Andreas Dombret: The situation in the German banking sector -
challenges in striking a balance between weak profitability and the
lowinterest-rate environment
Speech by Dr Andreas Dombret, Member of the Executive Board of the Deutsche Bundesbank,
at the press conference to unveil the Deutsche Bundesbank's Financial Stability Review,
Frankfurt am Main, 25 November 2015.
* * *
1. Banking supervision: successful first year in the SSM
Ladies and gentlemen
Before I delve into the risk situation in the German banking sector, I would briefly like to look
back with you on year one of European banking supervision.
On 4 November 2014, the ECB assumed direct responsibility for supervising the largest 120 or
so banks in the euro area. Those included 21 German institutions, although the number has
risen to 22 in the meantime. Given the sheer scale of the project and the very short time
available for preparation, many were doubtful about whether European banking supervision
could actually work.
My answer after one year of the Single Supervisory Mechanism (SSM) is: yes, it is working,
and I am confident it will continue to meet the high expectations placed in it. Cooperation
between the ECB and the national supervisors is running pretty smoothly, and we are indeed
observing a gradual Europeanisation of banking supervision. So I'm satisfied with the first year
of European banking supervision.
There are a few points we can improve on. These include, for instance, decision-making
structures and processes. In this regard, I believe that an adequate distinction is still not being
made between important processes and routine decisions; having said that, however, my
comments are by no means intended to imply criticism.
Of course, European banking supervision has heralded a lot of changes, especially for the
major banks. Communication with banking supervisors is increasingly taking place in English,
cross-border peer comparisons between banks are growing more important, and the
supervisory approach has taken on a more quantitative slant on the whole. These factors all
entail more work for the banks, of course; but the banks, too, ultimately stand to benefit from
improved supervision and a Europe-wide level playing field.
Looking to the future, another topic that's on the table right now is a European deposit
guarantee scheme; indeed, the European Commission presented a plan only yesterday. I take
quite a critical view indeed of this project because I don't believe that the groundwork has been
laid for such a scheme yet.
We have a common currency and a single European banking supervision set-up. But to a large
extent, it is still domestic fiscal and economic policymaking which determines the state of play
in the banking system. As a case in point, corporate and personal insolvencies are still
regulated very differently across Europe. Bearing this in mind, if a common deposit guarantee
scheme were in place, the repercussions of flawed national policy decisions could be passed
through to savers throughout the euro area.
And there is another point which needs to be considered. As long as banks continue to carry
a large stock of sovereign bonds issued by their home country on their balance sheets, a
common deposit guarantee scheme would mutualise the risks of sovereign debt. Ultimately,
that would introduce Eurobonds through the back door.
Aside from that, the question can be raised as to whether the Single Resolution Board would
really be the right institution to operate a European deposit guarantee scheme. And last but
not least, regulatory proportionality needs to be maintained as well - would the burden be
shared fairly among the large and small banks?
2. Banking regulation: nearly all items on the reform agenda ticked off
But let's return to the here and now. The first year of European banking supervision went very
smoothly. But a functioning banking supervision set-up also needs a sound regulatory footing.
From a regulatory perspective, we have now experienced seven years of reform.
Many of the items on the Basel Committee's reform agenda have been ticked off. Before we
cast our minds to future regulatory projects, we should first observe the effect of the new rules
- not just each one individually but how they interact with each other.
Ultimately, though, regulation and supervision are not the only challenges facing banks, nor
are they the most pressing ones. Let us now consider the risk situation in the German banking
sector.
3. The German banking sector: stability improved further ...
As far as German banks' resilience is concerned, we are seeing a gratifying development.
German banks have further improved their resilience by raising new equity and retaining
earnings.
The tier 1 capital ratio of the German banking system as a whole rose by 0.6 percentage points
between June 2014 and June 2015, and currently stands at 15.6 %. Thus, the long-term trend
towards strengthening their equity base progressed further in 2015. You will recall that at the
beginning of 2008, the year of the global financial crisis, the tier 1 capital ratio averaged around
9.1 %.
Meanwhile, leverage has continued to decline and is likewise following a multi-year trend. By
way of illustration: to fulfil the minimum leverage ratio requirement under the Basel regime,
eight of the major German banks with an international focus would now have to raise a
combined total of less than Euro1 billion of additional tier 1 capital. The corresponding figure
at the end of 2013 was around Euro18.5 billion. So the gap has largely been closed.
4. ... but profitability still weak
In order to safeguard resilience on a sustained basis, however, banks will also need to be
sustainably profitable. And this is where, in my view, German banks still have some
catchingup to do - not least given the protracted spell of very low interest rates.
Let us begin by returning to the German major banks with an international focus. Measured as
a percentage of total assets, these institutions have improved their operating income slightly
in the past years - from 1.31 % in 2009 to 1.46 % in 2014.
The major banks' return on total assets rose last year for the third time in succession. At a
mere 0.2 %, their return on total assets is still low by international standards, however. And
also in terms of their return on equity - which still stands at less than 5 % - German banks still
have some catching-up to do relative to the rest of the world.
Which brings us to the biggest challenge facing the German banking sector: it appears to be
suffering from weak profitability. Supervisors also have a problem with this, as banks' low
profitability limits their ability to retain earnings and build up equity.
Nor is the persistent spell of very low interest rates helping to remedy the German banking
sector's weak profitability - quite the contrary, in fact. Particularly for credit institutions with a
heavily interest-driven business model, the ongoing low-interest-rate environment could pose
a serious threat in the medium to long term. The longer the low interest rate levels persist, the
likelier it is that net interest income will come under pressure.
Looking to the present, however, there is some good news which expressly also applies to
small and medium-sized institutions. At the moment, the effects of low interest rates on the
aggregate profitability and the stability of the German banking system are still limited. All told,
the operating income of all German banks rose moderately in 2014, to Euro121.5 billion,
against the backdrop of declining total assets. Even aggregate net interest income in 2014, at
Euro90.4 billion, was Euro4.1 billion up on the year.
And even the credit cooperatives and savings banks, which depend comparatively heavily on
interest business, were able last year to increase further both operating income and net interest
income. This they succeeded in doing by expanding credit business on the asset side of the
balance sheet and by shifting financing on the liability side to transferable deposits bearing a
lower rate of interest.
Yet both measures could easily lead to risks for the financial system. With regard to credit
business, we do not currently see the savings banks and credit cooperatives loosening their
lending standards, which would engender greater risk. Nevertheless, banks' interest rate risk
has increased significantly because loan maturities were expanded at the same time as lending
was increased. We have seen the so-called Basel coefficient, which is a measure of a bank's
interest rate risk, rise almost continuously since 2011.
With regard to German banks, I see three dangers. First, the currently good net measurement
gains and losses could return to more normal levels if the economy falters. Second, banks
could be forced to correct their optimistic projections of administrative spending. Third, plans
to increase net fee and commission income could prove unfeasible. These three things could
additionally weigh on the net profits of all banks and savings banks.
And of course no look at the future would be complete without a stress test. To avoid any
confusion, let my begin by saying that we calculated this stress test for our Financial Stability
Review (FSR) on the basis of figures available to us; the banks themselves were not involved.
It is therefore not to be compared with the stress test carried out in 2014 as part of the
comprehensive assessment, nor is it to be compared with the pan-European stress test which
the European Banking Authority (EBA) will carry out in 2016. In addition, a number of aspects
were not taken into consideration in our FSR stress test - banks' liquidity risks and negative
feedback loops between the banking sector and the real economy, to name but two.
However, this "small" stress test, too, produced a couple of interesting findings. We analysed
how the simultaneous occurrence of various macroeconomic shocks over the next three years
might affect the German banking system. To this end, we assumed a sudden rise in short-term
interest rates and a sharp fall in stock prices, the real economy and real estate prices: all things
considered, an exceedingly severe scenario.
As far as German institutions' profits are concerned, this extreme scenario would have a
considerable impact. Pre-tax results would fall into negative territory for almost half of the small
and medium-sized banks. The average annual profit of the small and medium-sized institutions
would drop by 91 % at its most extreme. The big banks would be affected, too: in particular,
they would suffer losses in their trading business and need to increase risk provisioning in their
lending business. Owing to good capitalisation, however, none of the large institutions would
run into difficulties. In light of the extreme scenario, that's a gratifying outcome for the stability
of Germany's banking sector.
5. Conclusion
Ladies and gentlemen, allow me to conclude by reiterating the four main points of my speech.
First, the first year of European banking supervision went smoothly. Of course
there are still a few things that we can improve upon, but we're working on them.
Second, many of the items on the Basel Committee's reform agenda have been
ticked off, and the entire list is expected to be finished by the end of next year. The
Bundesbank is committed to regulatory certainty, since it enables banks to plan for
the long term on a robust basis.
Third, German banks have further increased their stability - capital ratios have
continued to climb; leveraging is down further.
Fourth, German banks are suffering from persistent low earnings. Although the
low-interest-rate environment is not yet making itself felt in this regard, looking to
the medium to long-term future, however, small and medium-sized institutions in
particular look set to feel the pinch.
Ladies and gentlemen, Germany's banking sector has become much more stable since the
crisis, but some major challenges still need to be tackled - the low-interest-rate environment
and weak earnings, to name but two. These are challenges that banks must overcome in order
to assure their stability and profitability.
Thank you very much.