The German financial system has weathered the period of exceptionally strongly rising interest rates well overall and remained stable over the past twelve months, too. Interest rates have gone back down in the meantime. Although the unrealised losses that had accumulated on the balance sheets of financial intermediaries such as insurers, investment funds and pension funds as interest rates were rising have receded, credit risk is now increasingly coming under the spotlight. The financial system is facing acute challenges due to geopolitical tensions and a weak economy. The economy is also undergoing transformation. This is making supervisors more vigilant, particularly with regard to the commercial real estate sector, said Michael Theurer, Member of the Executive Board of the Deutsche Bundesbank, at the unveiling of the Financial Stability Review 2024. Our top priority must be a resilient financial system, Theurer continued.

Macro-financial environment remains challenging

The macro-financial environment improved over the course of 2023, yet remains challenging in light of continued geopolitical tensions. On the whole, Germany has seen signs of a return to price stability without any major disruptions. Commercial real estate, prices of which continued to decline in 2024, remains exposed to elevated risk. High levels of public and private debt around the world are creating risks. Following the outcome of the US elections, the German economy faces additional uncertainty regarding the precise form that US economic policy will take.

Stable banks and financial intermediaries

Banks’ profitability is continuing to develop positively due to the low interest rates in deposit business and correspondingly low funding costs. The major vulnerabilities stemming from the period of low interest rates have so far been declining gradually, particularly those to which residential real estate loans are exposed. Banks’ capitalisation has improved steadily over recent years, as Theurer put it.

German non-bank financial intermediaries weathered the rise in interest rates just as well as banks, but they continue to face liquidity risk. Losses on commercial real estate loans have gone up considerably. However, these are concentrated amongst a handful of banks and insurers. On the whole, therefore, the risks remain manageable for the financial system. Liquidity risk in open-end real estate funds could amplify the aforementioned developments in the commercial real estate market. The speed at which liquidity risk can materialise for open-end retail real estate funds is being kept in check by long redemption notice periods and minimum holding periods, though. 

Overall risk situation requires sufficient resilience

Given the overall risk situation, it is still important for the German financial system to remain sufficiently resilient. To this end, the package of macroprudential measures from January 2022 remains appropriate. It comprises the countercyclical capital buffer, with which banks had built up additional capital in order to be better prepared for crisis periods. It also contains the sectoral systemic risk buffer, which sets additional capital requirements specifically for loans secured by residential real estate in order to mitigate systemic risk. In the residential real estate market, the favourable developments point to a slow easing of the situation regarding residential real estate loans granted up to 2022. However, uncertainties persist. Overall, an orderly reduction of vulnerabilities in the residential real estate market has become more likely. Macroprudential supervisors will monitor further developments in this area closely.

Structural change and climate risks

Given the structural transformation caused by climate change, the financial system remains in a phase of transition. A special article in the Financial Stability Review explains that an unexpected increase in the carbon price could weigh on the German financial system. Digitalisation is another driver of structural change. This year’s Financial Stability Review therefore also looks at the short and long-term impact of the introduction of a digital euro on bank liquidity and funding costs.

Strengthen macroprudential supervision

Since the global financial crisis, the sector for non-bank financial intermediaries has been growing in Europe and Germany. Additionally, German banks and investment funds have close ties with global non-bank financial intermediaries. The regulation of non-bank financial intermediaries, which has thus far been primarily microprudential in its orientation, should therefore strengthen its macroprudential perspective. This macroprudential view still suffers from data gaps. Closing these data gaps is important in order to be able to better assess risks such as liquidity bottlenecks and contagion effects and to take timely measures such as imposing capital or liquidity requirements. Foundations should be laid for a European and international exchange of information on non-bank financial intermediaries, Theurer remarked.