Real economy and banking industry

In the spring of 2020, virtually all areas of economic activity and everyday life were affected by the novel coronavirus pandemic. In an effort to contain the spread of the virus and avoid healthcare systems becoming overwhelmed, the governments of many countries implemented measures that severely restricted personal contact. This caused disruption in production and supply chains and diminished opportunities for consumers to spend money. Just like many other countries, Germany has adopted extensive support measures to mitigate the economic fallout from this crisis, such as the fiscal stimulus package announced by the German government at the start of June, which comprises a total volume of €130 billion.

Nonetheless, a significant decline in Germany’s economic output for 2020 as a whole seems inevitable. Among the indicators pointing in this direction is industrial output, which – adjusted for inflation and seasonal and calendar factors – recorded an exceptionally sharp month-on-month decline in April 2020 (down by 22.1 percent). However, it can be assumed that this marked the low point of the economic slump. In light of steps implemented in the meantime to gradually ease containment measures and the resumption of production in the all-important automotive industry, the German economy should begin to recover in the second half of the year. For a variety of reasons, it is difficult to quantify the impact of the coronavirus crisis on Germany’s overall economic performance in 2020. For example, consumer freedoms and production might have to be restricted again in the future depending on how the pandemic unfolds. This would severely affect the economy.

Taking account of the extreme level of uncertainty, the Deutsche Bundesbank (Germany’s central bank) presented a variety of economic outlook scenarios as part of its projection published at the start of June. However, these scenarios did not account for any effects of the fiscal stimulus package that was adopted in early June. According to the projections of the Bundesbank, the coronavirus pandemic is triggering a deep recession in the country. The baseline scenario, which is regarded as the most likely case, assumes that the recovery will be slow at first, as the negative effects caused by the pandemic will diminish only gradually. Adjusted for inflation, Germany’s gross domestic product (GDP) for 2020 is expected to shrink by 6.8 percent year on year in this scenario. The recession will also leave its mark on the job market and consumer prices. In the baseline scenario, the unemployment rate would rise to 6.1 percent on average for 2020 as a whole. The rate of inflation, based on the Harmonized Index of Consumer Prices, is expected to fall to 0.8 percent due to the coronavirus-induced oil price crash. The baseline scenario also assumes that an effective medical solution to the pandemic will become available in mid-2021. This would provide a fresh boost for the recovery, resulting in predicted GDP growth of around 3.2 percent in 2021.

As the likely economic impact of the pandemic became clearer, the ECB responded by adopting a comprehensive quantitative easing program. At its meeting on March 12, the ECB Governing Council announced the expansion of its targeted longer-term refinancing operations for banks and the expansion of its existing asset purchase program by €120 billion until the end of 2020. On March 18, the ECB also announced an additional asset purchase program with a volume of €750 billion. This second program was increased by a further €600 billion on June 4 and is scheduled to run at least until the end of June 2021. In light of the crisis, German government bonds remain in demand as a safe haven. Consequently, yields on Bunds with long maturities will probably remain in negative territory.

The aforementioned negative influences on the overall economy will also have an impact on the banking sector. The financial situation of most companies and their employees, who form the customer base of the banking industry, is going to deteriorate – in some cases significantly. In all probability, this will be reflected in a rising number of insolvencies in 2020. The institutions will thus have to be prepared for a marked increase in risk costs and a migration in the ratings of many borrowers. In addition to the increase in counterparty risk, it is also likely that consumer demand for long-term investments will diminish. This would have an adverse impact on banks’ net fee and commission income. Growth in demand for lending is going to be affected by the deterioration in economic circumstances of many consumers who have been placed on short-time working or become unemployed. On the other hand, demand from corporate customers for loans is expected to increase in the wake of the coronavirus crisis and demand for real estate loans should remain stable. This should more than offset the aforementioned negative effect.

Efforts to address the challenges described above will be made more difficult in 2020 by what is expected, from the current perspective, to remain a comparatively low level of nominal interest rates. This will be accompanied by a relatively flat yield curve and will prevent any significant increase in margins in interest-related business. The statements are based on a current assessment of the ECB’s monetary policy, which will remain expansionary because of low inflation rates in the eurozone. Interest rates are not expected to return to normal levels in the medium term.

In 2020, banks are continuing to address the persistently high pressure on earnings by taking steps to improve their efficiency with the aim of reducing costs. There will continue to be mergers for economic reasons, and reviews of the appropriateness of the branch networks remain on the agenda. The trend toward greater digitalization can be expected to accelerate, especially in light of the reduction in personal contact due to the pandemic. Customers are also pushing for progress in this respect. The increase in the online use and electronic purchase of banking products probably also means that the number of employees required in the financial sector is going to continue to fall.

In addition, the financial sector continues to face the now even more pressing challenge of having to defend existing business models against those of technology-driven competitors and adjust to new customer needs. Substantially improving efficiency by digitalizing business processes and IT processes will be a crucial lever. The corresponding capital investment is initially likely to push up costs in the industry before the anticipated profitability gains can be realized.

In addition, risks arising from events with an impact on the global economy that were already known before the coronavirus crisis continue to apply and intensify the threat to the economic health of the banking sector. More specifically, this includes persistent uncertainty about Brexit, the continued lack of any prospect of interest-rate rises, Italy’s increasingly precarious economic situation and its potential implications for the eurozone, and uncertainty in connection with the trade dispute between the US and China.

Management Report 2019