The German financial system weathered the period of exceptionally strong interest rates increases well overall. The macro-financial environment gradually improved over the course of last year, but remains challenging in light of the economic environment and heightened geopolitical tensions, in particular.

Against the background of lower inflation rates, interest rates have gradually fallen. Financing conditions have progressively improved in broad terms. Changes in the composite indicator of financial conditions reflect this development. The indicator decreased, having been significantly elevated as interest rates were rising. 

For more information, see Chart 4.1.1 .

Residential real estate prices are stabilising and commercial real estate prices have not fallen any further. The risk of additional price drops for commercial real estate remains high, particularly in view of low transaction volumes. Looking at residential real estate, there is less of a chance that prices will fall again. Valuation levels in financial markets continued to rise, so the risk of market price corrections and the associated losses for financial intermediaries remains elevated.

For more information, see Chart 4.1.6.

Risks from commercial real estate lending by banks remain high. One indicator of this is the high level of non-performing loans secured by commercial real estate. Risks from commercial real estate are concentrated amongst a small number of banks and insurers. So far, they remain manageable for the banking and insurance sector as a whole. Open-end retail real estate funds could amplify developments on the commercial real estate market; redemption notice periods and minimum holding periods are keeping prevailing risks in check.

For more information, see Chart 4.2.8.

Having declined in the wake of rising interest rates, loan growth remains low, but it stabilised at a low level over the course of last year.

For more information, see Chart 4.1.4.

Compared with periods of rising interest rates in the past, interest rates on overnight bank deposits rose far less significantly. This had a positive impact on banks’ net interest income. Depositors shifting their holdings to deposit categories with higher remuneration, together with weak credit demand, could put pressure on net interest income in the future.

For more information, see Chart 4.2.3.

Banks’ need to make loss allowances for loans has risen sharply overall, albeit from a very low level. As economic activity remains subdued and lending rates are higher, loss allowances are set to keep rising over the next few quarters – especially if economic activity is weaker than expected.

For more information, see Chart 4.2.6.

Banks’ capitalisation has improved steadily over recent years. Thanks to their capital reserves, banks can cope with larger losses without falling below the regulatory minimum requirements. The package of macroprudential measures adopted in early 2022 was one factor that contributed to this. However, the high ratios could be overstating banks’ resilience, not least due to unrealised losses on their balance sheets and low risk weights.

For more information, see Chart 4.2.13.

Since the global financial crisis, the sector of non-bank financial intermediaries (NBFIs) has been growing in Europe and Germany. German NBFIs – i.e. investment funds, insurance corporations and pension funds as well as other financial intermediaries – together hold around 40 % of all financial assets in the German financial system. Additionally, German banks and investment funds have close ties with global NBFIs. This opens up direct and indirect contagion channels for the German financial system.

For more information, see Chart 4.3.1.

Since the interest rate hike in 2022, life insurers have been buying and selling far fewer fixed income securities than in previous years. Unrealised losses on fixed income securities lessen the incentives for life insurers to trade securities. Life insurers might, then, in times of stress, stabilise financial markets less than they did in the past.

For more information, see Chart 4.3.4.

Risks stemming from an unexpected and immediate carbon price increase are likely to be manageable for the German financial system. A disclosure requirement for firms could reduce the impact of climate risks.

For more information, see Chart 5.4.1.

The liquidity of government bonds plays an important role in the financial system. Differences in market and holder structure can affect the price discovery mechanism for government bonds and the propagation of shocks in the financial system. They thus affect the liquidity of government bonds. What is important here is whether more domestic or foreign investors are operating in the market and whether these are banks or NBFIs.

For more information, see Chart 6.2.1.
 

The resilience of the banking system is adequate thanks to high capital reserves. The vulnerabilities that built up during the protracted period of low interest rates are steadily diminishing, though only gradually. The period of exceptionally strong interest rate increases was weathered well overall. The package of macroprudential measures is still appropriate. Overall, an orderly reduction of vulnerabilities has become more likely. Macroprudential supervisors will monitor further developments in this area.

In order to safeguard the stability of the financial system, it is important for banking sector supervision and regulation to continually evolve. In this context, the preventive orientation of macroprudential policy needs to be strengthened.

Looking at the regulation of insurance corporations and investment funds, the macroprudential perspective needs to be strengthened, especially with respect to liquidity risk. Available data on NBFIs need to be shared between macroprudential authorities across Europe in the future, and worldwide data sharing likewise needs to be improved.

Climate policy should have a long-term focus and avoid unexpected and immediate carbon price increases. A consistent disclosure requirement concerning information on carbon emissions will improve capital allocation and can reduce the risks faced by the German financial system.

Market participants’ behaviour can have a decisive impact on liquidity conditions on the government bond market. Given the important role played by NBFIs on the German government bond market, it is vital that we expand our insights into their investment strategies and responses.