Bundesbank Vice President Claudia Buch warns banks

Buch sees an abrupt rise in market interest rates as the greatest risk to the financial system. “A sudden rise in interest rates would be difficult for everyone: banks, insurers, but also funds are vulnerable.” This could be triggered by higher risk premiums, which are currently very low, not necessarily the monetary policy of the central banks. Buch is also critical of the price development on the real estate market. “There are some ingredients that are worrying us.”

Read the full interview here:

Ms. Buch, the corona crisis is just coming to a head with Omikron. However, the banks in Germany declared very early on that they had virtually ticked off the pandemic. Are you just as relaxed?
No. The banks have come through the pandemic very well so far. But ultimately, the fiscal measures indirectly shielded the banks from the consequences of the pandemic. The banking sector is stable and there are sufficient capital buffers. Although the GDP fell sharply last year, the banks hardly had to make any losses. If the forecasts are correct, the economic recovery will come next year – and banks could handle even a delayed recovery.

How stable would you rate the banks at the moment – on a scale from one (very weak) to ten (very strong)?
About eight. But of course that’s always just a snapshot.

In your opinion, where are the remaining risks?
It is about the indirect consequences of the pandemic and the question of whether the financial system as a whole will come under stress again. This could happen, for example, if market interest rates rise abruptly. The trigger could be higher risk premiums, which are currently very low, not necessarily the monetary policy of the central banks. A sudden rise in interest rates would be difficult for everyone: banks, insurers, but also funds are vulnerable.

But it is now taken for granted that at least the US Federal Reserve will raise interest rates in the coming year, simply because inflationary pressures are much greater than originally expected.
However, a scenario in which interest rates are slowly rising is not that problematic. Some financial institutions are even relieved by this, namely when they have nominal interest promises to customers, keyword life insurance. Everyone can expect a slow rise in interest rates.

What would you recommend to the European Central Bank, which is rather slowly changing course when it comes to tightening?
We are not only spatially separated – the ECB is located here in Frankfurt at the other end of the city. The monetary policy of the euro system is decided independently in the Governing Council, so I don’t want to get involved. But in any case, a resilient financial system supports the ECB in its tasks. Financial stability is a prerequisite for ensuring price stability.

In the worst case, would the banks have enough buffer to cope with corona-related loan defaults and turbulence in the markets at the same time?
In such a more extreme scenario, it will be crucial that the banking sector use the existing capital buffers to stabilize lending. The countercyclical capital buffer should therefore be rebuilt. This conserves existing capital so that it can be used in the event of a crisis. Because at the moment we are seeing increasing vulnerabilities and a declining risk awareness in the financial system – everywhere the search for returns is in the foreground. That worries me.

Why? Yield is desirable …
Of course, the banks have to see that they are generating good returns. But in relative terms, more loans have been given to weaker companies for some time. The good companies can finance themselves with their own funds or on the capital market. The weaker companies are much more reliant on bank credit. Unfortunately, the banks’ internal models do not show the effects of macroeconomic risks very well. Banks could underestimate such future risks.

But it’s hard to tell the banks who to give credit to?
That’s not what I was talking about. The supervisor takes care of whether the banks’ risk models are working. Unfortunately, models usually look in the rearview mirror. But this look can be deceptive. In the pandemic, for example, banks hardly experienced any higher loan defaults. But that does not mean that they will be spared in future recessions. We look at the entire financial system to see if bigger risks are brewing anywhere. We also need a reliable regime for winding up and restructuring banks.

Do we already have that? The ultimate test is still pending.
Right, the test is still pending. But a lot has happened already. We have new laws and new institutions, we have the Single Resolution Board (SRB). I am very optimistic. We have made a big step forward and now we also know how we can improve the system further.

Let’s talk about the booming real estate market, prices are rising and rising. Is this creating a bubble?
There are some ingredients that cause us concern. These are the prices that have recently risen by around seven percent. Lending for real estate has also risen sharply. In addition, according to our surveys, around 90 percent of private households expect prices to continue to rise.

Why haven’t you already reacted more strongly to the regulatory regime?
Because lending standards have remained relatively stable so far. Indicators such as mortgage lending values, i.e. the ratio of the market value of a property to the loan amount, the debt of private households or the debt servicing in relation to income are not so noticeable. However, this is also due to the current low interest rates.

What if interest rates suddenly rise more sharply, as discussed earlier?
We have been warning about this problem for years. That would of course affect the debtors. However, one must also take into account that around half of real estate loans now have a term of more than ten years. A rise in interest rates does not come through all of a sudden, but of course it does.

But it then has an impact on the banks that have fixed interest rates for so long. Even if risks are passed on, they ultimately stay in the financial system.
Yes, an interest rate fixation of ten years is good for households that have secured the low interest rates for a long time when interest rates rise. The interest rate risk then lies with the banks.

Which banks are particularly affected?
Especially savings and cooperative banks, which traditionally play a particularly strong role in private real estate financing. The supervisory authority has a very close eye on this. But there are also other banks that are heavily involved there. We are also seeing insurers expand into this area. We pay attention to that.

Is the sharp rise in property prices in recent years primarily a German phenomenon, or is it similar in the euro area?
There is one common factor that drives prices – low interest rates. We see everywhere that investors are looking for investment properties that still yield returns, and that there is a flight into real assets.

What can the government do about it?
Risks in the real estate market cannot be counteracted precisely with a broad instrument alone, such as the countercyclical capital buffer. There is one approach in the new Ampel coalition agreement. It is intended to create the legal basis for further regulatory instruments. It is about the possibility of being able to determine two indicators: the total debt of private households in relation to income and debt servicing in relation to income.

Why is this important from your point of view?
So far, the Bafin can define two minimum standards as a supervisory authority, if this becomes necessary. It can set a minimum share of equity and a minimum repayment per year. Now it’s a matter of expanding the instrument box. Not necessarily to use the new instruments immediately, but to be prepared for increased risks.

When it comes to risks in the financial system, in addition to classic fields such as the real estate sector, the analysis of climate risks is becoming increasingly important. How can these be measured?
We highlighted one possibility in our financial stability report. There we looked at what CO2 prices would be necessary to achieve the Paris climate targets and what changes in valuation this could result in.

Is it that easy to do?
If you want to break that down to individual companies, you need disclosure and taxonomy obligations, i.e. rules that define whether a company is climate-friendly. We tried to estimate how individual sectors in the real economy would be affected by changes in CO2 prices. We focus on the loan portfolios of banks and the securities portfolios of insurers and funds.

With what result?
The changes in value would be relatively small, probably less than ten percent of the portfolios. These are losses that banks and insurers could deal with. The losses also come relatively promptly, because the markets anticipate this, and then slowly decrease.

But are there other approaches?
Another option is to consider physical damage from a rise in temperature, such as heat waves, droughts, or floods. But this is more about long-term damage. Most bank assets do not last longer than ten years, on average even significantly shorter.

So are the climate risks for the financial system being overestimated?
Our analysis rather shows how important it is to deal with the transition to a climate-neutral economy at an early stage. If this is done well now, the risks of transition can be dealt with. Good climate policy protects the financial sector.

Jens Weidmann’s successor at the head of the Bundesbank is now to be Joachim Nagel. What do you wish for him?
Good luck and success of course! Joachim Nagel is a very valued colleague with a wide range of experiences. I’m really looking forward to working with him.

Ms. Buch, thank you for talking to us.

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