Historically low interest rates continue to be among the major challenges for supervised entities and supervisors alike. The longer they persist, the more they will weigh on the already weak earnings of German banks – especially those institutions whose main source of revenue is net interest income. Most recently, this was confirmed by the low interest rate environment survey initiated by BaFin jointly with the Bundesbank at the beginning of April 2017.

Continued decline in earnings

Sentiment among the institutions was slightly more optimistic this time than at the time of the 2015 survey, but depending on the scenario, there were again indications of a continued decline in earnings in the German banking industry. All in all, the institutions are expecting pre-tax profits to decline by 9 percent by 2021. If the business volume is expanded by approximately 10 percent, as planned, in the same period, profitability would fall by 16 percent. These developments would be driven in particular by increases expected in valuation allowances, for which an amount of €5.2 billion has been determined for the period to 2021.

Stress test

In order to estimate how a deterioration in the economic environment could impact on the capital resources of institutions, BaFin also performed a stress test as part of this survey. This involved BaFin examining the resilience of the credit institutions in various stress scenarios, which included interest rate, market and credit risk. The objective of this was to establish how effective the capital adequacy of the credit institutions was in cushioning these stress factors.

Good resilience in most institutions

An encouraging result was that most small and medium-sized institutions in Germany were more resilient than at the time of the last stress test. "Even in a post-stress scenario, most of the institutions have a strong capital base and continue to be able to exceed their supervisory capital requirements", explained Raimund Röseler, Chief Executive Director of Banking Supervision. The post-stress Tier 1 capital ratio is 13.3 percent across all participating banks. "However, about 4.5 percent of the participating institutions are unable to meet their Pillar I and II capital requirements plus capital conservation buffer in a stress scenario, even if hidden reserves are taken into account", cautioned Röseler.

The most evident effect seen in the stress test was the impact a sudden increase in interest rates would have on valuations. Such an increase also had a short-term negative impact on the banks' net interest income. In terms of market risk, the stress test effects are caused by interest-bearing and non-interest-bearing exposures in approximately equal measure. However, non-interest-bearing exposures only account for about one fifth of the portfolio and thus make a disproportionately large contribution to the stress effect. The credit risk stress test shows that the banks are well prepared for a sudden increase in credit risk. In this category, it was above all the positive macro-economic performance that had a beneficial effect.

BaFin uses the risks identified in the stress test to measure the supervisory target equity ratio. This ratio is a valuable early warning indicator for supervisors and as such contributes to further strengthening the stability of the German banking market. BaFin subjects institutions that are particularly vulnerable to even closer supervision.

Ways out of low earnings

Under growing pressure from low interest rates, banks are increasingly charging fees – "a development which is being viewed critically by the public, who have got used to receiving many banking services for free", remarked BaFin President Hufeld.

Their attitude was understandable, but short-sighted, he continued: if people wanted to be customers of healthy banks or savings banks, they had to accept that the institutions would impose prices in line with their expenses and open up new sources of income if old ones dried up. The fact that the most recent low interest rate environment survey has produced a more optimistic result than the two previous ones has shown, at any rate, that these measures can bear fruit. If the economic tailwind lessens, the pressure on institutions' earnings could rise again.