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Interview 14.03.2018

"We mustn't roll back reforms"

Interview published in "Handelsblatt"

Interview with Claudia Buch conducted by Frank Wiebe.

Ms Buch, cynics would say that after the financial crisis is before the financial crisis, to misquote German football coach Sepp Herberger. Where do we stand now? How secure is the financial system?

Since the crisis, many reforms have been introduced that have made the financial system more stable. For instance, banks are being asked to meet tougher capital requirements in terms of both quantity and quality. As a result, there are now larger buffers in the system to absorb future shocks. However, we shouldn’t allow ourselves to be lulled into a false sense of security and take it for granted that the economy will continue to perform as well as it is doing today. Above all, we mustn’t roll back the reforms adopted in the wake of the financial crisis.

Is it even possible to avert crises?

That’s not our goal at all. Make an economy completely static and you’ll end up snuffing out growth. We do, however, need to protect the financial system from any grave harm that could then bleed through to the real economy and amplify cyclical volatility. If recessions are accompanied by debt crises, this often has very long-lasting negative repercussions –both for economic growth and in the form of higher unemployment. 

What areas do you see as particularly susceptible to risk at present?

Banks, especially, are exposed to interest rate risk – they issue long-term loans and are funded by short-term deposits. Rising interest rates cause banks’ interest expenditure to outpace their interest income. This risk has become a more pressing issue: for instance, the share of building loans with long interest rate lock-in periods of ten years or more has climbed from 32% to 44% over the past ten years.

Which banks are particularly affected?

From a financial stability perspective, the all-important question is whether many institutions are affected concurrently. And it is precisely the smaller banks that are of particular importance to the German market – the savings banks, people’s banks and Raiffeisen banks – that are vulnerable here on account of their business model. 

Do you think that this could potentially spark the next financial crisis?

In and of itself, no, as the institutions have good capital buffers. What’s more, they ought to benefit from the most likely scenario of good growth and slowly rising interest rates. In this scenario, there would also be less pressure to take on risk in the search for yield. However, far less likely scenarios are also conceivable in which the problems would become more acute.


One possible scenario is that interest rates rise far more rapidly than expected. Interest rate risk would materialise, there would be losses, and the institutions’ resilience would take a hit. Another scenario is that interest rates remain low for much longer than currently foreseen. The search for yield would then continue unabated.

That second scenario sounds particularly unsettling –it conjures up images of asset price bubbles bursting and dragging down the financial system. 

At the moment, the low interest rates have indeed sent many valuations to very high levels. Consequently, we are seeing the danger of risks intensifying in the financial system. With that in mind, it would be wrong for market participants to simply extrapolate the positive figures we are seeing right now into the future; instead, they should also plan for unexpected events. Insolvencies and loss provisions, for instance, are at very low levels at present, meaning that banks’risk models could underestimate risks. Valuations on the real estate market are also high. That said, there has thus far been little to suggest that loans are the driving force behind these developments. The same is true, by the way, of Bitcoin, which would appear to be attracting relatively little credit-fuelled speculation in Germany.

Is the European Central Bank (ECB) amplifying these risks with its low interest rates?

Generally speaking, an accommodative monetary policy is appropriate, even if opinions differ on how to implement it. Furthermore, interest rates aren’t set by the central bank alone – long-term trends such as population and productivity developments also play a role.

But shouldn’t central banks be given a mandate to maintain the stability of the entire financial system rather than just price stability? 

As a policy objective, financial stability is very important. But I think it would be difficult to confer this mandate on central banks alone. The set-up in most countries is that a number of institutions share the financial stability mandate.

Which institutions have this mandate in Germany?

It’s the Financial Stability Committee chaired by the Federal Ministry of Finance. The Bundesbank has a statutory mandate to identify risks to financial stability and provides analyses. BaFin, the Federal Financial Supervisory Authority, is the competent authority.

Let’s come back to savings banks, people’s banks and Raiffeisen banks. One hallmark of Germany’s banking landscape is that it has many small credit institutions, while large banks account for a relatively small market share. Is that an advantage or a drawback in terms of risk?

Let me begin by saying that it’s an advantage if a financial system is diverse and made up of institutions with vastly varying structures and business models. This is good for the real economy, and risks are ultimately better distributed. However, there may come a time when many institutions are exposed to macroeconomic risk in a similar way. If this risk materialises, they will therefore all be in the same boat.

Can this be compared with the major US savings and loan crisis of the 1980s?

The structures in Germany and the United States are not directly comparable. But the risk that many smaller institutions will ultimately respond in a similar fashion and therefore leave themselves exposed has pretty much the same implications in both countries.

Let’s turn our attention from small banks to the big ones. On the one hand, there's the "too-big-to-fail"problem, of course –the fear that banks are still too large and would therefore be too weighty in the event of a crisis. But on the other, we are often hearing calls for cross-border mergers in Europe, which would increase concentration still further. How do you see this situation in Germany and other European countries?

International comparisons of banking sectors point to overcapacities in some countries. This situation is going hand in hand with low profits. Just like in any other sector, mergers and market exits can help reduce overcapacities. But they are certainly not a cure-all solution. And banks don’t necessarily have to be particularly large or risky to become a systemic risk –their interconnectedness within the financial system is also a major factor.

Has enough been done in the wake of the crisis to contain the risks presented by large banks?

A whole raft of new rules have been brought in since the crisis. Large banks now need to hold more capital. A resolution regime has been established for systemically important banks in distress. In future, these banks will have to issue more bonds that are automatically bailed in to help absorb losses. And then there is the risk-based European bank levy, which finances the resolution fund.

How are we even supposed to know for sure which measures will mitigate risk?

That’s a very important point. As part of the G20, we launched a programme to evaluate whether the reforms agreed and implemented since the financial crisis have achieved their intended outcomes. It also examines any interactions and unintended side-effects that the reforms may have. Both are important in case we need to fine-tune the reforms later on.

Are the results available yet?

Not in any great detail. That said, initial analyses do not indicate that the supply of credit to the real economy has suffered. That was a widespread concern.

But evaluation programmes often end up delivering a very precise tally of the costs but barely any insights into the benefits, and at the end of the day, there's an overwhelming case for rolling back regulation.

That’s exactly what a structured evaluation is supposed to prevent from happening. Its aim is to focus on the costs and benefits of regulation for society as a whole. Think of the costs of financial crises, for instance, much of which were shouldered by the taxpayer during the last crisis. In future, the perpetrators of the crisis – the shareholders and creditors of an ailing bank, for example – will be expected to foot this bill. That is likely to drive up the funding costs for banks because the onus will now be on them to cover systemic risk. And it's only natural for this redistribution of costs to be highlighted in the public debate. But there is also the matter of the lower costs for the taxpayer and the advantages of a more stable financial system. 

How do you view the role of the capital markets in this context? 

They play an essential role. The period prior to the financial crisis saw a huge build-up of leverage –not just within individual countries but also across borders. Unlike creditors, shareholders are directly exposed to loss. A higher proportion of equity capital therefore creates buffers in the system. Ultimately, this also takes the pressure off governments to absorb losses using public funds. In a financial system with a higher share of equity capital, shocks would therefore be cushioned via the markets instead of intensifying and spreading. 

We’ve heard a great deal about the concept of a capital markets union. But wouldn't you agree that we already have a single currency in Europe and no constraints whatsoever on capital movements?

You’re right, there are no direct restrictions. But in practice, differences in many areas such as tax and insolvency law can really hamper cross-border investment.

Would you say that regulation is driving business away from banks and into the realm of shadow banking, as it is doing in the United States?

A certain shift is evident –in Germany, it is mainly into investment funds. But the term "shadow banks" is slightly misleading here, because the funds themselves are also subject to supervision. And the shift is due in part to price gains, which have a greater impact on funds than on bank balance sheets.

Do you see any problem in Germany investing relatively large sums of money abroad, as reflected by its high current account surplus? This is also associated with risk, after all.

Much of Germany’s current account surplus is due to the country’s demographic developments. It certainly makes sense to invest abroad, where growth rates are higher. But of course, we do keep a close eye on the risks, too. This analysis is based on gross investment figures rather than the net figures displayed by the current account.

Let’s talk about specific risks again. What can we expect from Brexit, the UK's withdrawal from the European Union?

In terms of activity, it’s barely an issue – and that goes for the UK itself, too. And at the moment, markets have time to prepare. But nobody can say for certain what the impact of Brexit will be. We must therefore continue to ensure that financial transactions are backed by sufficient collateral – and that also applies to platforms used to settle securities and derivatives transactions.

So far we have mainly discussed classic financial risks of the kind that have been around for centuries. But what about cyber risks –are we prepared for these? 

Cyber risks are the subject of intense dialogue and initiatives within the G7 and G20, but also at the national level. In Germany, for instance, all firms have been required to report cyber attacks to the Federal Office for Information Security since the beginning of January. Thought is also being given to the idea of forcing firms to document their strategies and contingency plans in this area. 

It’s no secret that IT structures at many banks are outdated, making them more vulnerable to attacks. Is this something you can influence?

Of course, the onus is primarily on the banks to ensure that their IT systems are fit for purpose. But there are also areas, especially in the fields of statistics and reporting, where there are major interfaces with the Bundesbank. We are therefore engaged in a very fruitful dialogue with the banks as to how we can make the systems simpler and more efficient. And naturally, IT security is an important supervisory topic.

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Additional information

In conversation

Prof. Dr. Claudia M. Buch

Interview with Claudia M. Buch,
Vizepräsidentin der Deutschen Bundesbank

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