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German Central Bank Warns of Strains From Low Rates European Banking Unity Is No Easy Target
(about 9 hours later)
FRANKFURT — A week after the European Central Bank cut its main interest rate, the German central bank warned on Thursday that banks and insurers in the country were under severe strain because interest rates were too low. FRANKFURT — Low interest rates have a dark side, the German central bank warned on Thursday, sounding a gloomy note as European finance ministers gathered in Brussels to discuss the politically tricky question of how to share responsibility for fixing sick banks.
In its annual Financial Stability Review, the Bundesbank said the record low official rates had eroded profits of German banks, which traditionally generate most of their revenue from loans and can no longer charge high enough interest to make a profit. Given that some German banks are among the euro zone’s sickest, the confluence of events was a reminder of what is likely to be a long, hard struggle for the European banking system to regain its health.
In addition, the Bundesbank said, German insurance companies are suffering because they cannot earn a reasonable return on money they collect in premiums and reinvest in safe assets. The low rates are a particular problem for companies offering life insurance that pays an annuity when the insured person reaches retirement, the Bundesbank said. A week after the European Central Bank cut its benchmark interest rate to 0.25 percent, the German Bundesbank issued a report on Thursday saying that banks and insurers in Germany were under a severe strain because interest rates were too low.
Andreas Dombret, a member of the executive board of the Bundesbank, said he thought the E.C.B. rate cut last week was justified because inflation was well below the official target of about 2 percent. But he said it was important to recognize that the low rates also have negative consequences. German banks, which traditionally generate most of their revenue from loans, can no longer charge interest high enough to make them as profitable as they need to be, the Bundesbank said. And German insurance companies are having trouble earning enough interest to deliver promised returns on life insurance policies.
“Low interest rates are making it more and more difficult for life insurers to generate guaranteed returns,” Mr. Dombret said. “The low-interest-rate environment is placing a growing strain on the German financial system.” The Bundesbank report illustrates how difficult it is to write policy that will help rebuild the euro zone’s damaged banking system. What may be good for banks in some countries can be bad for others.
Last week, the European Central Bank cut its benchmark interest rate to a record low, putting its main rate at 0.25 percent, down from 0.5 percent. The rate cut was the first since May and the fifth since Mario Draghi became the E.C.B.'s president in 2011. “When one looks at the low-interest-rate environment, one is tempted to say: One person’s joy is another’s pain,” said Andreas Dombret, a member of the executive board of the Bundesbank.
The central bank was reacting to a sudden drop in euro zone inflation, which fell to an annual rate of 0.7 percent in October, well below the bank’s official target of about 2 percent. The decline raised the specter of deflation, a sustained fall in prices that can destroy the profits of companies and the jobs they provide. He and other Bundesbank officials were careful not to criticize the European Central Bank. Mr. Dombret did not comment specifically on last week’s decision to cut rates, but said he thought that low interest rates were justified because inflation was extremely low. Still, he said it was important to recognize that the low rates also have negative consequences.
“The low-interest-rate environment is placing a growing strain on the German financial system,” Mr. Dombret said.
The Bundesbank warning came as euro area finance ministers began meetings in Brussels that will include work on the creation of a banking union to replace the current Balkanized system. Europe’s dysfunctional banks and the inability of many of them to issue credit are major impediments to growth, which was only 0.4 percent in the 17 euro zone countries on an annualized basis in the third quarter, according to official data published Thursday.
One goal of the meetings, which will continue on Friday with the arrival of 11 other finance ministers from the European Union’s noneuro countries, is to agree on how to help banks that are deemed short of capital, as a result of a review by the E.C.B. In that review, which is about to begin, the central bank plans a thorough assessment of about 130 of the zone’s largest banks to determine if any have hidden problems and need to be recapitalized or shut down.
The finance ministers are expected to seek agreement to give countries with failing banks limited access to a shared pot of European money. The ministers may also announce an accord making clear that creditors of failing banks will have to suffer and that national funds must be used before a country is permitted to apply for European funds as a last resort.
The ministers could also recommend measures that would encourage mergers and acquisitions among banks from different euro zone countries, Mujtaba Rahman, the director for Europe of the Eurasia Group, a political consulting firm, wrote in a note to clients on Thursday.
Takeovers of weak banks by stronger ones would be another way to address problems in the euro zone financial system, as well as to reduce the oversupply of banks in countries like Germany, which makes it difficult for them to be profitable.
During the two days of meetings, the ministers will also try to make progress on creating an agency that could make decisions about when to restructure failing banks and could reduce pressure on taxpayers to bail them out. Countries remain far from an agreement on the so-called Single Resolution Mechanism, which European finance ministers have said they want in place by the end of the year. If the ministers cannot agree in coming weeks, European Union leaders might be left to decide at a meeting in December.
The seemingly endless debates among the bloc’s finance ministers highlight a deepening gulf between countries like France, which advocate rapid access to shared European resources in the name of solidarity, and Germany, which remains reluctant to open the spigot because of fears it may be difficult to turn off.
The standoff is undermining the broader plan for a banking union in Europe that is aimed at breaking the link between banks and heavily indebted states, which has threatened to sink the single currency.
When the central bank cut its benchmark interest last week, it was reacting to a sudden drop in euro zone inflation, which fell to an annual rate of 0.7 percent in October, well below the bank’s official target of about 2 percent. The decline raised the specter of deflation, a sustained fall in prices that can destroy the profits of companies and the jobs they provide.
Despite the extremely low rates, though, a scarcity of credit for small companies continues to plague the euro zone economy, the central bank said in a report it published Thursday.
The central bank surveyed 8,300 companies, most with fewer than 250 employees, on their access to credit. The companies reported that loans continued to become harder to get and that market interest rates rose.
Banks in Italy and other countries in Southern Europe are still struggling with huge portfolios of bad loans and are short of money to make new loans. At the same time, many companies have scant profits and so are not considered creditworthy. Those problems have largely nullified the effects of a succession of E.C.B. rate cuts.
German companies, by contrast, said that credit had become more available, according to the survey, in another indication of the big gap in economic performance between Northern and Southern Europe.
The problem for Germany is that interest rates are too low, the Bundesbank said in its report. German insurance companies are suffering because they cannot earn a reasonable return on money they collect in premiums and reinvest in safe assets. The low rates are a particular problem for companies offering life insurance that pays an annuity when the insured person reaches retirement, the Bundesbank said.
The Bundesbank also warned that low interest rates could fuel asset bubbles, as investors buy risky assets in a desperate search for better returns.
Partly as a result of low mortgage rates, property values in seven major German cities soared 24 percent from 2009 to 2012, the Bundesbank said, nearly five times the rate of the previous three years. They are expected to rise an additional 9 percent this year, the Bundesbank said.
The German central bank said it did not think the increase in property prices had become a threat to financial stability yet. But, Mr. Dombret said, “We will continue to keep a close eye on the situation.”

Jack Ewing reported from Frankfurt and James Kanter from Brussels.