The European sovereign debt crisis remains the greatest threat to financial stability in Germany as a substantial worsening of the situation would have a significant adverse impact on its banks and insurers, the German central bank said Wednesday.

"The risks to the German financial system are no lower in 2012 than they were in 2011," the Bundesbank said in a statement on its annual report on financial stability in the largest eurozone economy, noting that Spain and Italy - two major economies - have been drawn into the crisis.

Although monetary and fiscal policy measures on a massive scale are needed to stabilize the financial system, the bank warned that they can only buy time and cannot eliminate the causes of the crisis.

"This has entailed an ever greater transfer of risk to the public sector and has caused the low-interest rate environment to become entrenched", said Bundesbank executive board member Andreas Dombret, warning that "the side-effects of short-term stabilization measures could leave a difficult legacy for financial stability in the medium to long term."

In addition, low interest rates, high liquidity and potential exaggerations in the German real estate market could pose a future threat to financial stability, the report said.

The Bundesbank regards the low-interest rate environment as having negative repercussions on insurers, as Dombret noted that "life insurers will have to continue making provisions in order to meet guaranteed rates of return in the future."

The Bundesbank is also concerned with the risk that low interest rates are fostering rising prices in real estate market in urban areas.

Although he could see no signs yet of a rapid build-up of risks to financial stability in Germany, Dombret warned that "the experiences of other countries show that precisely such an environment of low interest rates and high liquidity can encourage exaggerations on the real estate markets", emphasizing that this situation may pose a considerable threat to financial stability in the country.

However, the report also noted positive news regarding German banks as they have lowered their leverage ratios, increased capital ratios and increasingly tapped more stable sources of funding, such as customer deposits. In addition, German banks have significantly reduced their claims on the countries hit by the sovereign debt crisis.

But the central bank warned that German banks are still substantially exposed to financial risks in Italy and Spain, as it held about 59 billion euros (75 billion U.S. dollars) government debt of the two countries in mid-2012. Endi

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