The European sovereign debt crisis remains the greatest threat to financial stability in Germany. The Bundesbank considers that a substantial worsening of the situation would have a significant adverse impact on German banks and insurers. In addition, low interest rates, high liquidity and potential exaggerations in the German real estate market could pose a future threat to financial stability.

The risks to the German financial system are no lower in 2012 than they were in 2011. The European sovereign debt crisis actually came to a head at several points this year; Spain and Italy – two major economies – have been drawn into the crisis. Monetary and fiscal policy measures on a massive scale were therefore needed to stabilise the financial system. “But monetary policy cannot eliminate the causes of the crisis; it can only buy time”, cautioned Sabine Lautenschläger, Deputy President of the Deutsche Bundesbank, at the press conference held today to present this year’s Financial Stability Review. She added that central banks had already done a lot to that end. “This has entailed an ever greater transfer of risk to the public sector and has caused the low-interest rate environment to become entrenched”, said Bundesbank Executive Board Member Dr Andreas Dombret, who is responsible for financial stability matters. He warned that “the side-effects of short-term stabilisation measures could leave a difficult legacy for financial stability in the medium to long term”.

However, there is good news regarding German banks: they have lowered their leverage ratios, increased their tier 1 capital ratios and increasingly tapped more stable sources of funding, such as customer deposits. In addition, German banks have significantly reduced their claims on the countries hit by the sovereign debt crisis. In mid-2012, however, the German banking system still had substantial exposures to Italy and Spain alone, of which just under €59 billion were to government debtors of both countries. “A substantial escalation of the sovereign debt crisis would, of course, have an adverse impact on the German financial system too”, warned Ms Lautenschläger. The Bundesbank also sees other structural developments that will weigh on banks’ profitability in the medium term. “These include regulatory costs and a looming rise in competition for customer deposits and lending business”, Ms Lautenschläger said, adding that “credit institutions should therefore review their business models on an ongoing basis and swiftly adapt to growing competition; consolidation should not be off-limits either”.

The Bundesbank, moreover, regards the low-interest rate environment as having negative repercussions on insurers. Bundesbank Executive Board Member Dr Andreas Dombret noted that “life insurers will have to continue making provisions in order to meet guaranteed rates of return in the future”. In view of the low interest rates, the Bundesbank has also focused its analysis on developments in the German real estate markets. Growth in housing prices in Germany’s urban centres is accelerating; exaggerated price developments in individual regional markets cannot be ruled out. Although he could see no signs yet of a rapid build-up of risks to financial stability in Germany, Mr Dombret warned that “the experiences of other countries show that precisely such an environment of low interest rates and high liquidity can encourage exaggerations on the real estate markets”, emphasising that this situation may also materialise in Germany's urban centres and pose a considerable threat to financial stability in this country.

The global shadow banking system continues to play a major role, as it did before the outbreak of the financial crisis. Although the German shadow banking system is comparatively small, it manages net assets of around €1,300 billion, corresponding to around 15% of the total assets of Germany’s regular banking system. Risks stemming from the global shadow banking system could nonetheless spill over quickly to the German financial system. “We are not an island. The shadow banking system should be monitored very closely and made subject to internationally consistent regulation. Only a global approach will truly help to contain contagion effects – including those on German banks and insurers”, said Mr Dombret.