A financial regulator must always expect the unexpected.

That said the President of the Federal Financial Supervisory Authority (BaFin), Mark Branson, on Monday at the New Year's reception in Frankfurt.

For him, this means running through various scenarios, even those that seem to be contradictory.

He currently includes interest rate risks in this category, after the turnaround in interest rates had already weighed on German banks last year.

Markus Fruehauf

Editor in Business.

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On the one hand, the higher interest rates ensure rising income, on the other hand, they are associated with bond price losses.

These have led to valuation losses in the banks.

"For many smaller banks, the hidden reserves as the first line of defense are now depleted," Branson said.

In close observation

"We are now primarily concerned with the capital planning of institutions with little excess capital and high interest rate risks." If interest rates continue to rise rapidly and significantly, he believes the stress for the institutions will increase - especially for those who no longer have any reserves , little excess capital and larger open interest positions.

These institutes are currently being monitored more closely.

The valuation losses had a short-term impact on the profitability of the smaller banks in particular, whose after-tax earnings were negative on average in the first nine months.

The former head of the Swiss Financial Market Authority admitted that with each interest rate shock, the next interest rate shock would become less likely.

But Branson, who has headed BaFin since August 2021, referred to recent statements by central bank representatives that market participants should reconsider their position on this.

At the World Economic Forum in Davos last week, the President of the European Central Bank (ECB), Christine Lagarde, called for further trade in the fight against inflation.

Higher bankruptcy risk

As a further focus of BaFin this year, its President named the credit default risks of German companies.

"You could almost get the impression that the German economy and the banks are immune to it," said Branson.

He attributed the fact that loan defaults hardly increased during the Corona crisis to “corresponding stimulants” – state aid and interest rates that were still low at the time.

But with the probable cooling of the economy, the risk of insolvencies has increased, he says.

He sees the highest risk of default in SMEs and energy-intensive companies.

In his view, the downturn can cause problems for the construction industry, manufacturing industry, the chemical industry and the energy supply companies.

Banks have to take more precautions

"Banks need to be prepared for that," Branson said.

He again criticized the current risk provisions as too low.

However, institutes increasingly demanded higher risk premiums and higher collateral from borrowers.

"BaFin will check carefully whether that's enough."

According to Branson, the yield curve that has been inverted for several months, in which short and long-term interest rates are higher, makes maturity transformation more difficult and reduces or shifts part of the positive effect of rising interest rates.

However, the supervised institutions would benefit from these in the long term.

Life insurers no longer need the transitional measures for the new capital adequacy requirements (Solvency II).