Dutch banks must continue improving their capital position

Dutch banks must continue improving their capital position

The European debt crisis rages on. Problems at banks engender problems for governments and vice versa. A banking union, if adequately structured and designed, would break this spiral. Dutch banks are making good progress towards Basel III compliance. However, their scope for absorbing setbacks as they advance towards this goal and their access to the capital market are limited. In order to spare the banking sector’s lending capacity, capital buffers must mainly be reinforced through profit retention. Market participants must be able to trust the accuracy of commercial real estate valuations by Dutch banks. This calls for up-to-date and high-quality appraisals that allow for the recent price falls and the vacancy rates that characterize the current market climate.

These and other messages can be found in the Overview of Financial Stability of De Nederlandsche Bank (DNB) which is published today. With this overview DNB aims to promote the financial stability in the Netherlands by monitoring and identifying the main risks for the financial system.

An adequate organisation of the proposed European banking union will help to reduce the unrest in the currency union. Dutch banks must continue improving their capital position in the coming years, which will restrict their scope for dividend payments. Moreover, in the current market conditions, it is important that banks ensure up-to-date and high quality commercial real estate appraisals.

The European debt crisis still constitutes the most urgent threat to the financial stability. Collapsing trust in vulnerable countries is leading to segmentation of financial markets and capital flight. The interconnectedness between banks and national governments is increasing. This undesirable development can be reversed through the creation of an effective European banking union. This calls for the coordinated introduction of strict supervision, powerful resolution mechanisms and sufficiently large financial safety nets. The European Stability Mechanism (ESM) must rapidly be empowered to directly recapitalise banks in countries where both the private and public sector are unable to do so. To minimise the costs for taxpayers, support must be confined to viable institutions; non-viable institutions should be wound down.

An up-to-date analysis of the banks’ balance sheets by an independent party will offer the reassurance that the European safety net is not saddled with hidden losses.

To stem rising tensions, the ECB has announced new policies that enable further support buying of government bonds under strict conditions. This programme, known as OMT, is designed to safeguard monetary transmission. One major improvement compared to earlier support buying is that this can only take place if countries commit and adhere to a macro-economic reform programme.Thanks to the strict conditionality, the OMT introduces the proper incentives for governments.

Dutch banks are making good progress towards Basel III compliance. However, their scope for absorbing setbacks as they advance towards this goalis limited. Larger capital buffers, as expressed in both a higher risk-weighted capital ratio and a higher leverage ratio (the ratio between equity and total assets), is necessary. This will bolster market confidence, which is extra important for Dutch institutions as they rely heavily on market funding. In the current economic climate, in which the issuance of capital instruments is difficult and asset sales are undesirable, banks depend on retention of profits. As a result, most banks will have little or no scope to pay dividends.

The market for commercial real estate is under pressure. Vacancy rates are rising and prices have been falling for about four years. Market parties must be able to rely on the quality of the valuations of commercial real estate by Dutch banks. Consequently, appraisals must be up-to-date and meticulous, and reflect the recent price falls and the vacancy rates that characterize the current market.

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