E.I.R., Strategic Alert

The Schiller Institute 

Although written in the usual understated banker language,
the 2017 Financial Stability Review of the German Bundesbank
sees risks of a financial meltdown, both in the event of a rise in
interest rates and in the continuation of a low level of interest
rates. There are several indications, according to the report,
“that risk premiums are systematically too low and risks are
therefore underestimated.”

And given the low interest rates,the solvency of market participants tends to be overestimated.The Bundesbank review warns that “risks for the stability of
the German financial system exist and could further increase”
for the two reasons cited above. “That creates the danger
that risks linked to reassessments of assets, changes in interest
rates and credit risks emerge simultaneously and reinforce
each other.”

The critical state of German banks is shown by the fact that
banks have increasingly borrowed at short-term and floating
rates, while their investments are long-term and at fixed rates,
which creates a dangerous imbalance in the event of a change
in interest rates or external shocks. Particularly exposed, the
report notes, are savings banks and credit unions. 83% of their
claims have an original maturity of over five years, while the
percentage for credit banks is only 47%.

At the same time, EIR STRATEGIC ALERT n°49 / 2017 WEEKLY NEWSLETTER 3
rates on overnight deposits “has significantly increased”.
The rate of residential housing credits with a ten-year fixed
rate has increased from 23% to 45% in the last 14 years.
Should the interest rates rise, banks will be forced to pay yields
on deposits that are higher than their return on those longterm
investments. This represents a large systemic risk, given
the volume of credits involved.

At the same time, a continued low-interest policy “could increase
the incentive to take increased risks in order to achieve
higher returns”, which would in turn create further difficulties
for the banks.

The report analyzes the price dynamics of the residential
housing market, noting with concern that housing prices in the
largest German cities were overvalued by 15 to 30% in 2016,
as compared to “only” 10-20% in 2015 (Data for 2017 are
not available, but if the trend has continued, housing should
currently be overpriced by 20-40%. ).

While the Bundesbank is warning of systemic risks, the ECB
is in a state of denial. Answering questions from members of
the Economic and Monetary Committee of the European Parliament
on Nov. 20, Mario Draghi said that he sees no bubbles
and no systemic risk.

To the question “What keeps you awake in the night”, in term
of risks for the global financial stability, Draghi answered: “Do
we see bubbles? Not so far.” Ignoring the stock market bubble,
the corporate debt bubble and the household debt bubble, he
concluded that “financial stability risks are localized…. They
are not systemic.”