The low interest rates continue to cause problems for banks and savings banks in Germany. "The phase of stagnation caused by low interest rates is far from over," said Andreas Dombret, the Bundesbank Executive Board member in charge of banking supervision, upon presenting the latest survey on the profitability and resilience of German credit institutions in Frankfurt am Main. According to the survey, the 1,555 surveyed small and medium-sized institutions expect to see a pre-tax decline in profits of 16% over the next five years, relative to their total assets. In the previous survey held in 2015, banks and savings banks had anticipated a 25% decrease.

Commenting on this result, Mr Dombret added: "The downturn has persisted, but at a somewhat slower pace than before." Banks suffer under low interest rates because they narrow their margins in interest business. If high-interest investments mature, for example, banks and savings banks can only reinvest these at considerably lower interest rates, squeezing their earnings. As Raimund Röseler, Executive Director for Banking Supervision at BaFin, who presented the survey results jointly with the Executive Board member of the Bundesbank, pointed out: "This year's survey revealed that Germany's banks and savings banks are nonetheless well capitalised, thus helping most institutions to cushion the impact of losses arising from the low-interest-rate environment." Measured in terms of their total assets, the participating banks and savings banks account for around 41% of the German banking market, constituting 88% of all German institutions. They are all subject to direct oversight by BaFin and the Bundesbank. The survey did not approach any of Germany's large banks, which are directly supervised by the European Central Bank.

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Credit institutions simulate multiple scenarios

Aside from having been asked to disclose their internal planning scenarios, the participating banks were asked to simulate five hypothetical interest rate scenarios covering the period 2017 to 2021. Looking at the findings, Mr Dombret explained that if the interest rate level stayed low or even shrank further, their results would slump. If interest rates remained low until 2021, net earnings would shrink by 41% under the scenario's assumption of constant total assets. In scenarios entailing further interest rate decreases, the institutions anticipated losses as high as 60%. If the banks were to adjust their portfolios under this scenario on the basis of a dynamic balance sheet assumption, then the losses incurred would be somewhat less (ie 41%). "A rise in interest rates would be a different story," Mr Dombret opined. In this instance, the model calculations indicate that while institutions would initially continue to post losses, they would see an upturn in profits in the medium to long term by as much as 7% above their level in 2016. "That said, neither the banks nor the savings banks anticipate such an improvement, as they regard this interest rate scenario as unrealistic," he added.

The survey also included a stress test, used to measure the resilience of the institutions in a variety of stress scenarios covering interest rate risk, credit risk and market risk. According to the supervisors, the majority of the surveyed institutions are sufficiently resilient, boasting capital buffers that are large enough to absorb possible shocks of this kind. "Even after being subjected to stress, most of the institutions are well capitalised and more than satisfy the prudential capital requirements," said Mr Röseler. "In each of the scenarios we see an erosion of the traditional earnings base but there is no evidence of a blanket problem afflicting the German banking sector." Even so, 68 of the institutions would be unable to meet the requirements in a stress event despite the inclusion of silent reserves.

Institutions under pressure

Given the latest developments, Mr Dombret believes that institutions' earnings are coming under pressure. While noting that there has not been any far-reaching loosening of credit standards, he pointed out that low interest rates mean there is a tendency among institutions to incur greater risks in light of the large demand for finance, as well as an observable trend of greater risk-taking in mortgage lending. "In the current low-interest-rate environment, there is an increase in mortgage loans in banks' balance sheets – both the overall volume and the average loan size have risen distinctly," said Mr Dombret. "On top of that, institutions also seem to be willing to grant loans against less collateral." Even so, the Bundesbank does not see any signs of a housing bubble forming.

Mr Dombret also remarked that banks and savings banks are also increasingly turning to alternative sources of earnings on the back of shrinking margins in interest business, adding that commission business in particular will play a more important role in stabilising their future earnings. He does not believe these countermeasures go far enough, however, commenting: "Further, more decisive action will be needed to turn things around." To this, Mr Röseler added: "Basically, we advise banks to charge prices that line up with the costs and the risks." BaFin's Executive Director also pointed out that the trend towards mergers is also growing.