The business models of German financial institutions depend critically on the presence of positive nominal interest rates. The International Monetary Fund noted in its latest Financial Stability Report that the pre-tax profits of German and Portuguese banks are most affected by negative rates.
German life insurers are also vulnerable. They have to guarantee a minimum rate of return, which is now 1.25 per cent a year. This is hard to do when the yield of the 10-year German government bond is only 0.13 per cent. Germany and Sweden are the two EU countries where life insurers face the biggest gap between market rates and guaranteed rates. To achieve the promised returns, the insurers have to take on more risk, for example by buying corporate bonds or tranches of complex financial products. If, or rather when, the next financial crisis arrives and triggers a change in the valuation of these assets, we may find that sections of the German financial sector are insolvent.
Of the German banks, the Sparkassen and the mutual savings banks are most affected. They are classic savings and loans outlets in that they lend locally and fund themselves through savings. Credit demand is more or less fixed. So when savings exceed loans, as they now do in Germany, the banks deposit their surplus with the ECB at negative rates — known as “penalty rates” in Germany. They cannot offset the losses by cutting interest rates on savings accounts because of the zero lower bound. Savers would switch from accounts to cash in safe deposit boxes.
That is from the always superb Wolfgang Münchnau at the FT. Regulatory and federalistic issues are another and underdiscussed reason why the eurozone is not an optimal currency area.