“The financial system is becoming more vulnerable” Interview published in “Handelsblatt”

03.02.2020 | Claudia Buch DE

Interview conducted by Jan Mallien and Frank Wiebe.

Ms Buch, these days it almost seems as if interest rates will be low forever. How dangerous is that for the financial system?

I don’t believe interest rates will stay low forever. Speaking very generally, interest rates reflect many factors, including demographic trends and productivity. But right now, vulnerabilities are still building up in the German financial system.

Where exactly are the hot spots?

We’ve enjoyed ten years of very good economic conditions – thanks, in part, to favourable financial conditions. Cyclical risks have built up: it’s possible that credit risks are being underestimated while assets, such as those on the real estate market, are being overvalued.

Just where are these risks having an impact?

Overall, the creditworthiness of firms has improved. However, there is a certain tendency for healthy firms to rely less on bank funding. This means that it tends to be the weaker firms – relatively speaking – that are obtaining bank financing.

What could trigger a crisis?

A sharp, unexpected slump in the economy or an abrupt interest rate rise if, for example, risk premia in the markets were to increase.

How can we make the system more secure?

The German Financial Stability Committee, on which the Federal Ministry of Finance, the Bundesbank and the Federal Financial Supervisory Authority (Bafin) are represented, last year recommended increasing the countercyclical buffer from zero to 25 basis points. This capital buffer is a preventive tool: it can be lowered in periods of stress so as to mitigate a decrease in lending.

And this came just when the economy in Germany has slowed …

… but now looks to be in slightly better shape again. Of course we also consider the economic environment we find ourselves in. But this particular capital buffer hinges on the financial cycle, not the short-term business cycle. And there we’ve been seeing a dynamic increase in the volume of credit relative to gross domestic product for some time now.

How well prepared are banks for a crisis?

Better than they were prior to the last financial crisis. They have significantly strengthened their capital. At the same time, the German banking sector is highly competitive, which is good for customers, but narrows margins. When cyclical risk is added to the equation, this can speed up structural change.

What exactly do you mean?

Structural change means that new providers enter the market and others exit – just as in other sectors. Banks can respond to this by reorganising or merging.

Savings banks and cooperative banks are undergoing mergers, but not much is happening with the big banks. Does the government need to step in and help?

Structural change can have many facets. Mergers, including across national borders, are one such facet. There also has to be the option for banks that run into difficulties to be restructured or to exit the market. That’s a task for supervisory authorities, and political will has a role to play.

Does that will exist?

We now have the necessary frameworks for dealing with the recovery and resolution of banks. Those mechanisms are designed to facilitate the orderly resolution of ailing banks.

But that only takes effect when a bank is already in bad shape. Isn’t it too late by then?

The mechanisms already take effect before that point is reached. Prior to the financial crisis, investors often assumed that big banks couldn’t exit the market because they would be bailed out by the government.

You’re referring to the “too big to fail” problem, where, because of their importance to the financial system, major financial institutions have to be bailed out by the government to err on the side of caution.

This implicit government subsidy enabled big banks to obtain relatively cheap funding. These indirect subsidies ultimately benefited shareholders and, to an extent, managers as well. The “too big to fail” reforms of the past decade aim to significantly reduce this effect – big banks also have to hold more bail-in capital, for example. Lower indirect subsidies mean that the banks affected have to adapt their ongoing operations.

The financial crisis saw a large number of financial corporations simultaneously running into problems. Will a resolution mechanism for banks come up against its limits in a major crisis?

In the event of a systemic crisis, not all decisions can be planned out in advance. But today we have a clear framework for dealing with crises, which shields taxpayers from the costs of such crises.

We're hearing lots of warnings about “situations like Japan” at the moment. What’s your take on that?

First and foremost, Japan has shown how dangerous it is to allow a crisis to linger in the financial sector rather than making a concerted effort to root it out.

One very frequent concern is that cheap money is artificially sustaining weak enterprises that should actually have been restructured or resolved a long time ago.

It’s not just about low interest rates, but also about structural problems in the banking sector. Studies show that problems that persist in the banking sector can spill over to the corporate sector. However, it’s hard to gauge how strong the impact of this is in macroeconomic terms.

So how can climate risk be taken into account when analysing financial stability?

Climate change is ultimately reflected in asset prices. Credit and market risks are emerging that may have an impact on financial stability. We therefore need to analyse whether the financial industry is sufficiently resilient to such risks. We’re just beginning this process. Together with other central banks and supervisory authorities, we are developing ways to investigate the impact of climate change on the financial industry in greater detail.

How much of that can already be implemented?

We’re often lacking key information – say, about climate risk in corporate balance sheets – for this task. At the international level, the Financial Stability Board has taken important steps towards improving disclosure of these risks.

But how should climate risk actually be evaluated?

Ultimately, through clear price signals. Prices give market participants a clear idea of where the greatest action is needed to avoid CO2 emissions. This requires policy decisions – and that’s a task for politicians, not central banks.

Generally speaking, does the Bundesbank have enough data to evaluate the risks?

We have a great deal of aggregate data. But there is often a lack of detailed information, such as conditions for real estate lending. That said, we are making progress. A regulation recently proposed by the Federal Ministry of Finance will improve the pool of information about residential real estate loans. At the end of the day, information like this benefits everyone.

Is the Bundesbank becoming a data provider?

We are already a data provider, but we want to extend the services we offer. We collect data for our own analyses as well as providing research data. But our data – such as information about credit conditions in individual sectors – are also important for banks and other market participants. In addition, together with the ECB, we are supporting initiatives to identify firms using a standardised, Europe-wide register – a “telephone directory” for the digital age.

One of the topics currently attracting intense debate is that of cryptocurrencies, such as Facebook’s Libra project, but also the potential issuance of crypto coins by central banks. What risks do you perceive here?

We must make sure that private providers are subject to regulation, just like other payment service providers, in order to prevent money laundering or the financing of terrorism, for example.

And what about crypto-euros issued directly by the central bank?

There are many models and proposals for this. I don’t think digital central bank money for the general public is something we need in our market at the current juncture. In any case, there's a distinction to be drawn between such coins being distributed via the banks, much like cash, or issued directly to the public via the central bank. If they were issued directly, this would alter the way we share tasks with the commercial banks – I am sceptical of this.

And finally, a general question. As you know, financial crises often emerge from risks that have been unrecognised for many years, or even overlooked. How can we tackle this?

Many developments in the financial system are highly uncertain -- we cannot calculate probabilities of specific events occurring and potential losses. That’s why we need sufficient capital buffers. Not only to ensure resilience of individual banks, but also of the whole system.

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