Chart 11
The fact that banks consider their credit risk to be fairly low reflects past
developments, first and foremost. During the pandemic, insolvencies in the
corporate sector actually decreased despite a sharp decline in GDP (chart
11) - thanks to extensive government measures. Credit risk was at a
commensurately low level. The time series on which banks are basing their
estimated future credit risks could therefore paint an excessively optimistic
picture of the future. So the fact that increasing credit risks have not yet
filtered through to loan loss allowances definitely does not constitute an all-
clear signal.
Chart 12
Furthermore, banks' capital ratios have fallen slightly since the middle of last
year. There are two reasons behind this: the continued fairly dynamic
increase in loans and write-downs on securities, which have already taken
place. The tier 1 capital ratios of savings banks and credit cooperatives and
of large, systemically important banks have fallen by around one percentage
point (chart 12).8 The unweighted capital ratios, too, declined during this
period.
In January 2022, the Federal Financial Supervisory Authority (BaFin)
therefore announced a package of macroprudential measures to strengthen
bank resilience. The countercyclical capital buffer was raised to 75 basis
points of domestic risk exposures in a move to enhance resilience to general
macroeconomic risks contained in the loan portfolios. The sectoral systemic
risk buffer was set at 2% for loans secured by domestic residential real
estate. Supervisors are also urging institutions to apply conservative credit
standards.
Chart 13
Other European countries have responded to elevated risks in a similar
fashion (chart 13). This year, 14 countries have already increased the
countercyclical capital buffer or announced plans to do so. Systemic risk
buffers have been activated in three countries. Five countries have
announced their intention to use borrower-based instruments.
Chart 14
Increasing the buffers in Germany will conserve capital in the banking
system. This will give banks an incentive to strengthen their capital base.
Banks have until February 2023 to meet the higher requirements. There is
still sufficient excess capital in the banking system, totalling €150 billion in
numerical terms, or 4.5% of risk-weighted assets (chart 14). Given this
headroom, the German banking system as a whole should not find it difficult
to meet the requirements.
The impact of the package of measures is reviewed on a regular basis, and
no negative side effects have been identified so far. The important thing is to
look at the financial system as a whole. If individual banks restrict their
lending because capital requirements become binding, this may in fact be
because the measures are having the desired effect. Lending business
would then be shifted from banks with less capital to those with a better
capital base. This would make the system more stable.
The level of the buffer depends on how systemic risks develop in the
financial system. This is because the countercyclical buffer is intended to be
used in precisely those stress phases when there is a risk that credit supply
could be tightened. Any required adjustment is contingent on the financial
cycle, not the economic cycle. Macroprudential policy is not economic policy!
Releasing buffers prematurely could weaken banks' resilience if distributions
subsequently go up. Should loans continue to rise and vulnerabilities
increase, an even greater degree of resilience would be required. If,
conversely, extremely adverse developments occur, supervisors are free to
release the macroprudential buffers at any time. This may be the case if
substantial losses occur or are clearly approaching in the financial system
and if, therefore, there is a risk of the credit supply being excessively
restricted. In such an event, the buffers give banks more scope to deal with
losses and continue lending.
It is safe to say that last year, nobody could have predicted the situation in
which we currently find ourselves. Fortunately, however, no crisis
developments have occurred within the financial system. At the current
juncture, then, there is no need to release the buffers. It would certainly be
good news if we could say this time next year that there was no need to
release the buffers to deal with a crisis situation.
♦♦♦
It isn't just the economic outlook that lacks certainty at present. Russia's war
against Ukraine, geopolitical tensions and the climate crisis are ratcheting up
the pressure for structural change in the German economy. All of this makes
a stable financial system which can support structural change - and which is
not itself a further source of stress - vital to the economy. As things currently
stand, nobody knows what challenges the economy and banks will have to
confront in future. This great uncertainty will push risk models to their limits.
Risks can, after all, be priced and quantified using probabilities. The same
cannot be said for uncertainties.
A stable financial system is in the interest of society as a whole. Those
responsible are thus called upon to enhance the resilience of the system.
Financial institutions should assess their risks in view of adverse scenarios.
In concrete terms, to enhance resilience means that banks should be very
cautious about distributing profits. Supervisors can support institutions in
fostering financial resilience by ensuring that there are sufficient capital
buffers in the financial system as a whole, thereby reducing systemic risk.
And it is up to policymakers to regularly review the regulatory framework and
adjust it as necessary in a way that does not erode resilience in the financial
system.
* * *