"Growing likelihood of price bubbles"
Bundesbank Executive Board member Andreas Dombret believes that there is currently not a heightened risk of a price bubble on the German real estate market. Speaking at the annual meeting of "Haus & Grund Deutschland" in Berlin, he said that, overall, real estate prices have developed moderately in Germany, despite very sharp regional price increases having been recorded since 2010, which resulted in overvaluations of up to 20 per cent in some regions up until 2013. Rather, the rise in prices reflects, "at least in part, a catching-up process following a period of weak price growth that persisted for quite a number of years". Dombret said that the European Central Bank's monetary policy easing has nevertheless increased the risk of a real estate bubble.
According to the Bundesbank Executive Board member, the threat of a bubble emerging had been so low up to now as, alongside prices, lending had also not risen excessively. Demand has increased, as high liquidity levels and low interest rates have made it easier to finance property purchases. The lower yields on alternative investments have also boosted interest in these ostensibly safer investments. "Thus, the volume of mortgage credit to households has risen steadily since 2010, albeit initially at a moderate pace," said Dombret. In November 2014, year-on-year growth was just shy of 2½ per cent. In Dombret's opinion, in terms of the volume of mortgage credit issued, banks' vulnerability has increased only slightly overall.
Structural vulnerability of German banks
Furthermore, the standards by which loans are granted – another criterion for identifying the threat of a bubble – are still high. This was also shown by a survey conducted by banking supervisors of 116 selected banks in German towns and cities. Conditions were more favourable for some customers due to the further decline in interest rates; the risk premiums that the banks priced in remained stable, however. "We cannot see any signs of trouble brewing," said Dombret. On the contrary: "Ultimately, credit standards for loans to households for house purchase remained unchanged in Germany, while they were eased in the rest of Europe."
However, the survey reveals a fairly large share of loans with what might be referred to as high German sustainable LTV ratios (Hochausläufer) in the "attractive towns and cities" segment. With such mortgages, the loan is greater than the mortgage lending value, that is the value the bank calculates in respect of the property serving as collateral. Dombret believes that these loans are not a cause for concern per se – the borrower's high level of available assets or income can have a risk-mitigating effect. "Nevertheless, the fact that such loans account for a large share of all mortgages does indicate that there might be structural vulnerabilities in the German banking system to crises on the real estate market," said Dombret, and announced that banking supervisors would be taking a closer look at this in future.
Even though there are currently hardly any indications of destabilising developments in the real estate sector as a whole, everyone needs to be aware that the ECB's recent decision will have far-reaching consequences for the capital markets, warned Dombret. The further rise in liquidity levels and falling interest rates mean that there is an increased danger of asset price bubbles, not least on the real estate market. "The world has thus become a rather more dangerous place for property investors," said Dombret. The situation on the housing market hinges on the currently relatively favourable macroeconomic environment. If conditions were to deteriorate and the default rates for residential mortgage loans were to rise, German banks would stand to make considerable losses. Foreign exchange risk also harbours risks. For example, the discontinuation of the minimum exchange rate for the Swiss franc and the subsequent appreciation thereof have created difficulties for some borrowers who had taken out residential mortgage loans in Swiss francs. However, Dombret considers the risk for German banks in connection with the default of loans in Swiss francs to be low: residential mortgage loans in Swiss francs in Germany account for only around €2 billion of the total volume of residential mortgage loans of €1,000 billion.
Central banks are the spoilsports
Financial supervisors need to be prepared in case a bubble should emerge on the real estate market, Dombret emphasised in his speech. It is crucial to have tools available to contain the risks. In the end, "it will be up to the central banks to step in and spoil the fun just as the party is in full swing". Dombret said that the use of new instruments is currently being reviewed. The Financial Stability Committee, in which the Bundesbank, the Federal Ministry of Finance and the Federal Financial Supervisory Authority (BaFin) play a role, plans to present the Federal Government with recommendations on establishing a legal basis for the use of these instruments in the next few months. In general, Mr Dombret continued, it is important that borrowers and lenders are aware that interest rates could rise again at some point in the future, and that this will not only result in increased financial burdens from residential mortgage loans. "As a rule, loan contracts should only be signed if borrowers can continue to repay them even at higher rates of interest," said Dombret.