The Financial Stability Committee discusses and assesses threats to financial stability in Germany based on analyses performed by the Bundesbank. In addition, its work is based to a large extent on findings of the Federal Financial Supervisory Authority (BaFin) taken from its supervisory activities in the banking, insurance and securities sectors.
Shocks, vulnerabilities and resilience
The Bundesbank analyses and monitors the systemic and macroeconomic implications of the collision of vulnerabilities and shocks. It also analyses and monitors the resilience of the financial system.
Shocks are primarily understood to refer to abrupt or extraordinary changes, such as sharply falling asset prices, but also suddenly rising interest rates or risk premiums. They often follow macroeconomic imbalances that may have built up over long periods of time. Shocks can impact the financial system or individual market participants and affect the system as a result of their scale and interconnectedness. When shocks collide with vulnerabilities in the financial system, difficulties experienced by one or more market participants, or their reactions, can excessively amplify the macroeconomic impact of the original shock, thereby threatening financial stability.
Vulnerabilities can be distinguished according to their structural and cyclical characteristics. Structural vulnerabilities refer to features within the financial system that are conducive to direct or indirect contagion effects. Examples include “too big to fail” (market participants are too large), “too interconnected to fail” (market participants are too interconnected), and "too many to fail" (too many market participants take similar risks).
Vulnerabilities arising from similar risks faced by many market participants can also be cyclical in nature. Cyclical vulnerabilities typically build during economic upturns. For example, a period of sustained economic growth can result in risks being underestimated. Lending may then be excessive, leading to more loan defaults, a pronounced contraction in lending, and negative feedback effects on the real economy when an economic downturn occurs.
The extent to which shocks affect the system depends crucially on its resilience. For example, the better equipped individual banks are in terms of capital and liquidity, the better they can absorb shocks and the smaller the repercussions on other financial intermediaries. Sufficient resilience is therefore a prerequisite for the financial system’s ability to perform its functions even during periods of stress.
Evaluation
The financial system is constantly evolving. For example, it is influenced by the spread of digital technology. Analysis methods and areas of analysis must therefore regularly be examined and critically reviewed. In doing so, the Financial Stability Committee takes research and findings of relevant international bodies into account.