The economy is faltering. This is placing a strain on many German companies. It can also become a risk for their associated credit institutions. The number of company insolvencies, though still low, is growing steadily. Many industries are suffering from inflation and the rise in labour costs. Energy-intensive industries are struggling with particularly high prices. And the increasing trade restrictions are putting pressure on those companies that are strongly focused on exports. All of this may impact the credit portfolios of financial institutions.

What is more, the government’s generous pandemic assistance programmes are now a thing of the past. This could lead to an increase in credit defaults for the companies that received this support. Retail institutions in particular should closely monitor the developments in the residential property market. The weaker new business could, in turn, weaken the institutions’ income. And if the downturn puts pressure on consumers’ income, there will be a rise in credit defaults. Extensions will pose risks for institutions as well.

The situation is being exacerbated by geopolitical challenges. The human toll of these wars and conflicts is catastrophic in any case. Economically, Russia’s war of aggression against Ukraine is impacting Germany’s financial institutions via second-round effects – such as even higher energy prices and shrinking demand.

Institutions need to make adequate provisions

In the conflict between China and Taiwan – as in other places – there is the threat of sanctions spiralling out of control and protectionism becoming the order of the day. If Taiwan were to be isolated, this could result in disruptions in microchip production, which is so important for many German companies. In the war between Israel and Hamas, there is still a material risk that the conflict will spread to neighbouring countries, which could trigger adverse second-round effects.

It goes without saying that BaFin is keeping a close eye on credit institutions with an especially large stake in companies from the sectors or regions affected. More than anything else, however, it will ultimately be up to the institutions themselves: they must be prepared for new periods of bad weather. They need to make adequate provisions for risk.

Credit institutions have begun to prepare at least for a rise in insolvencies: loan loss provisions rose sharply at the end of 2023. Furthermore, German institutions have tightened their credit standards. They are having to perform a balancing act: standards that are too lax run the risk of increasing credit defaults, but standards that are too strict might reduce income.

Banks will be facing stronger headwinds. They are currently still reporting record results. But these are ideal conditions – now is the time to prepare for hard times ahead.