Bundesbank worried about rise in interest rates & recession

That has completely changed. The rapid rise in interest rates has already caused massive corrections on the markets – and losses at banks, insurers and investment funds. Other problems could arise. For example, higher bank defaults, an intensification of the energy crisis and a recession.

“Overall, the macroeconomic risks have increased and the financial system remains vulnerable to these risks,” said Bundesbank Vice President Claudia Buch at the presentation of this year’s Financial Stability Report of the central bank. The Bundesbank’s economists expect a slight recession for the coming year.

The financial situation of companies has deteriorated, insolvencies are likely to increase and private households have lost purchasing power. “These factors weigh on the financial system,” said Buch.

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A particular risk is that the energy crisis could possibly worsen. The sharp rise in prices for energy products on the stock exchange has already led to energy suppliers having to deposit additional securities when trading certain financial contracts on the Leipzig electricity exchange. In part, they were only able to provide this security with the help of the state-owned Reconstruction Loan Corporation.

Analysis: Is the energy crisis getting worse?

In its report, the Bundesbank analyzed a crisis scenario in which Russia completely halts its energy exports to the EU, energy prices remain high and real economic output shrinks. In this example, the losses of banks, insurers and funds would increase sharply.

Gas deliveries from the pipeline

In the crisis scenario, the Bundesbank assumes that Russia will completely stop energy exports to the EU.

(Photo: Reuters)

From the Bundesbank’s point of view, one danger would then be that the banks could also hold back on lending. That could start a downward spiral of higher loan defaults and weak growth.

According to Bundesbank Vice President Claudia Buch, what matters in this case is how the banks react. So whether they limit their lending or use their capital buffers in that case. “The better the capitalization of the banks, the less likely it is that negative developments in the real economy will intensify in the system,” argued Buch.

The Bundesbank sees a problem in the fact that the banks have recently sharply scaled back their provisions against loan defaults. This is due to the fact that the provisions are based on risk models that include the default rates in recent years. The ratios have been low for years due to low inflation, low interest rates and stable growth.

>> Read here: How much are real estate prices falling? That’s what experts say

Similar to the development of inflation, there could now also be a so-called structural break in the default rates, where the connection changes fundamentally. According to the Bundesbank, the banks have so far hardly reacted to this and have continued to keep their provisions low.

“Loan defaults will be a constant companion of 2023”

From the point of view of the central bank, the default risks have increased significantly. The higher energy and raw material prices, delivery bottlenecks and tighter financing conditions would put a significant strain on many companies. Therefore, an increasing number of bankruptcies is to be expected.

In addition, according to the Bundesbank, the institutes granted an above-average number of loans to companies with a comparatively high risk during the low-interest phase. This could result in these companies struggling more quickly when interest rates rise.

The skyline of the banking metropolis of Frankfurt

The Bundesbank criticizes the lack of risk provisioning in German banks.

(Photo: dpa)

The default rates for loans to private households could also increase due to high energy costs, developments on the real estate market and possibly rising unemployment. So far, however, the banks have hardly reacted to this development.

>> Read here: Rising interest rates, poor economic prospects – experts expect a wave of restructuring cases

“What surprises us is that so little additional risk provisioning is being made,” said Joachim Wuermeling, the Bundesbank board member responsible for banking supervision. From his point of view, the banks should use the scope for further precautions. “Credit risk and credit defaults will be constant companions of 2023. And that is why we are issuing appropriate warnings.”

Wuermeling warned the banks to be cautious about dividends in view of the risks. “In view of the high level of uncertainty, you should make prudent risk provisions and only carefully distribute profits.”

The ECB warns of risks to financial stability in the euro area

The recent sharp rise in interest rates tends to be positive for the financial sector. Overall, the interest spectrum has shifted into positive territory. This increases the banks’ margins in the lending business.

In the short term, however, risks also arise because higher interest rates place an additional burden on borrowers. In addition, rising interest rates lead to falling prices for securities such as bonds.

The European Central Bank (ECB) recently warned of increased risks to financial stability in the euro area. ECB Vice President Luis des Guindos referred to the rise in energy prices and inflation rates and the slowdown in the economy.

The vulnerabilities of households, companies and states that have more debt have increased. The ECB also included tensions in the financial markets among the dangers.

More: ECB chief economist Lane sees fewer reasons for another mammoth rate hike.

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