Bundesbank warns of increasing risks on the real estate market

Rising house prices can jeopardize financial stability if loans are granted too loosely. Around half of the bank loans for residential property have an interest rate fixation period of more than ten years. If interest rates rise or real estate prices fall, many home builders would no longer be able to service their loans.

Traditionally, home loans in Germany had a relatively high equity contribution. If there were price corrections or interest rate changes, it could be painful for those affected, but the consequences for the financial system were limited. Today, however, a new situation threatens, according to the Bundesbank: If banks grant loans too freely and the own contribution falls, in the worst case there is a risk of large-scale failures and imbalances of institutions.

Discussed upper limits

“The banks must adhere to high lending standards,” warned Bundesbank board member Joachim Würmeling. “This enables banks to reduce real estate risk.”

Should such appeals not help, further instruments would be available. “There are two measures to avoid exaggerations in real estate loans,” said Würmeling. For example, upper limits could be set – on the one hand for the relationship between loan amount and property value (“loan to value”), on the other hand between income and debt servicing level of borrowers.

Measure one has not yet been introduced in Germany, but is already being used in other European countries. For measure two there is “interestingly, a declaration of intent in the coalition agreement” of the traffic light parties.

“We have always advocated such instruments, but we know that they represent a significant encroachment on the freedom of contract,” explained the board of directors. The Bundesbank would only recommend introducing them if the situation on the real estate market deteriorates further. At the present time, one is not relying on individual measures, but on stronger countercyclical capital buffers at all banks.

Criticism comes from the Association of German Banks. “We banks have done a lot in recent years to strengthen our capital buffers. Restricting the lending options would be the wrong step, ”explained Managing Director Christian Ossig. Banks need “planning security”: “That is why it would be the wrong signal right now to hold out the prospect of increasing the capital buffer.”

No “zombification”

The Bundesbank sees another danger for the financial system in the fact that banks underestimate the credit risks. Last year, the central bank had feared a significant increase in insolvencies due to the corona pandemic. However, these forecasts have proven to be too pessimistic.

In fact, there has been no dramatic increase in bankruptcies, on the contrary: the rates are historically low. The Bundesbank expects the number of bankruptcies to rise in the coming years, but does not see this as a threat to stability.

“We don’t see any evidence at the moment that we are getting a ‘zombification’, that is, that companies are being kept alive that are not viable,” said Buch. The very skeptical prognosis from 2020 shows the limits of the approach of “extrapolating past experiences into the future”. Last year, the Bundesbank was unable to foresee the extent of the state support measures in the pandemic.

But what is positive also applies to negative: Just because the insolvency figures have been low so far doesn’t have to stay that way, warns the Bundesbank. The situation could change in the event of a major recession. This becomes more likely the further the business cycle has advanced. “The normal pattern would be for bankruptcies to rise again,” said Buch.

Are the banks prepared for such a case? Not enough, warns the Bundesbank. The financial institutions’ risk models were based on data from the past. The banks could be blinded by this and set up insufficient provisions for loan losses. Andrea Enria, the supreme banking supervisor of the European Central Bank (ECB), had repeatedly warned against this.

“During the pandemic, the connection between the macroeconomic situation and credit risks has become looser,” says the Bundesbank report. “In future recessions, however, credit risks could increase more sharply.”

The all-clear for Evergrande

The central bank gave the all-clear in the Evergrande case: The direct claims of German banks, insurers and funds against the ailing Chinese real estate developer are comparatively low. Evergrande had become the focus of global financial markets in September. The company is heavily indebted and struggling to service claims from banks, suppliers and bondholders on time.

According to the Bundesbank, the financial ties between other European banks and Evergrande seem to be manageable – with the exception of British and Swiss banks. However, indirect effects could result from the networking of German financial intermediaries with the banks of both countries, the Bundesbank report said.

In its recent financial stability report, the ECB had also pointed out increasing risks on the real estate market: The risk of price corrections had increased especially in those countries in which valuations had already increased before the crisis.

As the Bloomberg agency reported on Thursday, citing financial circles, the ECB is now also considering restrictions on the riskiest leveraged loans in the banks’ loan books. The background is the fear that there could be distortions on the credit market for highly indebted companies.

With agency material.

More: Austria’s central bank: Risks from residential property loans are increasing