Bundesbank-Vizepräsidentin Claudia Buch: “Banks have smaller buffers” Interview published in the Frankfurter Allgemeinen Zeitung (FAZ)

Interview with Claudia Buch conducted by Markus Frühauf.
Translation: Deutsche Bundesbank

From 1 February 2023, banks will have to satisfy the countercyclical capital buffers – 0.75% for loans in general and 2.0% for loans secured by residential property. Institutions continue to oppose this. Do they have a case?

Banks actually have to hope that the buffers stay that way. Releasing the buffers only makes sense if the economic situation deteriorates sharply. You see, if credit risk materialises and leads to losses, banks could tighten the supply of credit and amplify the downturn. However, that would be a very unfavourable situation, which banks cannot wish for either. The countercyclical capital buffer protects against this.

Banks see it differently …

... still, the buffers are necessary because vulnerabilities have built up in the financial system. For many years, the level of credit risk was very low, and the number of insolvencies even declined. Banks accordingly reduced their risk provisioning. But this also means that future adverse developments are being underestimated. Already, a number of risks we were warning about in the past years have materialised. Banks have realised losses on securities. Looking ahead, economic difficulties facing enterprises and households could intensify. Credit defaults are then likely to increase.

Should we fear a credit crunch?

In general, banks have become more cautious owing to rising credit risk, but there are currently no signs that credit will dry up. Bank lending to enterprises is still very dynamic, no doubt bolstered by government loan guarantees as well. Among households, however, demand for housing loans has fallen off recently amid rising interest rates.

Do banks now need to set aside more provisions for credit defaults?

They need to prepare for adverse scenarios and be prudent about risk provisioning. Banks should now be looking to strengthen their resilience. That will also increase the resilience of the banking system as a whole.

Does that also mean that, as in the pandemic, they will no longer be allowed to distribute dividends?

After the pandemic began, supervisory authorities issued a general recommendation to refrain from distributions or share buy-backs. We do not intend to resort to such a measure at the present time. But the expectation for banks is clear: they should only proceed with distributions extremely cautiously.

Are banks still overly optimistic at present?

Banks should certainly bear in mind that the recessions of recent years have left their balance sheets largely unscathed. During the pandemic, the economy contracted significantly, but credit risk did not increase. It was a similar story with the global financial crisis. Banks’ capitalisation actually went up during the pandemic. Banks have benefited indirectly from government programmes introduced to support the real economy, which have prevented an increase in credit risk. Going forward, risks are likely to rise.

The wave of credit defaults that banking supervisors warned of during the pandemic has not come to pass. Looking at it from where we stand today, were the restrictions on distributions justified?

Yes. The pandemic was a once-in-a-century event, the fallout of which was impossible to predict before the fact. Lower distributions have made the banking sector more resilient to potential losses. Given the very high level of uncertainty, this has helped to bolster confidence. The fact that the losses ended up not materialising has a lot to do with fiscal measures.

How is the current situation different?

In the light of the energy crisis, structural change is intensifying. Real incomes have fallen. And the government cannot absorb all the risks that that entails.

How will the turnaround in interest rates affect banks and the financial system?

To begin with, rising interest rates are a positive thing for banks because they mean a return to higher interest income and increased profitability. But, rising interest rates can also lead to price losses in the equity and bond markets. Valuation losses have already all but exhausted German banks’ hidden reserves as it is. The buffers in the system have thinned accordingly. And so it’s not just banks that should be strengthening their resilience – valuation losses affect insurers and funds, too.

How would you define financial stability?

In a nutshell, a stable financial system is one that works and does not amplify shocks. This means that investment is financed, savings are invested and risks are appropriately distributed. Times of crisis can see all that under threat: losses erode capital and banks fearing inadequate capitalisation would have to scale back their lending. That can then lead to a credit crunch. This is why good times need to be utilised to build up buffers, so as to be prepared for crises. A robust system of supervision, which focuses on the stability of individual institutions, is the foundation of a stable financial system. But we also need to keep our eyes on vulnerabilities and looming risks in the financial system as a whole. If not, dangerous contagion effects can occur – as we saw during the financial crisis.

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