Low interest rates pose risk to financial stability; further cultural changes in financial sector needed
The budding economic recovery in the euro area and the Netherlands continues to be surrounded by downward risks to financial stability. The developments in Greece have put the European debt crisis in the limelight again, and geopolitical tensions have increased. The ECB's recently eased monetary policy is aimed at bringing back inflation to the price stability target (entailing price increases of just under 2% in the medium term) and underpinning economic recovery. This policy has side effects, however. It leads to increased risk appetite among investors and a search for yield in the financial markets, which in turn induces bubble formation.These developments are detailed in the DNB Overview of Financial Stability (OFS), which was published today.
Low interest rates prompt reassessment of financial sector business models
The low interest rate environment is forcing institutions to reconsider their business models.A prolonged period of low interest rates affects the resilience of Dutch financial institutions, insurance companies and pension funds in particular, and banks to a lesser degree. Its impact on life insurers may ultimately jeopardise financial stability, as they have limited recovery options and considerable interdependencies with other financial institutions. DNB expects Dutch financial institutions to prepare their business models for the future, if only in response to low interest rates, and it monitors their progress.
Cultural change in the financial sector remains as important as ever
Since the crisis, DNB has tightened its supervision on governance, conduct and culture at financial institutions. In addition, national and international remuneration policies have been developed to curb perverse incentives to excessive risk-taking. In the run up to the crisis, governance at a number of financial institutions was not sufficiently effective in controlling risks. The consequences are still making themselves felt, as costs of past misconduct are increasing. In spite of tighter supervision and newly developed policies, incidents are still occurring. This illustrates that the actual achievement of a cultural change - and really making governance effective - will demand perseverance in the years ahead, and the sector must still make a considerable effort in this respect.
Bail-in policy framework firmly established
The policy framework designed to help systemic banks steer clear of continuity problems has been firmly established, but it has not yet been completed. One of its key instruments is the bail-in tool, which ensures that private parties rather than governments bear the losses of failing systemic banks. This requires bail-in capital: debt instruments that are still available to absorb losses after depletion of regular capital. Specific requirements are still to be finalised nationally and internationally. For financial stability it is important that holders of bail-inable debt instruments will be able to bear losses without complications occurring. This demands rules that discourage banks to invest excessively in each other's bail-inable debt, thereby preventing a knock-on effect from occurring in the financial sector.
For more information, please contact Ben Feiertag at +31 20 524 2304 or +31 6 524 96 142.