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The Deutsche Bundesbank publishes its 2021 Financial Stability Review

11/25/2021 | 05:20am EST

The financial system has functioned well during the pandemic. Government stabilisation measures have shielded the real economy and - indirectly - the financial system from the pandemic fallout. The economy continued to be supplied with credit. At the same time, vulnerabilities to adverse macroeconomic developments have built up continually, with risks emanating from real estate financing in particular. "Now is the time to take preventative action against future risks," stressed Claudia Buch, Vice-President of the Deutsche Bundesbank, at the presentation of the 2021 Financial Stability Review. The report also studies the impact of climate risk, establishing that the German financial system appears to be only moderately vulnerable to valuation adjustments resulting from rising carbon prices.

Increased vulnerability to macroeconomic risks

GDP in Germany declined by 5 percent in 2020; however, government measures offset losses in corporate and household income. The number of insolvencies did not increase. Thus, barely any losses occurred in the financial system, and the resilience of the banks was not put to a serious test. Loan growth remained dynamic during the pandemic, and the financial cycle continued to expand.

The relationship between the macroeconomic situation and credit risk has loosened. In future recessions, however, credit risk could increase more strongly. The experiences of the past few years should therefore not be projected into the future.

The German economy is expected to make a sharp recovery in the coming years. However, as the pandemic is not yet over, the economic outlook remains uncertain. "The German financial system is currently resilient enough to cope well with constrained economic growth," said Joachim Wuermeling, the Bundesbank Executive Board member responsible for banking supervision. In the event of a severe macro-financial shock, banks could deploy the capital buffers they have built up; this would prevent them from having to curb their lending. Mr Wuermeling also emphasised that banks must equip themselves for the eventuality of materialising interest rate risk.

Risk increasing in the residential real estate market

In 2020, residential real estate prices rose sharply once again, by an average of 6.7 percent. Many forecasts expect further increases. Loans for house purchase climbed at a similar rate; in the third quarter of 2021, they rose by 7.2 percent on the year. As measured by fundamentals, current overvaluations of residential real estate are estimated to be between 10 percent and 30 percent. This increasingly applies to housing outside of urban areas, too. As a result, the value of loan collateral may be overestimated. The high proportion of long-term loans and capital investments in the German financial system makes it vulnerable to interest rate risk. For instance, around one-half of bank loans for residential real estate have an interest rate fixation period of over 10 years.

Preventative action must be taken against future risks

Against the backdrop of increased vulnerabilities, greater preventative action must be taken now in order to equip the financial system to deal with future risks. The aim of all market participants should be to build up resilience and limit vulnerabilities. "The countercyclical capital buffer should be built up again early on," Ms Buch said. The buffer strengthens banks' resilience and stabilises lending during times of crisis. It can be adjusted in line with financial cycle developments and reduced if necessary. Furthermore, developments in the residential real estate market must be monitored closely and risks must be limited. Borrowers and lenders alike should keep an eye on debt sustainability. Should a loosening of lending standards appear to be on the cards, the supervisory authorities would have various tools at hand to counter this.

Limited vulnerability to climate-related transition risks

The German financial system appears to be only moderately vulnerable to risks emanating from increased taxation of fossil fuels on the path to a climate-friendly economy. In a Bundesbank scenario analysis, it was assumed that global climate policy strives to meet the 1.5°C target under the Paris Agreement, raises carbon prices and achieves climate neutrality by 2050. This rise in carbon prices results in a revaluation of financial assets. Overall, the resultant effect on the portfolios of banks, insurance companies and investment funds does not exceed a single-digit percentage figure. The impact is relatively modest as most investments have a maturity of less than 10 years. However, there is no room for complacency, as physical risks in particular were not taken into account in this analysis, and the modelling of climate risk is subject to uncertainty. Targeted and credible climate action will reduce the risks faced by the financial system during the transition to a climate-friendly economy. Enterprises' disclosure of their carbon emissions would contribute greatly to facilitating a better assessment of risks.

Disclaimer

Deutsche Bundesbank published this content on 25 November 2021 and is solely responsible for the information contained therein. Distributed by Public, unedited and unaltered, on 25 November 2021 10:19:06 UTC.


ę Publicnow 2021
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