Negative Interest Rates Bite: Bundesbank Warns of Risks to Financial Stability, Moody’s Downgrades Outlook for German Banks

Yield-starved banks expanded lending to “relatively high-risk businesses” and to the property sector, as the Bundesbank considers house prices in many cities overvalued by 15% to 30%.

The “risks to financial stability have continued to build up in Germany,” the Bundesbank warns in its Financial Stability Report, published this week. One major risk highlighted by the central bank is that Germany’s current economic slowdown — the result largely of “unfavourable external economic developments” — could turn into an “unexpected economic downturn”.

The country’s export-led economy has barely grown in the last five quarters as global trade has slowed. If the situation gets much worse, it could trigger a “deterioration in the debt sustainability of enterprises and households,” which in turn could lead to cascading loan defaults and credit write-downs.

Many yield-starved banks have significantly expanded their lending to “relatively high-risk businesses” while simultaneously reducing their provisions against losses on lending. As the Bundesbank puts it, “there are signs that banks’ lending portfolios now include a higher share of enterprises whose credit ratings could deteriorate the most in the event of an economic downturn.”

The banks are also heavily exposed to the fast-growing domestic real estate market, one of the few in Europe to have avoided a slump in the wake of the 2008 crisis. Since then, prices have surged as investors, domestic and foreign, have poured funds into real estate, and banks have shifted their focus toward property transactions.

Last year alone, house prices in Germany grew at an average rate of 8%. The Bundesbank estimates that property prices in German towns and cities are overvalued by between 15% and 30%. According to the 2019 Global Real Estate Bubble Index, housing in Munich is now the most overpriced in the world.

If the economy’s slowdown turns into a downturn, as the Bundesbank fears, Germany’s property boom could turn to bust, leaving investors, banks and developers shouldering large losses. Yet for now, surveys suggest that both households and lenders expect prices to continue rising long into the future. As the central bank notes, even as Germany’s macroeconomic situation deteriorates, the persistently low interest rates not only help to mask that reality, they provide ideal conditions for the financial vulnerabilities to grow further.

Continue reading the article on Wolf Street

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