Low-interest-rate environment takes toll on German banks’ profits

In a challenging financial market setting of persistently low interest rates on the one hand and solid economic growth on the other, the profitability of German banks has declined in their core business areas. This is the thrust of an analysis published in the latest Bundesbank Monthly Report of the 2016 annual financial statements of German credit institutions prepared according to the German Commercial Code (Handelsgesetzbuch). Last year, income from interest and commission business fell by €5.4 billion to €120.9 billion. By contrast, the other operating result, which improved significantly due to one-off factors, had a stabilising effect, meaning that operating income just exceeded the previous year's level, at €128.1 billion. The process of consolidation in the banking sector reduced the number of credit institutions covered by the analysis by 68 to 1,611.

Net interest income down significantly

In 2016, net interest income declined across all categories of banks by 4.9% to €91.1 billion. This not only includes the contribution to earnings made by interest business but also the sum of current income and income from profit transfers. Though net interest income continues to be the most important source of income for banks, it is two percentage points below the long-term average, at 71.2% of operating income. According to the Bundesbank’s experts, the reason for this decline is that the sum of current income (which includes, for example, shares and variable-yield securities) and income from profit transfers fell by 17.3%. Net income from traditional interest business narrowed by 2.1% to €76.4 billion.

After net interest income, income from commission business is the second most important source of revenue for banks. In particular, this includes fees for giro transactions and payments, fees for securities and safe custody business, and fees for brokerage activities relating to savings and loan agreements and insurance contracts. According to the Monthly Report, net commission income had a stabilising effect in the low-interest-rate setting. Across all categories of banks, income from commission business in 2016 decreased by 2.3% to €29.8 billion. However, the commission margin, calculated as the ratio of net commission income to total assets, matched the long-term average, at 0.36%.

One-off factors raised operating income

The institutions’ operating income last year totalled €128.1 billion, which despite the shrinking growth in interest and commission income thus increased slightly on the year. Bundesbank economists mainly put this down to one-off factors. Lower spending in connection with one major bank’s legal disputes as well as a legislative amendment regarding the valuation of pension obligations meant that the other operating result improved significantly from -€2.2 billion to €4.1 billion. "Overall, the heterogeneity between and also within the various categories of banks was particularly pronounced in 2016 on account of one-off factors, some of which affected specific larger banks only," the Monthly Report notes.

Administrative spending down slightly

Banks’ expenses are primarily driven by administrative spending, which includes staff costs and other administrative spending. Last year, this contracted slightly by 1.5% to €88.7 billion, which is reported to have been caused mainly by falling expenditure on pensions, which is included not only in wage and salary payments and social security contributions but also in staff costs.

The cost/income ratio is an important measure of business’s cost effectiveness and thus also of its efficiency. This ratio improved slightly in 2016 by 1.2 percentage points to 69.2%, meaning that the administrative spending used to generate €100 of operating income fell by €1.20. Bundesbank specialists nevertheless point out that, "German banks continue to have a very high cost/income ratio compared to the long-term average and also by international standards, however."

Many banks topped up equity

After tax, banks recorded an annual profit of €15.8 billion. Many used this profit to further improve their equity base. Savings banks and cooperative banks alone boosted their capital positions by €10 billion from the profit for the year. Overall, since 2007 German institutions have stepped up their equity ratios from 3.8% to 5.6%.