Insufficient loss buffers, banking supervision worried about depleted reserves

The unexpected must always be anticipated by a financial regulator. At the New Year's reception in Frankfurt on Monday, Mark Branson, the president of the Federal Financial Supervisory Authority (BaFin), made this statement.

This requires him to consider a variety of scenarios, including those that appear to be at odds with one another. He now categorizes interest rate risks under this heading because last year's interest rate turnaround already put pressure on German banks.

While higher interest rates guarantee rising income on the one hand, they are also linked to falling bond prices on the other. These have caused the banks to experience valuation losses.

According to Branson, "for many smaller banks, the hidden reserves as the first line of defense are now depleted.". According to a close examination, "We are currently mostly worried about the capital planning of institutions with little excess capital and high interest rate risks.

" possessed greater reserves, little excess capital, and larger open interest positions. Currently, these institutions are being watched over more carefully.

Particularly the smaller banks, whose after-tax earnings were on average negative in the first nine months, were negatively impacted in the short term by the valuation losses. With each shock to interest rates, the former head of the Swiss Financial Market Authority acknowledged that the likelihood of the following shock would decrease.

Branson, who has been in charge of BaFin since August 2021, however, cited recent remarks made by officials from the central banks that suggested market participants should change their minds about this. The president of the European Central Bank (ECB), Christine Lagarde, advocated for increased trade at the World Economic Forum in Davos last week.

Higher risk of bankruptcy According to BaFin's president, this year, the organization's focus will also be on the credit default risks posed by German companies. Branson observed that it "almost gives the impression that the German economy and the banks are immune to it.".

Due to "corresponding stimulants," which included state aid and the period's still-low interest rates, loan defaults barely increased during the Corona crisis, according to him. The risk of insolvencies has increased, he claims, though, as a result of the economy's likely cooling.

He believes that SMEs and businesses that use a lot of energy pose the greatest default risk. The construction industry, manufacturing industry, chemical industry, and energy supply companies could all experience issues as a result of the downturn, in his opinion.

The need for better bank preparedness According to Branson, "Banks need to be prepared for that.". He criticized the current risk provisions once more as being inadequate.

However, lenders had to provide more collateral as well as higher risk premiums in order to meet institutes' demands. Whether that is sufficient will be carefully considered by BaFin.

As a result, part of the beneficial effect of rising interest rates is diminished or delayed, in Branson's opinion, and maturity transformation is made more challenging. Long-term gains from these, though, would go to the institutions that are under supervision.

For the new capital adequacy requirements (Solvency II), life insurers are no longer required to take the transitional measures.

With each shock to interest rates, the former head of the Swiss Financial Market Authority acknowledged that the likelihood of the following shock would decrease.