Frankfurt New problems are coming to Germany’s banks. The Bundesbank is urging German financial institutions to exercise caution in view of the high inflation rates, the turnaround in interest rates and the growing fear of an economic crisis. “Some banks could underestimate the extent of the problems they are facing,” said Bundesbank board member Joachim Wuermeling in an interview with the Handelsblatt.
“The turnaround in interest rates is positive for the German banking industry in the medium term, but will initially lead to burdens for many banks,” explained Wuermeling, who is responsible for banking supervision on the Bundesbank board.
In addition, the forecasts for economic growth have clouded over significantly, and inflation is weighing on private households and companies. “This increases the risk of loan defaults. The banks have to be prepared for some headwinds.”
In the boardrooms of the financial institutions, the nervousness is currently correspondingly high. In the first two quarters, the business of most corporate customers was still going well. The board of directors of a large German institute warns that if the Russian gas supply were to be stopped, that could change abruptly and drive up loan defaults. “Then it will be as bad as in the first year of Corona.”
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Deutsche Bank boss Christian Sewing is also alarmed about the dangers of inflation, interest rate hikes, war in Ukraine, Corona and bottlenecks in the labor market. “In the more than 30 years that I’ve been in banking now, I’ve never seen a comparable accumulation of risks as I do now,” he said on Monday.
“The turnaround in interest rates is positive for the German banking industry in the medium term, but will initially lead to burdens for many banks,” says the Bundesbank board member.
(Photo: Deutsche Bundesbank)
Sentiment in the banking sector has deteriorated drastically within a few months. At the beginning of the year, many financial institutions were still euphoric about the interest rate turnaround in Europe. Since the start of the Russian attack on Ukraine at the end of February, however, there has been little sign of this.
The share prices of large financial institutions such as Deutsche Bank and Commerzbank have recently fallen significantly. “The big discussion among investors now is: Do the positive effects of interest rate hikes outweigh the negative effects of the potential increase in loan defaults?” says the renowned banking analyst Magdalena Stoklosa from Morgan Stanley.
She expects a recession in the fourth quarter of 2022 and the first quarter of 2023 – and then also an increase in loan defaults. According to financial circles, if Russia does not resume gas deliveries to Germany after the maintenance of the Nord Stream 1 Baltic Sea pipeline at the end of July, some banks are considering forming additional general loan loss provisions as part of the half-year financial statements.
Wuermeling: “Institutes must remain vigilant”
From the point of view of Bundesbank board member Wuermeling, the situation is critical regardless of an imminent gas supply stop. “Most banks have sufficiently large capital buffers and can absorb some strains,” he said. “But the institutes have to remain vigilant due to the tense framework conditions.”
In June, the Bundesbank lowered its forecast for economic growth in Germany in 2022 from 4.2 to 1.9 percent. “There is definitely a risk of recession worldwide,” says Wuermeling. “This will leave its mark on the real economy and ultimately on the banks as well.”
The chief bank supervisor at the Bundesbank is also concerned about the high prices, which in June in Germany were 7.6 percent higher than in the same month last year. “The increased inflation can mean that some households no longer have enough money at the end of the month,” emphasized Wuermeling. “Even highly indebted companies can run into problems when their funding costs rise.”
The turnaround in interest rates is basically positive for the banks, because the institutes would then no longer have to pay negative interest and could tend to expand their interest margins. “Due to the rise in market interest rates, however, refinancing by banks has already become more expensive, while low-interest loans continue to run for the time being,” said Wuermeling. “In addition, the value of many stocks and bonds on bank balance sheets has fallen.”
Enria also warned of the consequences of the recession
Andrea Enria, the European Central Bank’s (ECB) chief banking supervisor, also urged banks on Thursday to prepare for a recession – and to hold back on dividend payments accordingly. “We have asked banks to review their capital planning, considering appropriately conservative scenarios adjusted to the adverse macroeconomic environment,” Enria said. Banks should coordinate capital planning with their supervisory teams and take this into account in their distribution policy.
At the beginning of the corona crisis, the ECB completely prohibited banks from paying dividends. In this way, she wanted to ensure that the institutions have enough buffers to absorb losses and support companies with loans. The banks have sharply criticized this blanket ban – among other things because they believe it makes investments in bank stocks less attractive for investors.
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So far, many in the banking sector are hoping that there will not be a wave of loan defaults despite the expected economic downturn. So far, the figures for the companies are still good, said Lutz Diederichs, Germany head of the major French bank BNP, at a banking conference earlier in the week.
“We will have to adjust to the fact that profits will decrease.” The ratings of the companies could also deteriorate slightly – but that is not a big problem. “German companies come from a very high profit level. There’s a bit of buffer and breathing space before they talk about value adjustments.” Diederichs warned, however, that the situation would change fundamentally if there were an energy embargo. Then a recession is inevitable.
“And when we talk about a recession, we also talk about the fact that banks will see higher value adjustments.” Basically, many bankers assume that the German state – as in the corona crisis – will take aid measures to support companies that got into trouble because of gas shortages. The federal government is currently preparing a possible entry into the gas trader Uniper.
Feedback is often positive
In addition, banks are currently going through their large corporate customers and discussing with them what a gas supply stop would mean for them. The feedback is often more positive than expected. Many companies are internationally positioned and can ramp up production abroad if necessary, says a bank board member. “If there were a gas supply halt, it would be a bad day for many companies’ shareholders and employees, but not necessarily for their lenders.”
Morgan Stanley analyst Stoklosa is currently focusing primarily on consumers, small and medium-sized companies and highly indebted companies. The expert assumes that private customers will consume less, but that there will not necessarily be loan defaults because the labor market is quite robust.
From their point of view, medium-sized companies will suffer from the economic downturn. On the other hand, many companies are still sufficiently financed because they secured extensive loans after the outbreak of Corona. “The situation is more difficult for highly indebted companies because many of them simply can no longer finance themselves,” says the analyst. In the second quarter, issuing activity in the so-called “high-yield market” for riskier corporate bonds collapsed by around 80 percent compared to the previous year.
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