Financial stability risks increased due to war and high inflation

DNB President Klaas Knot said: “With Russia’s terrible war against Ukraine the world is clearly in a very different place compared to the beginning of this year. In macroeconomic terms we have weathered the COVID-19 crisis well, but the war and high inflation present us with new challenges. There has not been a war on the European continent for more than 20 years and we have not seen the current high levels of inflation for four decades. Add to that historically low consumer confidence and one can only conclude that we are living in strange times amid great economic uncertainty. The resistance and resilience of our economy and of the financial system will be tested again in the period ahead.”

Impact felt around the world

The consequences of the war are impacting the global economy in various ways. Prices in energy and commodity markets have risen to record levels since the Russian invasion. Global trade has also been further disrupted, causing problems in supply chains and production processes, exacerbated by the strict COVID-19 policy in China. Further economic developments will ultimately depend on the course and impact of the war.

High inflation has reduced households’ purchasing power. Businesses are having to contend with higher production and logistics costs. The impact can also be seen in financial markets. After a long period of very low interest rates and a search for yield, interest rates have risen in response to high inflation. Over time, the higher financing costs may put pressure on the debt sustainability of governments, businesses and households. This may lead to growing losses in the loan portfolios of financial institutions. The fact that households are able to borrow less due to rising mortgage interest rates may nevertheless help cool the overheated housing market.

Resilient financial system

Despite the major uncertainty, the financial system has so far also proved resilient to these new shocks. Although volatility in financial markets has increased, and crypto assets in particular have recently posted large losses, the markets have continued to function well. The financial sector is also proving robust, thanks to a healthy starting position. To ensure a timely restoration of the bank buffers that were lowered at the start of the pandemic and prepare banks for future shocks, we are activating the countercyclical capital buffer(CCyB) and raising it to 1%. Provided there is no sharp deterioration in the risk profile, this buffer will take effect on 25 May 2023. We are aiming ultimately for a CCyB of 2%.

Monetary policy

The high inflation is prompting central banks around the world to adjust their monetary policy. The European Central Bank has also taken steps towards normalisation. It is important for both financial stability and price stability that this normalisation takes place in a timely and predictable manner. A sudden tightening of financial conditions could have a negative impact on financial stability and ultimately harm price stability.

DNB President Klaas Knot will elaborate on the FSR in a public discussion in the House of Representatives on 1 June.