Germany’s central bank has delivered one of its starkest warnings in years. In its latest Financial Stability Report 2025, the Bundesbank describes a dangerous combination of rising interest rates, overvalued markets and mounting public debt — a “toxic mix” that could trigger a new financial storm in Europe’s largest economy.
While banks, insurers and investment funds are still benefiting from higher interest margins, the report cautions that this phase may prove short-lived. Once growth slows further, credit losses and market corrections could hit the financial system simultaneously.
Interest rate shock threatens households and firms
The Bundesbank identifies the rapid shift in interest rates over the past two years as a key pressure point. Loans granted during the era of zero or negative rates are now being refinanced at much higher costs, straining companies and private borrowers alike.
“The probability of credit defaults has increased,” the report states. What currently looks like strong profitability in the banking sector may be an illusion — “a rate-driven moment rather than a sign of resilience.”
Particularly at risk: commercial real estate and loans to mid-sized companies, where refinancing challenges are growing and demand is weakening.
Overheated markets — and a looming correction
The second major fault line lies in financial markets. The Bundesbank openly warns of “excessive valuations” in both equity and bond markets.
What shines during an upswing, it cautions, can turn painful in a downturn. Should global growth cool or geopolitical tensions intensify, a sharp correction could occur — potentially coinciding with rising credit losses.
Such a combination, the report warns, could amplify stress across the system: “Credit risks and market losses reinforce each other.”
Debt policies seen as “fire accelerant”
The third and most politically charged warning concerns public finances.
The Bundesbank flags soaring public debt in Germany and across Europe as a growing structural threat. “High deficits and rising interest burdens limit fiscal flexibility and can jeopardize financial stability,” the report notes.
When governments borrow more at higher rates, bond prices fall — reducing the value of securities held by banks. The result, according to Bundesbank economists, is a dangerous “doom loop” between sovereign and financial sectors — a dynamic reminiscent of the Eurozone debt crisis a decade ago.
Property markets under pressure
Germany’s property sector remains divided: while residential markets show tentative signs of stabilisation, commercial real estate continues to deteriorate.
Vacancy rates are up, rents are under pressure, and financing costs remain high. The Bundesbank cites an “ongoing deterioration in credit quality” in the sector — another potential trigger point if the economy weakens further.
The central bank stresses that although German institutions are now better capitalised than they were in 2008, “resilience must not be mistaken for invulnerability.” In plain terms: buffers are sufficient — until a real shock arrives.
Political dilemma: fiscal restraint vs. growth spending
The report also highlights a growing political contradiction. On one side, there is pressure for greater investment in infrastructure, defence and energy transition. On the other, mounting warnings against expanding public debt. As a result, Berlin increasingly relies on special funds and creative accounting structures — workarounds that the Bundesbank views critically. It calls for “fiscal clarity” and a credible plan to secure debt sustainability before higher rates push borrowing costs even further.
“A fragile calm” in Europe’s financial core
The Bundesbank’s message is clear: Germany’s financial system is vulnerable, not crisis-proof.
Too many risks are running in parallel — fragile loans, inflated valuations, rising debt and political hesitation. For now, the system remains stable. But as the report concludes, “resilience should not be confused with immunity.” In other words, the storm clouds are already forming — and the first gusts may not be far away.
