Klaas Knot, President of De Nederlandsche Bank (DNB), today has taken office as Financial Stability Board (FSB) Chair. He has been serving as FSB Vice Chair before taking office.Read more
Robust economic recovery, but vulnerabilities on the rise
The economic recovery continues at a robust pace, the search for yield continues and house prices keep going up. Against this backdrop, it is important not to lose sight of growing vulnerabilities and risks to financial stability. In the Financial Stability Report published today, De Nederlandsche Bank (DNB) describes these vulnerabilities, which are associated particularly with risky behaviour in financial markets and the housing market. A new climate stress test also shows that financial institutions could be substantially impacted by flooding in the Netherlands as a result of their real estate exposures, particularly if climate change continues unabated.
The economic outlook has continued to improve since the spring and many sectors have now recovered fully from the economic crisis caused by the coronavirus pandemic. The substantial support packages have limited the damage and supported the macroeconomic recovery.
DNB President Klaas Knot said “The pandemic appears to be largely under control and our economy is growing again at a brisk pace. But we cannot rest on our laurels. This is precisely the time when vulnerabilities and risks build up.”
Increase in risky behaviour in financial markets
Sentiment in financial markets is still predominantly optimistic. Spurred on by unprecedented low interest rates – also before the pandemic – a search for yield has been going on for some time now. Share prices are at historically high levels, compensation for credit risk is low and the issuance of risky debt, also often highly leveraged, has continued to increase.
The constant rise in risky asset prices relies heavily on the assumption that interest rates will remain low for a long time. This makes financial markets vulnerable to a turnaround in sentiment. Valuations of risky assets could come under abrupt pressure, particularly in a scenario with structurally higher inflation and interest rates.
Continued overheating of the housing market
House prices have risen more steeply this year. Whereas the average annual rise over the last five years was 8%, we have recently seen rises of more than 15% year-on-year practically throughout the country. House prices also rose markedly faster in the Netherlands than in most other European countries.
Prompted by the overheating of the housing market, buyers are engaging in increasingly riskier borrowing behaviour, leading to risks in financial institutions' mortgage portfolios. House buyers, particularly first-timers, are more often borrowing at, or close to, the limit relative to their income. Buyers are also taking out more interest-only mortgages, which entails refinancing risks.
We believe banks are currently failing to take sufficient account of the systemic risk in the housing market, and their loan portfolios are vulnerable to the impact of a house price correction on our economy. We will therefore implement the previously announced floor for the risk weighting of mortgages with effect from 1 January 2022.
Climate-related risks pose a threat to financial stability
In order to examine the climate change risks to financial institutions, we are analysing more than €700 billion worth of real estate in a new climate stress test. More than half of this real estate is located in parts of the Netherlands vulnerable to flooding. Serious flooding would cause major damage to buildings and an economic downturn that could substantially impact the Dutch financial sector. The financial risks of climate change underline the importance of a timely start of the transition to a climate-neutral built environment. In addition, it is important that the financial sector incorporates climate-related risks more explicitly in its risk management.
Examination of banks' capital framework
Finally, the Financial Stability Report examines the current capital framework for banks. The economic shock of the coronavirus pandemic has shown how desirable it is to have buffers that can be deployed to support lending. At the outset of the pandemic, we already announced our intention to restore these buffers in due course by building up a Countercyclical Capital Buffer (CCyB). Cyclical deployment of this buffer will ensure that the system remains resilient while staying flexible. We will consult on the modified analytical framework for this buffer at the end of this year.
For more information, please contact Bouke Bergsma on +31 20 524 3797 or +31 653 25 84 00.