For years, the ECB has been keeping interest rates at very low levels, driving up equity and real estate markets in the process. Now the countercyclical capital buffer is being introduced to rectify this situation. The objective is to build up reserves in the banking system at times of economic expansion in a preemptive measure to cover losses. Once the cyclical systemic risks have been reduced, the buffer can be lowered again. In this way, the real economy is to be ensured a steady provision of credit, especially during periods of stress.
According to a recommendation of the German Financial Stability Committee (Ausschuss für Finanzmarktstabilität, or AFS), the domestic countercyclical capital buffer is to be activated from the third quarter of 2019 and set at 0.25%. From this date, banks in Germany will have twelve months in which to meet the additional capital requirements. The AFS justifies the decision by referring to the cyclical systemic risks that have built up during the long period of economic upswing, and the low interest rates. It cites the following: potentially underestimated credit risks, overvalued loan collateral as a result of rising real estate prices and interest rate risks.
The German economy is indeed in a long phase of expansion. Credit markets are growing strongly and real estate prices have risen significantly. Even so, economic growth in Germany is expected to weaken further from 1.4% last year to around 1% this year. Credit markets have also already shifted in the direction of slower growth: corporate lending peaked in December of last year at an adjusted 12-month growth rate of 6.5% which then weakened to 6.0% by March 2019. Growth in loans to private households already peaked in November 2018 at 3.9% and has remained at this level ever since. Viewed in a historical context, the current growth rates of the economy and credit markets are also not showing any signs of overheating either.
On the other hand, the increase in real estate prices in some big cities does indeed give cause for alarm. The price rises are primarily attributable to an insufficient supply of real estate. A shortage of building land, capacity bottlenecks in the construction industry and a proliferation of building regulations are the reasons why new residential construction is unable to keep pace with demand. However, the upward price spiral has already weakened up thanks to the growing number of new buildings and high price levels. On the other hand, there is nothing to suggest that capital is being misallocated into the construction of housing that no one needs. Quite the contrary in fact, there is still not enough housing being constructed. A countercyclical capital buffer with the power to effectively curb lending would exacerbate the problems in the real estate and housing markets. The only way to lastingly halt rising rents and real estate prices is to ensure that new housing is constructed in line with demand.
The good news is that most credit institutions are able to meet the tighter capital requirements with the surplus capital they have already accumulated. This will temper the decelerating effect on the lending activities of banks in Germany.