Why German banks were so weak in the resistance test

"In the particularly strong slowdown scenario that hit Germany, all German banks have held up well," says Raimund Röseler, supreme bank supervisor of financial supervision, Bafin. And finance professor Sascha Steffen of the Frankfurt School of Finance notes: "Overall, the stress test is not very significant."

The interpretation of results is therefore an issue of approach. The following six questions play a central role:

How were the German banks cut?
The stress test examined the extent to which financial margins of financial institutions would decline in the event of a significant economic downturn. For the eight participating German banks, the gross capital ratio decreased by an average of 5.2 percentage points in the crisis scenario. The losses were therefore well above the European average of 3.95%.

NordLB and Deutsche Bank were the weakest on the domestic market. In the crisis scenario, the rigid core capital ratio dropped to 7.1% and 8.1%, respectively. This makes NordLB and Deutsche Bank one of the ten lowest of the 48 participating institutions.

The simulated economic recession is different in each country, but the results of banks in different countries are only partially comparable.

What about the rate of debt?
Most badysts focus on capital ratios when evaluating stress test results. But some experts believe that the leverage ratio is actually the most informative measure. The leverage ratio is the ratio of equity and the total exposure of a bank. The degree of risk of institutions in the estimation of certain positions is therefore not taken into account in the leverage ratio, unlike the capital ratio.

The Eba test also examined the changing leverage ratio of banks in a crisis scenario. And here, German banks performed even less than the capital ratio.

NordLB, which dropped to 1.83% in the crisis scenario, is the weakest bench of all tests in this category. Deutsche Bank stands at 2.61% from the penultimate rank. In addition, BayernLB and DZ Bank are two other German institutions in the last ten places.

"The performance of German banks is bad," says finance professor Steffen. "This shows that in Germany we should not point fingers at other banks in other countries, but that banks and regulators still have to do a lot of chores here."

Why did the German banks do so badly?
In the crisis scenario, a stronger economic decline was simulated in Germany compared to other countries in which the economy does not work as well as in the Federal Republic. In addition, a collapse of the global economy has been simulated, which would have been particularly hard on the German export-oriented economy. "Unlike the previous resistance test, the scenario of German banks has proved much more difficult," said Bundesbank Managing Director Joachim Wuermeling.

In addition to the severe crisis scenario, the weak performance of German banks is also due to another reason: their low profitability. Because Eba badumed in its test that the financial institutions of the years 2018, 2019 and 2020 were generating as much profits as in 2017 – which was not much for many German currency houses .

The low profits of the German banks could therefore only mitigate the losses resulting from the crisis scenario in a limited way, explains Philipp Wackerbeck, a partner at Strategy & Germany. "These loss effects are therefore starting to feed the local banks' own funds fairly quickly."

Were the scenarios too hard or too soft?
Many German banks criticize the stress scenario as too hard and far from reality. Assumptions in the test are "very unlikely to evaluate," said the German banking sector. In addition, it is badumed that the institutions themselves would have no opportunity to react to negative economic development, for example by reducing risks or increasing their own funds. "For a period of three years, it's also an badumption that seems very unrealistic."

Professor Steffen, however, does not consider the test too difficult. "The scenarios were perhaps more rigorous than in previous years, but not really in Europe in the event of a crisis such as 2008/2009 and 2011/2012."

The green politician Giegold would have liked even more difficult badumptions. "Eba defines stress as a normal major recession," said Giegold. It has not tested a serious financial crisis such as 2008. "It also has not tested any sovereign debt crisis in Italy, no chaotic scenario on the Brexit, no contagion of bankruptcy." a very big bank, no shock overheating interests. " But that could happen according to Giegold during the next recession.

What are the consequences of the test?
Banks could not fail the stress test in 2018. But regulators have included the results in the annual badessment of the institutes. Banks that have performed poorly in the test must therefore be prepared to meet higher regulatory capital ratios in the future.

"For most European banks, capital reserves exceed expected losses in Eba's hypothetical crisis scenario," adviser Wackerbeck said. "Nevertheless, regulators should address each European bank and demand a reinforcement of capital or a reduction of risks."

The German resistance tester NordLB has been looking for investors for a long time to strengthen its capital position. The result of the bank's stress test is in line with expectations, said CEO Thomas Bürkle. NordLB will continue the planned capital reinforcement and present a viable solution by the end of the year. "The process of calling offers with potential investors launched in this context is proceeding as planned and is promising," said Bürkle.

What should banks do beyond this?
From the Regulators' point of view, the results of stress tests show that the resilience of German banks has increased in recent years. "Since the end of the financial crisis, a targeted capital formation and firm supervision have helped to achieve this goal," said Bundesbank CEO Wuermeling.

Experts like Wackerbeck think this is similar, but they are now asking that institutions focus more on higher profits. "The regulatory agenda should not prevent banks from taking profitability measures," said the advisor. "Sustained profitability, below average, remains the Achilles' heel of German institutes."

Deutsche Bank has the same aspect. The stress test showed that the risk profile of Germany's largest financial institution is sound, says CFO James von Moltke. "But we're not profitable enough yet, it's exactly what we're working on now."