Prolonged low interest rates constitute one of the major risks to financial stability internationally. Financial conditions have been accommodative for several years now.This reduces incentives for bringing down debts and lead to distorted pricing in financial markets, which could cause asset...Read more
Prolonged low interest rates pose risk to the Dutch financial sector
Prolonged low interest rates constitute one of the major risks to the Dutch financial sector. This emerges from DNB's spring 2017 Financial Stability Report (FSR) published today. The report will serve as DNB's input for the annual public meeting of the standing parliamentary committee for Finance, the president of DNB, and the executive director of the Netherlands Bureau for Economic Policy Analysis to discuss macroeconomic risks to the financial system. The meeting will be held on Wednesday 14 June.
Policy uncertainty has increased sharply
The accommodating monetary policy stance and the improved global economic outlook are fostering a positive financial market sentiment. The low market volatility, however, is in sharp contrast to mounting political and policy uncertainty. If market sentiment were to turn suddenly, e.g. due to unexpected geopolitical events, existing vulnerabilities may be amplified. Several European countries are still facing excessive debt levels for instance. The Dutch financial sector is also vulnerable to a sudden rise in risk premiums, for instance due to losses on investment portfolios.
Interest rate decline is positive for sectors with high debt levels
Interest rates have fallen to historically low levels. The interest rate decline reflects macroeconomic conditions where structural factors are at play. In addition, the accommodating monetary policy stance has been aimed at boosting economic growth and inflation. Generally speaking, falling interest rates have had a positive effect for the government, households and businesses with high debts as their interest rate burden has eased. At the same time, the interest rate decline has had a negative impact on pension funds and life insurance companies in particular, which have seen their financial position deteriorate.
Prolonged low interest rates entail risks, but also offer opportunities
The prolonged low interest environment entails risks for the financial sector and the real economy. Bank profitability is expected to come under pressure, while pension funds and insurance companies will find it increasingly difficult to meet their commitments. This may induce them to look for higher risk investment opportunities. Prolonged low interest rates may also lead to misallocation of capital in the real economy. As interest rates remain low for longer periods of time, households, businesses and the public sector may grow accustomed to them and may lose the incentive to reduce their debts. Low interest rates also offer opportunities, however. Structural adjustments like the reduction of mortgage interest tax relief and increasing the sustainability of the economy can be stepped up in times of low interest rates.