FRANKFURT, Nov 23 Reuters Germany39;s financial firms may be well capitalised now but face challenges ranging from rising interest expenditure and weak loan demand to unrealised losses, Bundesbank Vice President Claudia Buch said on Wednesday.

Interest rates have risen at the fastest pace on record in the past year and banks have done well to cope with the change but the new operating environment also holds risks, including a sharp fall in the value of securities held by lenders.

Almost twothirds of savings banks and credit cooperatives now have unrealised losses throughout their banking book, which comprises loans as well as securities, Buch said in a statement. Life insurers are in a similar situation.

As a result, book values are often higher than current market values, so selling securities would result in losses, which could then lead to liquidity shortfalls in times of stress, the Bundesbank warned in a financial stability report.

Buch warned that interest rate expenditure was likely to rise in the future, which will compress margins and weigh on earnings.

Our simulations show that if banks had passed on higher interest rates at a similar pace as they had done in the past, their net interest income this year would be 29 billion euros, or onethird, lower, Buch said.

Banks will struggle to offset higher costs via rising loan volumes since corporate demand is weak amid a recessionary environment.

Adding to the troubles, the commercial real estate market…