The German financial system remains vulnerable to adverse economic developments. Future credit risk could be underestimated and the recoverability of loan collateral such as real estate overestimated.

Times of strong growth and low interest rates have seen vulnerabilities build up in the German financial system. In addition, the probability of an economic downturn has increased.

Given the upbeat prospects for the economy as a whole, there is little risk to the stability of the German financial system at present. Yet with interest rates sitting at low levels for years now and the economy in such robust shape, there is a danger that market participants might underestimate the risks to financial stability, the Bundesbank cautions.

Given its public mandate to safeguard monetary stability, the Bundesbank has an inherent interest in ensuring a stable financial system. As an integral part of the European System of Central Banks, it also has an explicit mandate to contribute to financial stability.

Exceptionally low interest rates remain a salient feature of the financial system setting in Germany. They reflect the global low real economic growth and expansionary monetary policy stance.

The main topics in this year's edition are risks to the stability of the German banking and financial system in the current low-interest-rate environment, developments in the German real estate market and the importance of the banking union for a stable financial system.

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.

The European sovereign debt crisis remains the greatest threat to financial stability in Germany. The Bundesbank considers that a substantial worsening of the situation would have a significant adverse impact on German banks and insurers. In addition, low interest rates, high liquidity and potential exaggerations in the German real estate market could pose a future threat to financial stability.

Risks to the German financial system are clearly on the increase – main challenges lie in the worsening and widening sovereign debt crisis and the associated loss of confidence in the European banking system.

Stability of the German financial system improved – focus now on European sovereign debt crisis and medium-term risks from protracted low-interest rate environment.