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Low interest rates and economic downturn: risks to the German financial system rise

            

              
              
                

            

              

The vulnerability of the German financial system has increased, warns the Deutsche Bundesbank. Low interest rates and increasingly risky loans pose a risk to the entire system.

              

The risks to the German financial system have increased further in the opinion of the Deutsche Bundesbank. Among other things, the Bundesbank sees the risk of banks underestimating their credit risk, overestimating the value of collateral, and lending to lower credit customers because of the low level of economic growth in recent years.

"An unexpected economic downturn and abruptly rising risk premiums could make the German financial system sensitive," explained Bundesbank Vice President Claudia Buch at the presentation of the Federal Reserve's Financial Stability Report in Frankfurt. Last year, a slowly rising interest rate level was expected. But the European Central Bank (ECB) cemented its zero interest rate policy again in the autumn. In addition, trade disputes and Brexit worries are clouding the outlook for the economy.

"Low interest rates are putting pressure on the interest margins of institutions, putting pressure on their profitability and thus posing a risk to financial stability," added Joachim Wuermeling, who is responsible for banking supervision on the Board of the Bundesbank. The experts of the Bundesbank are worried that banks are increasingly granting riskier loans. The demand for loans is growing, according to the Bundesbank, loans to the private sector, with annual nominal growth of just under 5 percent, are growing faster than they have been for over 15 years. In the event of an economic downturn, institutions could therefore be more heavily burdened by write-downs and loan defaults.

Among the sectors with strong growth is the construction industry. More than half of all outstanding bank loans to domestic households and companies are housing loans, according to the Bundesbank. In addition, real estate in Germany accounted for a substantial proportion of fixed assets at 80 percent.

The tendency of rising prices on the German real estate market continues to be closely monitored by the Bundesbank. There is a risk "that market participants continue to over-optimistic about the past, overestimating the value of collateral," Buch said. According to the Bundesbank, residential real estate in Germany in urban areas was overvalued by between 15 and 30 percent in 2018. Nevertheless, the Bundesbank still does not see a dangerous price bubble on the German real estate market. "We currently see no evidence that we have a credit-driven speculative dynamics in the markets," said Buch.

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