Buch sees a growing threat to financial stability

At the same time, the top central banker warns the banks to be careful. The institutes must ask themselves whether their risk models, which are based on historical data, are representative for future crises. “Each bank should consider in its own interest which scenarios it is assuming and whether it shouldn’t be a little more cautious when it comes to the economic environment.”

Read the full interview here:

Ms. Buch, Europe is struggling with high inflation and an energy crisis. In Great Britain, a government has just fallen over the financial markets. How unstable is the financial system at the moment?

There are a lot of risks at the moment. These include, above all, Russia’s war against Ukraine, geopolitical risks for existing supply chains and the consequences of climate change. The danger of a recession or an abrupt rise in interest rates on the markets is therefore increased. Each individual risk may seem manageable, but it can become dangerous when several occur at the same time.

The reaction of the financial markets has forced the British government to make a 180 degree turnaround in its tax policy. Is such a scenario also conceivable in the European Union?

It is not my place to judge British tax policy. The institutional framework in the EU looks completely different. There are clear rules and control mechanisms in European fiscal policy. National and European institutions are responsible for financial stability, which cooperate closely and have effective instruments.

Nervous financial markets could see things differently and still react in panic …

I don’t see it that way at the moment. Nevertheless, the volatility on the markets is high. We must therefore continue to monitor the situation and all risk factors very systematically. Accordingly, the European Systemic Risk Board (ESRB) has just warned of risks and called for ensuring sufficient resilience in the financial system.

The financial system has coped with the corona pandemic quite well. Does that make you optimistic about the upheavals triggered by the Ukraine war?

The situation today is hardly comparable to two years ago. The corona pandemic was a shock to the real economy. It did not necessarily have longer-term structural effects, especially since vaccines have now been developed against Corona. Now the situation is completely different. Russia’s war is a fundamental threat to our peaceful order, with significant implications for the global economy. Both the energy price shock and the negative globalization shock have the potential to have lasting effects.

Should the state do more to cushion these shocks?

Many industries are currently calling for government help. However, governments’ ability to compensate for all higher costs is limited as the rise in energy prices weighs on the economy as a whole. We will probably therefore not see that the state can cushion the consequences of the crisis to the same extent as during the pandemic. Conversely, this means that we need more resilience in the private sector.

In the energy sector, the state stepped in because suppliers suddenly had to deposit more collateral when buying gas and electricity on the stock exchanges. Should we learn from this that even more safety buffers should be used in such corners of the financial system, or will the whole system eventually become too sluggish out of sheer security?

Given the multiplication of prices and the simultaneous uncertainty about the supply of Russian gas, the financial situation of some suppliers and importers was very tight. Politicians have reacted to this with an aid program. The crisis certainly shows the value of resilience. As a society, we will therefore have to reconsider how resilience and efficiency should be weighted.

At the beginning of the year, the financial supervisory authority Bafin decided that banks should accumulate an extra buffer of equity capital for bad times for normal loans and in particular private construction financing. Shouldn’t this buffer be abolished again in view of the recession?

The capital buffers increase the resilience of the financial system. The Financial Stability Committee (AFS), which includes the Bundesbank, the Federal Ministry of Finance and BaFin, therefore welcomed the decision. The countercyclical capital buffer is not based on the business cycle, i.e. the question of whether the economy is currently weakening. It is based on the financial cycle, i.e. essentially on the development of credit relative to GDP. And lending has developed dynamically until recently. There is no sign of a credit crunch.

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However, there are early indicators showing that banks are becoming noticeably more restrictive when it comes to lending.

But that’s not because banks can no longer grant loans due to a shortage of capital. Since their risk assessment has changed, they no longer want to extend some loans. In the German banking system, we still have free equity of EUR 130 billion, which is a good cushion.

Don’t you see any signs of tension in the financial system yet?

The financial system has been working quite well so far. But of course some companies, especially energy-intensive ones, have increased their credit lines as a precaution.

When would a point be reached where you would do without these buffers?

What is important here is how the entire financial system develops – whether risks materialize, losses occur and balance sheet restrictions become binding. There would then be a risk that the banks would have to restrict their lending overall. In such a crisis situation, the buffer could be lowered, giving the banks leeway to continue lending. This is checked very regularly in the AFS and decided together. The committee is unanimous: that point in time has not yet been reached.

Is the situation still that dangerous? The committee was very concerned, especially with regard to private construction financing.

The price level for real estate is still very high, even if the price increase has flattened out. The overvaluations are still there. And lending in this area is still growing, only the growth rate is slowing down. It is currently around 6.4 percent for the year. New lending has recently declined because demand for credit has fallen due to higher interest rates.

Do you think that the demand for real estate financing will weaken significantly?

We see in surveys that private households have become very cautious about buying a property or making major purchases. And with prices that are currently still quite high and interest rates rising, affordability is suffering. A decline in demand for real estate is not surprising in this environment.

Are there still customers who finance the full purchase price of a property with a loan?

The ratio of equity invested to the purchase price has risen slightly, and the proportion of 100 percent financing is declining. But the debt service burden on households is increasing, also because of higher interest rates.

And what does it mean for the real estate market if the labor market weakens?

Should there be a stronger increase in unemployment, then this would certainly have consequences for the housing market. However, we currently have a completely different situation on the labor market in view of demographic change, a structural shortage of skilled workers and the many vacancies in the German economy.

They describe a relatively unstable situation in the economy and on the financial markets. Are the banks taking the dangers seriously enough? The institutions’ loan loss provisions for defaulting loans have not risen excessively.

The individual banks certainly take the risks seriously and take credit risks into account. But the problem is that the individual bank does not see the entire system and cannot know whether similar risks are building up in many places. Nor can she simply respond to suspicion. Our task is to act preventively for the entire system. But what I would like is for banks to take a close look at their risk models and apply conservative lending standards.

What do you mean?

When assessing risks, banks use models based on historical experience. However, in recent years we have had a very unusual macroeconomic environment…

… for example, because we had a very loose monetary policy for many years and unusually few insolvencies.

Right. This also applies in particular to the corona pandemic, when the state prevented a wave of insolvencies with its help during the recession. The banks must therefore ask themselves whether their current models are really representative of future crises. And they should examine what happens if they calculate not with long-term averages but with very adverse scenarios, such as the highest default rates in the past.

So the banks are too careless after all?

I don’t want to judge that, but every bank should consider in its own interest which scenarios it is assuming and whether it shouldn’t be a little more cautious when it comes to the economic environment.

The consequences of the energy crisis play an important role. We have a difficult winter ahead of us. In your opinion, what would be the most dangerous scenario?

A real shortage of gas. That would have a serious impact on the economy. The state can financially compensate for price increases, but if a raw material is simply missing, it cannot replace it.

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