Real economy and banking industry

Economic activity and public life in Germany continue to be dominated by the COVID-19 pandemic in 2021. However, the economic growth picture is divided. According to the spring report of the economic research institutions that contribute to the Joint Economic Forecast, German industry continued to recover from its slump in the first half of 2020. The pick-up in international business stimulated growth in industrial sectors. By contrast, activity in consumer-centric service sectors declined noticeably once again owing to the second wave of the pandemic and the tightening of infection control measures from November 2020 onward.

According to the economic research institutions, there were signs in mid-April 2021 that many of the infection control measures that had been eased in March 2021 would be reimposed once again due to the number of coronavirus cases. Any across-the-board easing of measures was unlikely before the end of the second quarter when there would be a high vaccination rate. This would lay the foundations for a broad-based upturn. The economic research institutions also believed that all restrictions would be lifted by the end of the third quarter, as the vaccination rate should be high enough by then.

The economic research institutions have significantly lowered their 2021 growth forecast for Germany because the course of the pandemic has delayed the economic upswing. Having forecast a rise in GDP of 4.7 percent in their autumn 2020 report, they predict GDP growth of 3.7 percent in their spring 2021 report.

In this spring report, the economic research institutions anticipate a rebound in the domestic labor market, which should result in an increase of 26,000 in the average number of people in employment in 2021. The spring report also predicts a 2.4 percent rise in consumer prices in 2021. This inflation will be driven by a number of one-off effects that will fade away in 2022. German public finances are expected to run a deficit of €159 billion in 2021.

Interest rates remain extremely low in the eurozone and are likely to start rising only very slowly. The ECB anticipates that key interest rates will remain at their current level, or possibly even lower, until the inflation outlook approaches and remains around the central bank’s target of close to, but below, 2.0 percent. Meanwhile, the Eurosystem continues to buy significant volumes of securities. The intention with the asset purchase program (APP) is to continue acquiring additional securities until just before key interest rates are raised. Under the pandemic emergency purchase program (PEPP), net purchases will continue until at least March 2022. The ECB responded to rising capital market rates at the start of this year by stepping up its purchases.

The predicted effects on the overall economy will also have an impact on the banking sector, whose 2021 outlook thus depends on a greater variety of factors than in previous years. The ongoing COVID-19 pandemic will have a defining influence on how the economy performs going forward. From the second quarter of 2021 onward, there is initially likely to be a rise in insolvencies following the recession in 2020 and the suspension of the obligation to apply for insolvency. This will lead to increased loss allowances. There will be no let-up in the move toward digitalization. In the most probable scenario, higher vaccination rates and thus falling coronavirus case numbers over the course of 2021 and 2022 will enable the economy to rally sharply, helping to stabilize banks’ earnings. In the negative scenario, the economic recovery will be later and less pronounced, which would mean a further marked decline in earnings in the banking industry this year.

Once again, the flat yield curve will not change significantly in 2021, although the predicted rise in the rate of inflation may provide some latitude for small interest-rate hikes. No material margin increases are expected in interest-related business, which means that, at best, interest income will not decrease. Against this backdrop, action to improve efficiency will remain the order of the day and further mergers are therefore to be anticipated.

The reduction in face-to-face contact between customers and advisors in bank branches as a result of the pandemic is continuing to fuel a clear shift to digital channels. As this is a sustained trend, many customers are now more familiar with digital channels and will carry on using them even after everything has reopened.

Volksbanken Raiffeisenbanken Cooperative Financial Network

The financial sector still faces considerable pressure to adjust as well as mounting costs caused by the need to comply with regulatory reforms and to implement structural change in response to a changing market. The regulatory measures introduced since the financial crisis have had a range of objectives, including making the financial sector more resilient in the event of a crisis, mainly through improved capital and liquidity adequacy, and ensuring that the risks arising from the business activities in the financial industry are not borne by the public sector. In addition, new competitors with approaches based on the use of technology are prompting the financial sector to scrutinize its existing business models, adapt them to new customer requirements, and substantially improve its efficiency by digitalizing business and IT processes. In 2020, a framework for strategic development was therefore put in place. A comprehensive plan of action entitled ‘Strategic agenda – shaping the future cooperatively’ will be fleshed out and implemented in the years ahead. One of the key elements will be a cooperative ecosystem that is fundamentally regional in character, at the center of which are the independent cooperative banks and their regional operations. The necessary capital spending on this strategic agenda is initially likely to push up costs in the industry before the anticipated profitability gains can be realized.

Given that monetary policy has become even more expansionary as a result of the pandemic, virtually all central banks will keep interest rates at historically low levels in 2021. This will make the tasks outlined above for the financial sector all the more difficult. Interest rates are not expected to return to normal levels in the next few years. Based on current assessments, net interest income will hold steady or decline only slightly in 2021 even though interest rates are expected to remain low. The growth trend in the lending and deposit-taking businesses will continue apace.

The Cooperative Financial Network anticipates that net fee and commission income in 2021 will be on a par with the 2020 level. The main positive factors in this income forecast are payments processing and the significant growth in the volume of assets under management and the associated volume-related income. The consequences of the latest decision by the Bundesgerichtshof (BGH) [German Federal Court of Justice] on the mechanism for changing general terms and conditions may have an adverse effect on net fee and commission income. At present, it is too early to precisely quantify the exact impact on net fee and commission income and the recognition of provisions. Further details are expected during the course of 2021. The banks will take account of the ruling in their operations in the customer business so that they comply with the requirements of the ruling in their business with consumers and business customers going forward.

Gains and losses on trading activities, which are particularly influenced by those of the Central Institution and Major Corporate Customers operating segment, will deteriorate markedly and are dependent on future volatility levels in the capital markets. Customer-driven capital markets business may again provide impetus in 2021 but this is likely to be outweighed by the absence of the positive one-off effects that occurred in 2020.

Gains and losses on investments are anticipated to decline sharply in 2021 because of the absence of positive one-off items that were recognized in 2020 and, like gains and losses on trading activities, are dependent on volatility levels in the capital markets.

Expenses for loss allowances in 2021 are likely to be at a comparable level to 2020 because of the negative consequences of the COVID-19 pandemic on businesses and consumers.

Net income from insurance business in 2021 is expected to be well above the 2020 figure. In addition to the premium growth that has been assumed in the different divisions of the Insurance operating segment, the net gains under gains and losses on investments held by insurance companies are predicted to climb very sharply.

In 2021, administrative expenses are predicted to hold steady on the whole compared with 2020. While staff expenses will decline slightly according to current predictions, general and administrative expenses are likely to remain largely unchanged in view of the required capital spending on digitalization.

The Cooperative Financial Network’s cost/income ratio is expected to rise a little in 2021 as a result of the expected slight decrease in income and an unchanged level of expenses. As before, a particular focus will be on managing costs and generating growth in the operating business.