Interest rates in Germany continue to decline. The interest rate on deposits at the Bundesbank already slipped into negative territory five years ago. Banks may soon pass these negative rates on to even more customers.

Policymakers are already thinking about prohibiting this, however. At the same time, credit institutions are sharply criticised every time they hike up charges. But how are they supposed to earn money in the future? And how should they accumulate capital in order to remain stable? 

Banking supervisors are in a state of high alert. Credit institutions in Germany have traditionally earned the lion’s share of their revenues from interest business. In other words, they granted loans at a higher interest rate than the rate they gave customers for their savings. The institutions used the margin to finance their business operations. With interest rates constantly in decline, this model yields hardly any profit – because margins keep shrinking. In 1990, Germany’s credit institutions still earned €1.72 on loaned savings of €100, but today it is less than €1 – and the downward trend threatens to persist. Banks have to act to avoid making a loss and if they want to survive. 

Yet every response, be it higher prices or branch closures, is criticised as unjustified. This is understandable from the customers' perspective, but they did in fact “pay” for the service which was free in the past with the deposits which were on-lent. These times are over. Savings are worth far less due to the low interest rates. Indeed, banks even incur costs by maintaining deposits at the central bank at negative interest rates; this may even be true in future if banks lend money to customers at negative interest rates.

There is no getting away from the fact that current accounts cost money, like every other service. Even parking in the inner city for a few hours is often more expensive than the monthly current account fee. It is therefore no wonder that banks are demanding higher fees and thinking about negative interest rates. It may even be necessary in order to be commercially viable and from a banking supervision viewpoint. Consumer law protects against excesses.

However, that’s not the whole story. Germany’s banks also have an efficiency problem and many are trailing behind in the digital revolution. First, Germany's banking sector is close to the bottom of the list in the international comparison of cost ratios, i.e. the ratio of administrative expenditure to income. Budgets are stretched through too many branches, time-consuming processes, generous headcounts and antiquated IT. It is therefore not enough to merely raise charges.

Second, the digital revolution and the smartphone generation demand more than just making traditional banking slightly more efficient. Customer requirements and business operations must be entirely re-evaluated. New competitors such as FinTechs and BigTechs are about to shake up the financial community, and even Facebook plans to launch its own payment medium. Banks therefore have to become tech companies to a certain extent. Banking supervision should not stand in the way of innovation, but it needs to have old and new risks under control.

In this context, supervisors continue to demand that credit institutions accumulate more capital and improve their risk management. The implementation of so many new rules gives rise to considerable costs. The new requirements make sense, however, as they render the banking sector more resilient.

Banks, then, are in the process of reinventing themselves. At the same time, supervisors demand that the institutions are stable, resilient and profitable. This is why boards of directors at banks must have the scope to ensure a sound relationship between costs and earnings. A bank’s business model has to function even in a phase of low interest rates, digital transformation and regulatory pressure.

Bank customers are also right to expect this. Credit institutions should focus on the customers’ needs, but at the same time they have to be stable and generate adequate earnings. And customers should be prepared to pay an appropriate price for this, as stable banks don’t come free of charge.