German banks have seen their interest margin in lending and deposit business narrow during the negative interest rate period. Yet their profits remained stable up to the onset of the coronavirus pandemic, according to the results of a study published in the Bundesbank’s latest Monthly Report. Analysing developments in the German banking system between June 2014 and August 2020, the Bank’s economists note that the reluctance to pass through negative interest rates in deposit business with households, in particular, was squeezing banks’ interest margins. While lending rates declined in tandem with general interest rate movements, banks’ deposit rates hovered around the zero mark for the most part, they observe.

No impediment to lending

However, margin pressure has not been an impediment to lending so far, according to the Bundesbank’s experts. On the contrary: German banks saw this line of business grow in importance during the negative interest rate period on the back of brisk demand for credit and a strong willingness among banks to grant loans. The Bank’s economists write that this period saw banks that had previously attached relatively little importance to lending business also step up their operations in this area. Furthermore, the Eurosystem’s non-standard monetary policy measures, such as the asset purchase programme (APP), and the concomitant reduction of debt securities on banks’ balance sheets are also likely to have made banks more willing to grant loans.

Despite experiencing margin pressure, banks had even managed to improve their capital adequacy up to the onset of the coronavirus pandemic, the economists report, pointing to low credit loss rates and the resulting need for less loan-loss provisions as two major factors at play. This positive development can be put down to the favourable economic situation, which in turn was being bolstered by the accommodative monetary policy.

Implications of the pandemic still to come for banks

However, the economic downturn caused by the coronavirus crisis is now also likely to have implications for banks’ profits, the Bundesbank warns. If many borrowers run into payment difficulties, there is likely to be an uptick in defaults on loans. In addition, banks’ equity ratios could come under pressure if risk weights rise. The Monthly Report explains how the comprehensive package of fiscal support measures and the temporary suspension of the obligation to file for insolvency have prevented a steep increase in credit defaults for now. However, the negative repercussions are more likely to surface once the assistance programmes come to an end. In this setting, banks will also find it harder to compensate for margin pressure in lending and deposit business. This increases the likelihood that margin pressure could lead to a shortage of credit. The Bundesbank’s economists explain in the Monthly Report how the monetary policy, supervisory and fiscal policy measures taken in response to the coronavirus crisis are counteracting this risk.