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Low rates making conventional banking 'substantially more difficult:' Aareal CEO

The low interest rates applied by the ECB were of "great help" to the financial system during the financial crisis, but now, more than a decade on from the credit crunch, the side effects are growing stronger, Aareal Bank AG CEO Hermann Merkens told S&P Global Market Intelligence.

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Aareal Bank AG CEO Hermann Merkens

Source: Aareal Bank AG

The long period of persistently low rates poses a considerable challenge to banks and makes the "conventional banking business substantially more difficult," Merkens said in a written comment. Savers in the eurozone are also increasingly affected as the low-rate environment is set to continue for longer, he added.

The ECB cut its deposit rate by 10 basis points on Sept. 12, pushing it further into negative territory to -0.50%. The bank last rate cut was in 2016.

ECB President Mario Draghi said the concern about potential negative side effects of the continued accommodative policy of the central bank is "well placed" and noted the ECB is monitoring these side effects closely. However, this is not a reason to change the whole course of action but rather act on individual threats when they are identified, the ECB chief said.

A particular side effect of the ECB's negative rate on deposits which banks hold at central banks has been that lenders have gradually started to pass on the extra costs to clients. So far, banks across Europe have largely applied negative rates on corporate client deposits rather than on retail customer holdings.

Deposit charges

Aareal Bank charges its corporate clients fees. The bank does not engage in conventional deposit-taking business with retail clients as it services the housing industry and the utility sector in Germany, Merkens said. The bank now charges fees on the deposits of institutional housing companies it holds, he added.

However, worries about imminent extra charges to retail customers have increased as the ECB's low-rate policy continued. The German government had recently even proposed to ban banks from charging negative rates on retail deposits to ease savers' fears.

German Finance Minister Olaf Scholz reassured German savers ahead of the ECB monetary policy announcement, telling local newspaper Passauer Neue Presse there is no risk of a country-wide application of negative rates on retail deposits. Most contracts which retail clients have with their banks do not even allow negative rate charges, Scholz said but noted the government is closely following the situation and is exploring potential measures, according to the report.

In a Sept. 12 policy statement, Draghi said the two-tier system for bank deposit holdings at central banks, which exempts part of credit institutions' excess liquidity holdings, is meant to mitigate the effects of the negative rates.

Banks' themselves have to tackle own structural issues before blaming their lack of profitability entirely on the low rate environment, Draghi said.

Non-rate dependent business

Aareal Bank, for its part, has already started to look for ways to strengthen its profitability by focusing on the non-rate dependent business. "[W]ith our two business segments structured property financing and consulting/services, we continue to see ourselves as being well-positioned to firmly maintain our position even in a deteriorating interest rate environment," Merkens told S&P Global Market Intelligence.

The Consulting/Services segment, with the IT subsidiary Aareon at its core, is not exposed to the interest rate environment and already makes a significant contribution to the group's revenues and operating profit, the CEO said. Aareon "is the most important growth driver" for the group under the Aareal 2020 strategic program, he added.

A double-digit revenue increase at the Aareon unit helped Aareal Bank grow its second quarter net commission income to €57 million, from €51 million a year ago, according to the bank's latest earnings statement. Aareal's second quarter net interest income remained relatively stable at €134 million, compared to €136 million in the prior-year period.

Key challenges for banks in 2020, apart from the lower-for-longer rate environment, will be general political uncertainty, the economic slowdown and "the still demanding regulatory requirements," Merkens said.

Digitalization and the need to systematically adapt business models because of it is another challenge, Merkens added.