The Interview with Prof Claudia Buch, Vice-President of the Deutsche Bundesbank, was conducted by Martin Arnold.

How is the eurozone banking system doing?

The banks are well-capitalised and they're liquid. So all the indicators are fine and that's good news because it shows, of course, the efforts the banks have made. It particularly shows the success of the regulatory agenda we had over the past 15 years and the success of supervision. 

But we need to be forward-looking. We have to consider the macro environment. This is not only my concern, but I think the concern of all the supervisors right now. How do we deal with the uncertainty and the increase in risk that we see all around us? Interest rate risk has increased, and it has actually materialised already. 

We don’t know how big the increase in credit risk is going to be as there will be structural change in the real economy, and there’s liquidity risk. Central banks have changed the policy stance, so the ample provision of liquidity through central banks that everybody got used to, that's changing.

What do you think should be the priority for eurozone banking supervision in the next few years?

I think the focus has to be on adapting to this changing environment. That means looking at the analytical tools, the supervisory instruments, how do we use them, how effective they are. So that's the analytical part. 

But we also need the people who are sufficiently agile and sufficiently critical, who have a critical mindset and take the decisions to make sure supervisory action is taken. So we need both: adapting to the new environment and continued cultural change in supervision, an area where we've made a lot of progress already.

Does the recent turmoil in the US and Swiss banking sectors make it more important to create a common deposit insurance scheme in the eurozone?

In an ideal world, having everything under the same system, having less complexity, not dealing with different deposit insurance systems, of course is always better. But in the real world, we have very different institutional regimes across countries and so we can't just with one snap of the fingers jump to a new system. 

I think the more realistic steps in between would be to do everything we can to close the gaps when it comes to resolution. And then, of course, we also need a political discussion about the organisation of deposit insurance. But I wouldn’t say that the system is not working because we have missing parts in the banking union. 

How do higher interest rates affect banks?

We are, of course, talking with the banks and they are aware that they are exposed to interest rate risk. We are imposing higher capital surcharges on highly exposed institutions to ensure they have sufficient buffers against this risk. 

You can do some simple simulations on what would happen if a significant share of depositors switches to higher interest paying deposits, and then you see that the net interest margins are shrinking.

So we're telling the banks: where we think that interest rate risk is quite significant, we are imposing higher capital charges.

They always asked for higher interest rates and now they have them. This leads to higher interest rate margins, but there’s also a big question how long this effect lasts. The problem in Germany is that banks are under pressure to increase their deposit rates and they can’t pass this on fully to their loan customers because loan demand is relatively weak. 

Bankruptcies fell during the pandemic, but they are starting to rise again. Is this a concern?

Indeed, corporate insolvencies are now slightly increasing. I think we also see a little bit of an increase in credit risk and appropriate provisioning of the banks, but it's all at relatively low levels. When you look at the corporate sector in Germany, it was very sound financially going into the corona pandemic and then you had the fiscal support. So far everything looks good. But that, of course, doesn't mean that it will stay this way. 

We could have a bigger need for structural change with resources moving out of the very energy intensive sectors to less energy intensive sectors or with entire business models in the corporate sector that don't work anymore. 

So far, we see relatively gradual adjustment, including on the labour market, which is certainly a big stabilising factor all over Europe. The job flows you are seeing are not those you would expect in a period of a big structural change.

Normally in a downturn, defaults go up, but do you expect that to only happen after a lag?

I think it takes a while because companies can use their financial buffers. The aggregate numbers we have on the financial situation of the corporate sector lag behind something like two years or so. We are talking regularly to the banks. They do report increasing tensions but it’s nothing we would see yet in the aggregate numbers which are very backward looking. 

But if I'm right, we get more structural change, more credit risk, more non-performing loans. We see forbearance activity of the banks going up a bit. I think we're still in the situation where we all can prepare for more structural change. 

We have countries in Europe that learned the hard way how to deal with non-performing loans. Fortunately, this hasn't been the case for a long time in Germany. But I think there is a good window of opportunity to really learn from others and to use the time that we have to see what we can do. The aim is to prevent non-performing loans from building up.

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