German regulator calls on banks to reserve windfall profits for potential losses

The banking industry has been thriving in recent years as interest rates rise and central banks tighten monetary policy. However, despite the bumper profits, the head of the German regulator, BaFin, is warning that banks need to be prepared for potential difficulties ahead.

The impact of higher interest rates on clients’ ability to repay loans, particularly in the real estate and real economy sectors, has yet to fully materialize. This means that banks should not be solely focused on increasing shareholder profits, but also allocate a substantial portion of their profits to provisions for potential loan defaults.

While it’s undeniable that banks have enjoyed substantial profits, the head of BaFin suggests that they should be cautious and set aside funds to deal with the costs that are likely to arise due to ongoing historically high interest rates.

For instance, Germany’s largest lender, Deutsche Bank, announced a 1.031 billion euro ($1.12 billion) net profit and plans to increase and accelerate shareholder payouts. While the profits are considerable, it is important for banks to consider the potential costs that might arise in the future.

Amidst these considerations, the euro zone economy is projected to be in recession, and many banks, despite being in the midst of higher interest rates, have not significantly increased their loan loss provisions. It is expected that they will need to start doing so this year, and some may have already begun setting aside more money for bad loans.

The head of BaFin also emphasized the importance of investing in operational security and stability, particularly in protection against cyberattacks, and echoed concerns about anticipated rising company insolvencies, which have been largely kept artificially low due to past government stimulus and extremely low interest rates.

It is crucial for banks to exercise caution, be prudent in their financial planning, and prepare for the potential costs that may arise as a result of persistent high interest rates. By doing so, they can ensure they are well-prepared to weather the challenges that lie ahead and maintain stability in the face of the ongoing economic conditions.

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