Skyline Frankfurt am Main ©Frank Rumpenhorst

Strong improvement in the performance of German banks in 2021

How are German banks faring? The Bundesbank’s latest Monthly Report delves into precisely that question, describing the performance of German banks in the past year and providing an outlook on current challenges. It reveals that German banks saw a strong improvement in their financial performance in 2021. Profit for the financial year before tax rose €12.8 billion and, at €27.1 billion, hit almost double the previous year’s figure, taking it well above the long-term average of €18.0 billion for the first time since 2017 as well as exceeding the average of the post-financial crisis years. According to the report, almost all of the categories of banks under review were able to substantially increase their results for the financial year before tax.

Significantly less risk provisioning by banks

The Bundesbank’s experts write that this development was mainly due to banks significantly scaling back their risk provisioning compared with 2020 and releasing some of the risk provisions that they had formed that prior year. Three-quarters of the growth in overall profit for the financial year can be ascribed to a year-on-year reduction in net valuation charges of just over 70%.

Performance: Statistics on banks’ profit and loss accounts. This involves the evaluation of the profits and losses calculated from the annual accounts which the banks must submit to the Bundesbank pursuant to Section 26 of the Banking Act (Kreditwesengesetz). As the annual accounts apply to the respective institution as a whole (but not to the group), the charges and income of foreign branches are also recorded. Initial results are analysed and published on an annual basis – usually in September – in an article on the performance of German credit institutions in the Bundesbank’s Monthly Report.
Return on equity: Ratio of profit for the financial year before tax to annual average equity as shown in the balance sheet.
Return on assets: Ratio of profit for the financial year before tax to annual average total assets.
Net valuation charges: Net valuation charges comprise the effects of value adjustments, write-ups and write-downs on accounts receivable and securities in the liquidity reserve. In addition, income and charges in connection with transfers from and to loan-loss provisions are taken into account, as are transfers and releases relating to undisclosed reserves pursuant to Section 340f of the Commercial Code (Handelsgesetzbuch). However, due to the cross-offsetting option permissible under the Commercial Code, the annual accounts do not show the extent to which undisclosed reserves have been formed or released.
Operating income: Sum of net interest income, net commission income, result from the trading portfolio and the other operating result.
Profit for the financial year before tax: Operating income less administrative spending and net valuation charges plus the balance of other and extraordinary items.
Cost/income ratio: Ratio of administrative spending to operating income.

This happened against the backdrop of a strong economic recovery in 2021 and a setting which saw the credit defaults initially feared at the beginning of the coronavirus pandemic fail to materialise. The report also goes on to state that, given the more favourable economic situation and with the share of non-performing loans in the total credit volume declining up to the third quarter of 2021, German banks still assessed credit risk to be low. In particular, savings banks and credit cooperatives – which together generated more than half of the aggregate profit for the financial year before tax in 2021 – and big banks reduced their net valuation charges by around 90% or more on the year, the report reveals. The increase in operating income of around 5% was another key factor behind the improvement in profit for the year before tax. This was due, in particular, to the rise in net commission income of roughly 18%. However, net interest income also rose somewhat for the first time since 2018, as German banks found renewed declines in interest income could be more than offset by lower interest expenditure. Overall, however, the report points out that the increase in operating income proved only slightly more than half as significant in driving the growth in profit for the financial year as the decline in net valuation charges.

Meanwhile, the profit for the financial year before tax was weighed down by an increase in banks’ general administrative spending of around 6%. According to the report, higher social security contributions, amongst other things, led to a rise in staff costs. The increase in other administrative spending was primarily ascribed to IT and digitalisation costs. Despite the growth in operating income, this led to a slight deterioration in the cost efficiency of German banks.

Current challenges

In the current year, the impact of Russia’s war of aggression on Ukraine has been the predominant drag on macroeconomic developments in Germany and around the globe. The experts write “if the economic environment deteriorates further, this could also weigh on the profitability of German banks, through higher credit losses for example”. They add that rising interest rates, too, could place a strain on performance in the short term. In the medium term, however, they are likely to bolster the performance of German institutions. The report also identifies that, besides investment in digitalisation, investments made with climate change in mind will probably pose a major challenge for the sector.