It's a story which has been recurring for the last five years, and so far to little avail. As house prices across Germany continue to rise, the Bundesbank has been continually issuing warnings about a bubble developing and prices decoupling from their long-term relationship with incomes.
In its most recent Stability Report, which focuses more than usual on property, particularly residential property, the Bundesbank said that Germany's banks are increasingly vulnerable to an overvalued property market and finance authorities should force lenders to build up capital buffers.
At the start of the pandemic Germany cut the so-called countercyclical buffer for banks to zero but economic growth is now robust and bank lending is rapid, so they should be forced to hold more capital in preparation for a rainy day, warned the central bank.
The buffer, now at 0, was set 0.25% of banks' total risk exposure before the pandemic but current credit levels suggest that an even higher level may be needed, the Bundesbank added. This buffer does not explicitly take into account the booming residential property market, which requires careful monitoring and potential action by regulators, it said. Vice-president Claudia Buch said in a statement, "The countercyclical capital buffer should be built up again early on."
In the report the Bundesbank repeated its warning about the overvaluation of residential property prices and rental growth outpacing incomes. "Price exaggerations in the residential real estate market have tended to increase further, with Bundesbank estimates putting them at between 10% and 30% in Germany in 2020."
When this happens, lending banks may be overestimating the value of loan collateral, leaving them exposed to large losses in case of a price adjustment. Banks are also vulnerable to interest rate rises as large parts of their long-term lending is at fixed rates, particularly in the case of mortgages, the Bundesbank added.
The Bundesbank noted that cost of buying a house in Germany rose by an average of 6.7% in 2020. With this trend continuing in 2021, the danger of the housing market becoming overheated is real, it warns.
Lending for residential real estate has also increased in Germany, by 7.2% percent in the past year. Buy-to-let continues to be an attractive option for investors, with the Bundesbank survey highlighting how 90% of people in Germany currently expect house prices to continue to rise.
Home ownership in Germany accounts for over half of household wealth. Three-quarters of household debt is attributable to housing loans. So far, according to the Bundesbank, the debt sustainability of private households has remained solid. However, since 2018, debt has risen steadily in relation to income.
Lending standards have not yet been relaxed, notes the Bundesbank. And, since the majority of loan agreements in Germany have been concluded with long-term fixed interest rates, an increase in interest rates does not pose an acute risk. Households would even benefit from higher interest rates on the asset side in the short term.
The Bundesbank said that the country’s financial system has coped well with the coronavirus pandemic. “The extensive government measures have protected the financial sector from losses. But vulnerabilities continue to build up - to negative macroeconomic developments and especially on the real estate market." The Bundesbank is now concerned that, due to the perceived strength in Germany’s financial system, other banks may lower their standards for lending. With half of all mortgages in Germany having a fixed interest period of over 10 years, Buch cautions that "rising real estate prices can be critical for financial stability if more loans are granted with greatly relaxed lending standards and rising prices are expected.”
It is thus very important that the banks stick to their lending standards in order not to encourage over-indebtedness among borrowers and thus the formation of a bubble. However, compared to other European countries, the German real estate market is still relatively stable, the bank concludes.
