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Fifth Fi­nan­cial Sta­bil­i­ty Com­mit­tee re­port to the Ger­man Bun­destag on the fi­nan­cial sta­bil­i­ty sit­u­a­tion and trends

The Financial Stability Committee considers the German system to be stable, despite uncertainties such as Brexit and the possibility of an abrupt rise in interest rates. The Financial Stability Committee also addressed developments related to crypto-assets and the regulatory treatment of government bonds.

Despite continuing uncertainties, the Financial Stability Committee considers the German financial system to be stable (during the reporting period from April 2017 to March 2018). The economic environment in Germany is extremely favourable, as the German economy continues to grow strongly and has a broad base. However, the sustained favourable economic conditions mean that market participants could underestimate risks such as debt sustainability.

Such negative developments can be amplified in the financial system if large numbers of market participants are interconnected or exposed to similar macroeconomic risks. This can affect the functioning of the entire system and ultimately the real economy. The variety of interest rate scenarios is causing problems for savings banks and credit cooperatives in particular, and they are exposed to high interest rate risks as a result. In addition, there is still political uncertainty caused by Brexit and US economic policy.

Low interest rates are also putting considerable strain on German life insurers. Although an increase in interest rates would, in principle, have a positive effect on the solvency of life insurers, it would entail risks as well. As a result, life insurers are investing more heavily in investment funds, in part to establish buffers for future losses.

The investment fund sector has grown significantly in recent years, not only in Germany but globally as well. However, the Financial Stability Committee believes that this may increase the risk of negative liquidity spirals. These spirals could arise if funds were required to sell assets on a large scale in response to sharp rises in share redemptions. The significance of cyber risks has also increased. Accordingly, they should not only be viewed in microprudential terms but in macroprudential terms as well.

Despite their increased importance, crypto tokens do not pose a threat to financial stability at this stage. The same applies to the upward pressure on prices from the residential real estate lending sector. Supervisory authorities can use macroprudential tools in the event of a threat to financial stability. However, better data is still needed in this area.

As in previous reports, the Financial Stability Committee notes that regulatory privileges for sovereign debt continues to create the wrong incentives. These privileges stand in the way of adequately dealing with the actual default and concentration risks posed by these debt instruments. They foster a close interdependence between state solvency and the stability of the domestic banking system. This state-bank nexus has an exacerbating effect, most recently in the financial crisis and the European sovereign debt crisis. Consequently, regulatory privileges for sovereign debt instruments should be dismantled in the medium to long term.