Renewed escalation of European debt crisis remains major risk to financial stability in the Netherlands

Renewed escalation of European debt crisis remains major risk to financial stability in the Netherlands

In the Overview, which is published twice a year, DNB promotes financial stability in the Netherlands by monitoring and identifying key risks for the financial system.

A renewed escalation of the European debt crisis remains a major risk. Further progress with the implementation of the banking union therefore remains necessary. A thorough asset quality review of European banks will prevent hidden losses being carried over.

When restructuring problem loans, it is important that banks form adequate provisions. The present low interest rate environment makes this even more important.

Life insurers need to adopt a cautious approach towards offering interest rate guarantees. The persistently low interest rates are putting their prospective returns under pressure.

The use of secured funding is increasing in the Dutch banking sector. Banks need to be transparent about this towards investors, because secured funding shifts risks.

These are some of the points contained in the Overview of Financial Stability that is published today by De Nederlandsche Bank (DNB). In the Overview, which is published twice a year, DNB promotes financial stability in the Netherlands by monitoring and identifying key risks for the financial system.

The market stress in Europe has abated further since last autumn. This is evidenced by the muted market reaction to the Cypriot bailout package. However, a renewed escalation of the European debt crisis still forms a threat to financial stability in the Netherlands. Further progress in the implementation of an effective banking union remains necessary in order to control the debt crisis. It is essential that European supervision be supplemented by an effective European resolution regime, resolution fund and deposit guarantee scheme. Market players must have confidence that the banking union will be launched with no hidden losses. A thorough review of European bank balance sheets will bolster that confidence and thus reduce the risk of a renewed escalation of the European debt crisis.

It is important that banks form adequate provisions for problem loans, even when defaults are avoided through restructuring. This is all the more important at present because the historically low interest rates make it more likely that problem loans will be restructured through repayment deferral.

Life insurers are asked to apply prudence in issuing interest rate guarantees. The low interest rates make it difficult to generate adequate returns to fulfil such guarantees, and could therefore put pressure on solvency. Insurers need to mitigate this risk by issuing fewer or shorter-term guarantees.

The use of secured funding by Dutch banks is still limited in volume terms, but is becoming more and more common. Banks need to be transparent about this. Secured funding increases the risks for other creditors, because in the unfortunate event of a bank failure there will be fewer assets available to meet their claims. Secured funding also increases the risks for the deposit guarantee scheme (DGS) and the interconnectedness between financial institutions.

The new housing market policy, which was recently introduced, will gradually reduce the deposit funding gap of the Dutch banking sector and make it easier to finance this gap. More repayment and lower loan-to-value ratios will result in smaller and safer mortgage loans. The fundability of the deposit funding gap can be increased further in the future through more standardisation of mortgage products and a larger role for institutional investors. Fundability is important, because in the short term Dutch banks will remain heavily dependent on market funding through the international capital markets. This dependence makes them vulnerable to unrest in the financial markets and increases the volatility of lending operations in the Netherlands.

Source: DNB

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