German regulator urges banks to set aside bumper profits for bad news on the horizon

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German Regulator
German Regulator

The president of Germany’s regulatory authority suggests that banks should allocate a portion of their recent substantial profits to prepare for possible defaults on loans caused by the economic impact of increased interest rates.

In 2023, German banks experienced a significant boost in profits due to the increase in interest rates by central banks. Despite this, they maintained low deposit rates.

In an effort to control rising inflation, central banks across the globe have implemented strict monetary policies in the past couple of years. However, attention has now shifted towards when major banks such as the U.S. Federal Reserve, the European Central Bank, and the Bank of England will begin reducing interest rates once again.

Despite the increase in borrowing rates, economies have shown unexpected resilience. However, policymakers are cautioning that the effects on households and businesses may not have been fully experienced yet.

According to the chief of BaFin, the German regulator (also known as the Federal Financial Supervisory Authority), the banking sector has managed to handle the impact of rate increases. However, there is a possibility of encountering more difficulties in the future.

“The difficulties that come from this rate environment for the clients of the banking sector — whether that’s in the real estate sector or in the real economy — we haven’t seen that flow through yet,” he told CNBC’s Annette Weisbach, adding that it “won’t be easy” to repeat the profitability expected in 2023 and 2024 as rates remain historically high.

“So firms have to be very wary about provisioning requirements about not only letting the shareholders profit from this good year that they’ve had, but put as much aside to deal with the costs that are coming because they will come.”

Germany’s biggest lender, Deutsche Bank, exceeded expectations for the third quarter by achieving a net profit of 1.031 billion euros ($1.12 billion). As a result, the bank has announced its plans to enhance and expedite shareholder payouts.

Insolvencies ‘pre-programmed’ to rise

It is predicted that insolvencies will increase due to the expected recession in the euro zone economy. Germany, in particular, is anticipated to experience a long-lasting economic decline, with a contraction of 0.3% in 2023. This is attributed to the negative impact of high inflation and interest rates on growth.

Despite this, a significant number of banks have not made significant increases in their reserves for potential loan losses. Branson stated that it is anticipated that they will begin doing so this year, and it is possible that some banks have already begun allocating more funds for nonperforming loans during the last quarter of 2023.

“We’ve seen things happen in the commercial real estate market, which we’ve maybe predicted for a long time but now are crystallizing, so as I said 2024 and the years thereafter, they’re not going to be as easy as 2023,” Branson said.

The number of bankruptcies among companies has not significantly increased as one would typically expect when interest rates rise rapidly. However, Branson pointed out that the current figures are not truly reflective of the situation because they have been kept artificially low. This is mainly due to the prolonged period of exceptionally low interest rates and the significant financial support provided by governments to address the challenges posed by the Covid-19 pandemic and energy crisis in recent times.

“So I think it’s almost pre-programmed that insolvencies will begin to rise again and that’s in a way normal for banks that they’ll also have have to deal with some credit losses in their books,” he said.

“That’s why we’re a bit skeptical the profitability will continue to rise after such a good 2023, and that’s why the banks have to look carefully now about what they need to provision.”

source: CNBC

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