The 2013 Financial Stability Review of the Deutsche Bundesbank

Low interest rates and an ample supply of central bank liquidity have helped to ease the tensions on the international financial markets. So far this year, the German financial system has also benefited from this situation. However, the Bundesbank believes that these exceptional financial conditions present risks to financial stability the longer they prevail.

In addition, high levels of public and household debt in a number of euro-area countries continue to pose a significant risk. "The debt crisis is not yet over," said Sabine Lautenschläger, Deputy President of the Deutsche Bundesbank, at today’s presentation of the 2013 Financial Stability Review. As was the case last year, she emphasised that "the time bought using central bank measures must be used to tackle the causes of the crisis through structural and institutional reforms. It is particularly important to keep these reforms on track."

Although the low interest rates have helped to ease the situation, Dr Andreas Dombret, Member of the Bundesbank’s Executive Board, noted that "the longer the low-interest-rate environment lasts, the greater the undesired side-effects and risks for financial stability," adding: "the low-interest-rate environment is placing a growing strain on the German financial system".

For instance, low interest rates are increasingly eating away at life insurers’ financial buffers. "Low interest rates are making it more and more difficult for life insurers to generate guaranteed returns," explained Mr Dombret, who is responsible for financial stability issues. He added that low interest rates are creating higher valuation reserves on insurance companies’ balance sheets, which have to be paid out to policyholders. Mr Dombret continued: "In the interests of financial stability, a sound and sustainable regulatory framework should be created for policyholders’ participation in valuation reserves."

The German banking system is also affected by the low-interest-rate environment because interest income is traditionally its most important source of earnings. "The fierce competition for customers over the last 15 years has halved the banks’ interest margins from 200 to 100 basis points. And the low-interest-rate environment is now placing further strain on the banks," explained Ms Lautenschläger, who is responsible for banking supervision at the Bundesbank. She said that this would put some banks’ business models under considerable pressure in the medium term and that it would therefore be essential to adjust their cost structures. Despite the intense competition in the German banking sector, she pointed out that banks’ resilience had further improved in comparison to the previous year, partly due to the robust domestic economy. Ms Lautenschläger emphasised that the institutions had once more decreased their debt ratio and increased their capital ratio compared to last year. "The balance sheet adjustments carried out over the last few years have also decreased risk and increased capital ratios – this is a positive development, especially in terms of the European Central Bank's comprehensive balance sheet assessment," she said.

The low-interest-rate environment is also affecting developments on the German housing market. Housing prices have risen significantly over the past few years, particularly in cities. After prices in these areas rose by almost a quarter between 2009 and 2012, the Bundesbank expects a further price increase of around 9% in 2013. However, the Bundesbank does not see this as a serious risk to financial stability. "In view of households’ sound levels of debt sustainability and a moderate rate of growth in lending, rising property prices do not at present harbour any excessive risks to stability," said Mr Dombret. He added: "However, the possibility that property owners could experience wealth losses due to potential price corrections cannot be ruled out". Mr Dombret continued: "The experience of other countries has shown that a prolonged period of low interest rates can result in price bubbles." He confirmed that the Bundesbank would therefore continue to monitor the situation on the German housing market closely.

Overall, he emphasised that it was important to keep a close watch on the impact of low interest rates on financial stability and that the longer the period of low interest rates lasted, the more likely it was that macroprudential instruments would be employed. "One thing is certain: as soon as we see a risk to financial stability, we will act," said Mr Dombret.