German Banks’ Profitability and Loan Loss Provisions Amidst Economic Uncertainty

The banking industry in Germany experienced a significant windfall in 2023, with lenders reaping the benefits of central banks’ interest rate hikes while keeping deposit rates low. However, the president of the German regulator, BaFin, has urged caution, warning that further troubles may lie ahead.

Central banks around the world, including the U.S. Federal Reserve, the European Central Bank, and the Bank of England, have aggressively tightened monetary policy to combat soaring inflation. While economies have shown surprising resilience in the face of rising borrowing rates, many policymakers have warned that the impact on households and businesses has yet to be fully felt.

The head of BaFin, Felix Branson, told CNBC that while the shock from rate increases has been “digested in the banking books,” there could be further difficulties ahead. “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 said.

German banks, such as Deutsche Bank and Commerzbank, have reported impressive profits in recent quarters. Deutsche Bank, for instance, beat third-quarter expectations with a net profit of €1.031 billion ($1.12 billion), promptly announcing plans to increase and accelerate shareholder payouts.

However, Branson advised banks to set aside recent profits to provision for potential loan defaults as the impact of higher interest rates feeds into the economy. “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,” he stated.

The eurozone economy is projected to be in recession, with Germany in particular facing a prolonged slump. High inflation and interest rates have taken a toll on growth, with the German economy contracting by 0.3% year-on-year in 2023.

Despite these economic headwinds, many banks have yet to meaningfully increase their loan loss provisions. Branson expects insolvencies to begin rising in the coming years, and banks will need to prepare for potential credit losses. “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,” he explained.

Banks should also invest in operational security and stability, such as protection against cyberattacks, as they prepare for the more challenging times ahead.

In conclusion, German banks have enjoyed strong profits in 2023, but the economic uncertainty ahead necessitates caution. Banks must set aside profits to provision for potential loan defaults and invest in operational security and stability to prepare for the challenges that lie ahead. The impact of higher interest rates on the economy has yet to be fully felt, and insolvencies are expected to begin rising in the coming years.