Bundesbank Says Strong Economy Could Mask Risks for Investors

(Bloomberg) -- Germany’s Bundesbank expressed concern that investors might be letting their guard down as the economy improves and interest rates stay low.

“In this favorable environment, market participants have become more vulnerable to unexpected developments,” Bundesbank Vice President Claudia Buch said in Frankfurt on Wednesday, presenting the German central bank’s 2017 financial stability review. “Risks stemming from revaluations, changes in interest rates and credit losses could materialize simultaneously and reinforce each other.”

The warning comes as Europe’s largest economy heads for its fastest annual expansion since 2011, with unemployment levels at a record low and business confidence at an all-time high. Yet as inflation only slowly picks up in the euro area -- and in Germany -- the European Central Bank is taking a gradual approach to phasing out its stimulus and has pledged to keep interest rates low for an extended period.

Those persistently low rates might tempt market participants to overestimate their debt sustainability, the Bundesbank said, adding that the residential real-estate market in particular is a highly important area for financial stability.

It said residential real estate may be overvalued by between 15 percent and 30 percent in towns and cities, though the risks stemming from housing loans still appear to be limited.

Get Ready

The report warned that an abrupt rise in interest rates “could hit the financial system hard” and that banks might not have a sufficient buffer to cushion the blow of any economic shock as they have significantly cut their provisioning for credit risk in recent years.

Andreas Dombret, the Bundesbank board member in charge of banking supervision, said lenders must ensure they have sufficient buffers.

“Above all, banks need to ready themselves to weather a hike in interest rates in good time,” he said. Although German banks’ resilience might be solid overall, “we nonetheless continue to have our eye on the weak profitability at many German credit institutions,” that could “increase the incentive to take on more risk in order to generate higher returns.”

The ECB will publish its own financial stability report at 11 a.m. Frankfurt time. Inflation data for Germany will be released at 2 p.m.

--With assistance from Alessandro Speciale Boris Groendahl and Nicholas Comfort

To contact the reporter on this story: Carolynn Look in Frankfurt at clook4@bloomberg.net.

To contact the editors responsible for this story: Paul Gordon at pgordon6@bloomberg.net, Zoe Schneeweiss

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