Structural Change in the German Banking System? (German Edition)

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This is preventing them from being profitable in the long run. Net interest income at German credit institutions has been shrinking for years now. To this day, they still haven't managed to refocus their strategies on the new normal, which is why their profitability has been ebbing away. Our findings show that small and medium-sized German credit institutions are expecting their profits to continue shrinking between and , according to their planning.

Monetary policymakers are a popular scapegoat for this malaise - it is their low policy rates, some say, which have caused earnings to dry up in the banking sector. But that, I feel, would be oversimplifying things. Monetary policymakers are, after all, responsible for the entire euro-area economy. Seen through that prism, banking sector profitability is just one aspect, albeit an important one. As understandable as the criticism directed at interest rate policy may seem from the perspective of German credit institutions, there's a risk they might overlook the bigger economic picture.

I say that partly for historical reasons. Interest rate levels in Germany have generally been on the wane for more than 30 years now, notably on account of demographic and macroeconomic factors. Unsurprisingly, then, the German banking sector's interest margin has been steadily narrowing for more than 30 years as well. Hence, accommodative monetary policy is just one - albeit important - aspect. That said, interest-driven business models have been under pressure for quite some time already. And yet we are seeing very little in the way of adjustment. The business models of small and medium-sized German institutions, in particular, tend to be more reliant on interest business than those of their international peers, despite the fact that some of them can generate sufficient profits even in this challenging setting.

My conclusion, then, is this. Excessively interest-heavy business models are particularly exposed to structural change.

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It is becoming increasingly important to tap new sources of income. One simple escape route out of this malaise, it would appear, is a flight into risk - the search for yield is what I'm talking about here. My second theory, then, is this. Banks and savings banks would be unwise to escape from structural change by fleeing into risk. And the longer the low-interest-rate environment persists, the greater the risk of institutions taking on excessive risk.

After years of de-risking, we are now seeing the first signs in Germany of a growing willingness to assume risk. Prices in financial markets are leaping from one all-time high to the next - the only thing is, volatility is conspicuously low, despite the absence of a consistently robust economic and political backdrop.

What's the story for banks and savings banks? Interest rate risk remains at an elevated level. In real estate business, there are budding signs that institutions are softening their credit standards. Our low-interest-rate survey likewise points to an increase in risk propensity. One-third of small and medium-sized German credit institutions are planning to increase their business volume and risk taking.

However, they do not wish to increase their capital to the same extent - in the medium term, that will erode their resilience. As we all know, one swallow does not make a summer.

EconStor: Structural Change in the German Banking System?

And yet caution is warranted on two counts. For one thing, banks and savings banks need to meticulously check whether they have tabs on the effects of the risks in their portfolios and can handle them when a crisis strikes. For another, taking on more risk - be it through portfolio shifts or extending the balance sheet - does nothing to resolve structural issues. At best, it will provide short-lived respite from earnings problems. And that brings me to my third theory. If banks and savings banks are to fix their earnings problems once and for all, they will need to tap new sources of income and be open-minded to new forms of value creation.

And I dare say that simply hiking the prices for existing services won't go far enough. Especially if competitors don't follow suit. I have little time for overblown forecasts predicting that banks and savings banks will all be replaced by fintechs in the future. Hugely successful though Amazon has been, town centres are still abuzz with shoppers. As ubiquitous as smartphones are nowadays, people continue to send letters - but mail firms need to evolve to make up for the downturn in postal business, for example, by delivering parcels sent by online mail order companies.

I firmly believe that credit institutions will continue to exist in the future - but only the ones which are willing and in a position to embrace change. No-one can say for sure what banking business will look like some years hence.

Institutions can counter this uncertainty by exploring what it is that customers - both legacy and new ones - actually want; and also by harnessing the digital expertise of fintechs instead of regarding them as some kind of nemesis. Take a look at customers and you'll see that, millennials notwithstanding, there is more than one type of customer out there.

Plenty of people still prefer to bank via traditional channels. It's just that their share will continue to dwindle - making structural change an increasingly pressing topic for institutions. I would also recommend harnessing the benefits of swarm intelligence. Open banking systems - arrangements where banks open up their data to trusted fintech partners which then provide apps for bank customers - are increasingly catching on, meaning that there is scope for new fee models and for boosting customer satisfaction.

Open banking systems do have their risks, though - in this case, cyber risks. I am pleased to note that our low-interest-rate survey shows that institutions are planning to step up investment in this field - but at present many of them are still vulnerable. This is a hugely important topic to me because I feel it is still being neglected. We intend to increasingly probe the extent to which credit institutions can handle cyber attacks.

IMF Staff Country Reports

Yet at the same time, supervisors are keen to take account of the competitive environment. The Single Supervisory Mechanism, of which we are a member, today released a consultation on guides concerning the assessment of licence applications - and this explicitly also addresses the question of fintech credit institution licence applications.

I urge banks and fintechs to use the consultation phase constructively. I come now to the cost side and to the challenge of compensating for declining income through greater efficiency. This brings me to my fourth theory: German credit institutions could provide their services more efficiently.

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Once again, I would draw your attention to the low-interest-rate survey, whose findings suggest that small and medium-sized German institutions are expecting their cost-income ratio to increase. Unfortunately, this puts German credit institutions at the bottom of the European league. If the cost-income ratio remains poor because of a failure to significantly bring down administrative costs, then more has to be done. I fully support those institutions which are doing just that, but I have to say that there are still many institutions which are not. And I am talking here about all three pillars of the German banking system, although perhaps not to the same extent in each case.

Germany : Technical Note on Banking Sector Structure

We point out these differences in our conversations with the sector associations, and I hope that what we tell them sinks in, because differences can definitely be a sign that more has to be done in some quarters than in others. Banks and savings banks will have to become even more efficient, and they will have to do so in a new, tougher regulatory environment.

What I am getting at here is that the regulatory framework cannot be loosened so as to allow inefficient institutions to kick structural change into the long grass. I readily admit that credit institutions incur costs because of regulation and oversight. But a bank or savings bank which cannot survive in an effective regulatory and supervisory environment needs to urgently rethink its business model. It goes without saying that adapting to the new regulatory requirements is a mammoth task, and the uncertainty surrounding the regulatory reforms which have yet to be put in place is clearly a problem.

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