The Financial Stability Report recently published by Deutsche Bundesbank can be read to say that there is no acute threat to financial stability at present, but there are indeed a series of risks that bear monitoring. We share this assessment. From our viewpoint, the extremely low interest rates (for which the ECB is partly responsible given its monetary policy) are among the single greatest dangers to the stability of the financial markets in both Germany and Europe.
The consequences of low interest rates include massive forfeited interest income on the part of citizens, something that makes establishing provisions for old age difficult. Another impact is the huge bottleneck in financial investments that can be seen from the fact that already one quarter of private monetary assets are parked in sight deposits and cash. Life insurers are also busy hunting for profitable investments, and are finding it ever harder to generate the guaranteed interest that they have promised. Banks bemoan the narrowing interest spread and the greater risks of changes to interest rates: If clients increasingly shift their deposits into money due daily and at the same time the long maturity periods for loans continue to grow, then this leads to a “balancing act for terms” that is increasingly difficult to master.
The hunt for higher returns triggers rising demand for equities and property. As a result, the dangers of asset price bubbles and the misallocation of capital likewise increase. In fact, the stock market showed signs of overheating in 2015. At present rocketing property prices in conurbations are also a cause of concern. By contrast, it is hard to discern any massive misallocation of capital because investments in the German economy are as a whole somewhat weak. This relates to both government infrastructure investments and house building, which despite having picked up still lags behind actual needs.
The ECB’s monetary policy is intended to prompt banks to increase the number of loans they approve and thus to stimulate investments. Given the central bank’s immense outlays, the successes are somewhat modest. At the same time, the above-mentioned side-effects have come into play. The longer the phase of low interest rates persists (and the faster and more vigorous the subsequent rise in rates), the greater the potential pent-up danger. This applies to both the risk to banks of rates changing and the dangers that would result from property prices slumping.
The scope of monetary policy remains constrained. The fact that loan approvals have not really taken off is due, among other things, to the low demand for loans owing to weak investments. In Italy and elsewhere, things are compounded by the problems banks face. Monetary policy cannot substitute for implementing the reforms needed. Given growing risks, a cautious start should be made as soon as possible to terminating the extremely relaxed monetary policy. At the same time, efforts must be made to improve the health of the banking sector in the countries affected and the pedal be pushed on economic policy reform. Germany also needs reforms, as is shown by exaggerated regulations that impede investments. This applies to building regulations, for example, that make it hard or more expensive to build houses. Or the residential property loans guideline, which is far more restrictive than it needs to be.