The Deutsche Bundesbank’s Financial Stability Review 2024 has revealed that, despite facing a year of exceptionally rising interest rates and ongoing economic and geopolitical challenges, Germany’s financial system has remained stable and resilient. The report, unveiled on November 29, 2024, by Michael Theurer, Member of the Executive Board of the Deutsche Bundesbank, highlighted that the financial system’s ability to weather economic shifts has been largely successful, though challenges remain in certain sectors.
Interest rates, which had surged significantly in 2023, have since started to decline, allowing some of the unrealized losses that had accumulated on the balance sheets of financial intermediaries like insurers, investment funds, and pension funds to recede. However, new risks are emerging, particularly around credit exposure, as the economic landscape remains volatile due to geopolitical tensions, economic transformation, and ongoing global debt challenges. The commercial real estate sector, in particular, continues to face pressure, making it an area of particular focus for financial regulators.
Macroeconomic Challenges and Global Uncertainty
The macro-financial environment showed signs of improvement throughout 2023, but remains fraught with risks. Geopolitical tensions, especially stemming from ongoing global conflicts, continue to cloud the economic outlook. Furthermore, despite a return to some degree of price stability in Germany, the country is still facing the repercussions of a global economic slowdown, exacerbated by high levels of debt across both public and private sectors worldwide. Additionally, the results of the US elections have introduced further uncertainty regarding the direction of US economic policy, which may have downstream effects on the German economy.
Stability of Banks and Financial Intermediaries
The review underscores the stability of Germany’s banking sector, with banks continuing to report positive profitability, largely attributed to low interest rates on deposits and corresponding low funding costs. Vulnerabilities that had emerged during the period of low interest rates, particularly those related to residential real estate loans, have gradually diminished. Banks’ capital reserves have strengthened over the years, allowing them to remain well-capitalized in the face of external challenges.
German non-bank financial intermediaries, such as investment funds and insurers, have navigated the rise in interest rates effectively, but they are not immune to liquidity risks. In particular, losses from commercial real estate loans have increased, though these losses are primarily concentrated within a few financial institutions. Overall, the risks to the financial system remain manageable, but liquidity concerns related to open-end real estate funds could exacerbate issues in the commercial real estate sector. Fortunately, measures such as long redemption notice periods and minimum holding periods for retail real estate funds have helped mitigate the risks of liquidity crises.
Maintaining Resilience Amid Risk
Despite the relatively stable outlook, the report stresses the importance of maintaining resilience within the German financial system. The Bundesbank has continued to implement a package of macroprudential measures, which includes the countercyclical capital buffer and the sectoral systemic risk buffer. These measures, introduced in 2022, were designed to help banks build up additional capital reserves to prepare for future crises. While positive trends in the residential real estate market suggest that vulnerabilities in residential real estate loans are beginning to ease, uncertainties persist, and the financial system will need to be closely monitored.
Structural Change and Climate Risks
In addition to the immediate financial concerns, the review also highlights the long-term risks posed by climate change and technological transformation. The transition to a more sustainable economy presents both opportunities and challenges for the financial system. The review discusses how an unexpected increase in carbon prices could potentially disrupt the financial stability of Germany. Furthermore, digitalization, particularly the potential introduction of a digital euro, is expected to have both short- and long-term effects on bank liquidity and funding costs.
Strengthening Macroprudential Oversight
The report also advocates for a stronger macroprudential approach to regulating non-bank financial intermediaries, which have grown significantly in Europe, including Germany, since the global financial crisis. While the regulation of these intermediaries has traditionally been microprudential, the Bundesbank calls for a broader macroprudential focus to better assess risks such as liquidity bottlenecks and contagion effects. Closing data gaps and fostering international cooperation on non-bank financial intermediary regulation are key to strengthening the overall stability of the financial system.
In conclusion, while Germany’s financial system has shown resilience in the face of rising interest rates and global uncertainties, vigilance and continued adaptation to structural changes are essential for maintaining long-term financial stability.