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Profitability of German banks deteriorates

The profitability of German credit institutions deteriorated in 2018, as the Bundesbank’s Monthly Report reveals in an analysis of the annual accounts of German banks. Profit for the financial year before taxes fell significantly compared to the previous year, down by 31% to €18.9 billion.

This was caused, amongst other things, by the €3.1 billion deterioration in the result from the valuation of assets and the €2.1 billion fall in the trading result. According to the report, the institutions’ trading result was hampered, in particular, by losses from securities transactions that could not be offset by interest-related and foreign exchange business. In addition, the general downward trend in the capital markets in the second half of the year necessitated increased risk provisioning for securities in the liquidity reserve.

To make their assessment, Bundesbank experts analysed the profit and loss accounts of 1,484 credit institutions in Germany. Describing the business environment in which the institutions are operating, they note that, with low interest rates continuing to prevail and competitive pressure intensifying – also due to new competitors entering the market from the fintech sector – the need to cut costs and the trend towards mergers did not let up.

Banks further increase their equity

In 2018, banks boosted their equity ratio for the seventh time in a row, raising it from 5.93% in 2017 to 6.27%. As the Bundesbank’s Monthly Report notes, a solid capital base provides protection against unexpected losses. Given the challenging profitability situation, this is essential, particularly in case the economy takes a turn for the worse, the Bundesbank’s experts explain. At the same time, return on equity, i.e. the ratio of profit for the financial year before tax to balance sheet capital (total equity), fell considerably, dropping by 1.89 percentage points to 3.74%.

Low interest rates a challenge

Interest business continued to make the largest contribution to banks’ operating income. While net interest income, i.e. the balance of interest income and interest expenditure, rose slightly on the previous year to €87.2 billion, it remained below its long-term average. As the Bundesbank’s experts note, income was adversely affected, amongst other things, by the fact that institutions passed on negative interest rates to depositors to only a minor extent and that strong competition limited earning opportunities in lending business.

With regard to the ECB Governing Council’s recent decision to further loosen monetary policy with a comprehensive package of measures, the Bundesbank warned that the introduction of a two-tier system for reserve remuneration, which exempts part of credit institutions’ excess liquidity holdings from the negative deposit facility rate, would not alter the fact that banks will still have to operate in a low interest rate environment. Furthermore, the Bundesbank identified a possible economic downturn, intensifying international trade disputes and the United Kingdom’s impending exit from the EU as future challenges for the banking sector.