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EU debt crisis threat to financial stability

European debt crisis remains largest threat to financial stability. Growth in emerging markets pushes up commodity prices and inflation risk. Increased trade in commodity derivatives may lead to sudden losses.

These and other themes are explored in the biannual Overview of Financial Stability (OFS) published today by De Nederlandsche Bank (DNB). Through this overview, DNB seeks to promote financial stability in the Netherlands by monitoring and identifying the most important risks to the financial system.

The European debt crisis remains the largest threat to the stability of the Dutch financial sector. The combination with other factors, such as the increasing differences between euro countries, in particular as regards competitiveness, enlarges the risks. In addition, the risk remains that financial institutions will be hit by further price falls on European real estate markets. For instance, in the Dutch office market, structural vacancies are looming. In order to prevent losses from remaining hidden, it is essential that banks, insurers and pension funds are transparent about their investments in real estate and in countries that have been hit by the sovereign debt crisis. At the same time, the value of these investments must be estimated with sufficient caution.

The outlook for the global economy has improved over the past months. Thanks to the economic recovery, the capital buffers of financial institutions have strengthened. However, it is vital that they increase their buffers further to become less vulnerable to new shocks. This will also be enforced by the internationally agreed stricter regulations, such as the Basel III standards for banks and additional requirements for systemically important financial institutions. These rules and regulations are to be implemented over the next few years.

The economic recovery, partly boosted by the strong growth in emerging markets, is accompanied by rising commodities prices and increasing inflationary pressure. Some financial institutions try to profit from the developments in commodity markets. The emergence of complex products and trading strategies form a risk, should the present trend suddenly turn around. In addition, the recent economic developments have heightened the risk of interest rate shocks. A sudden rise in market rates would hit Dutch households, banks and the government. Over the past few years, Dutch households have become more vulnerable to interest rate shocks as the total outstanding mortgage debt has increased.

Source: De Nederlandsche Bank