Klaas Knot’s introductory statement

Introductory line for the VKC

I would like to thank the Chair and the House of Representatives for their invitation. In this setting – together with my colleagues from CPB and AFM – it has become good practice to discuss the main risks to the financial system with you. I will do so on the basis of the Financial Stability Report, which has been sent to you.

The world has changed dramatically since the last time we met. The war in Ukraine and high inflation have led to new major macroeconomic shocks, but the financial sector has held up well so far. Last year, we focused on the impact of the COVID-19 crisis. Just when we seem to have put the COVID-19 pandemic behind us and embarked on a strong economic recovery, the economy and the financial system are being tested again.

But let me first consider our starting position. In economic terms we have emerged very well from the COVID-19 pandemic. The Dutch economy staged a fast and particularly strong recovery. In retrospect, we may have sometimes looked too negatively at the economic impact of the pandemic. The economic impact of the pandemic could be mitigated and the shock was effectively absorbed because our government and financial institutions had sufficient buffers.

In recent months the economic outlook has worsened worldwide as a result of the war in Ukraine. The growth of the Dutch economy has also slowed down. So far, the economic impact of the war has mainly been felt in the energy and commodity markets, resulting in high inflation rates. Energy and commodity prices had already risen sharply in 2021 due to a combination of strong economic recovery, previous supply disruptions and geopolitical tensions, but prices have risen to record levels since the start of the war in Ukraine. Inflation has become more broad-based, but high energy prices still account for two-thirds of it.

Interest rates have also risen in the wake of inflation. That too marks a fundamental change, after a long period of very low interest rates. Financial markets are thus anticipating the expected further monetary tightening. The 10-year interest rate on Dutch government paper has now hit 1.4%, a level not seen since 2014. The interest rate rise is also reflected in rates on mortgages and corporate loans, and in those markets too people had become accustomed to low interest rates.

In summary, the war in Ukraine and high inflation are putting a substantial drag on the economic outlook. At the same time, as far as the financial institutions and financial markets are concerned, we can say: so far, so good.

First, the financial institutions. Here, the impact of the war has so far proved manageable. Dutch financial institutions have relatively limited direct exposures to Russia and to energy-sensitive business sectors. At the same time, second-order effects cannot be ruled out. A further escalation of the conflict could reverse the economic momentum and also impact the quality of banks' loans, for example. The operational challenges that financial institutions face have also increased significantly. Examples include compliance with sanctions and the heightened threat of cyberattacks.

Financial markets are also continuing to function well and have so far coped well with the new shock as a result of the war. The invasion heralded steep price losses amid greatly increased volatility, especially in commodity markets, but at the same time financial markets have proved resilient. This is important, because for the moment it prevents the stress from spreading further through the system.

So what does this risk overview mean in policy terms?

Let me start with the policy that DNB itself controls: prudential policy. In response to the COVID-19 crisis, we lowered the systemic risk buffers for banks in March 2020 in order to maintain the level of lending. At the same time, we immediately stated our intention to rebuild those buffers over time and to work towards a countercyclical capital buffer – the CCyB. The overall risk profile – with a rapid economic recovery after the COVID-19 crisis and continued strong fundamentals – now calls for the buffer to be activated. Banks are also well able to bear a higher CCyB. Therefore, as a first step, we have decided to raise the buffer to 1%. I should add, however, that the buffer can also be released immediately if circumstances dictate.

Now the housing market. It is still overheated. The rise in interest rates may have the desired cooling effect, but supply remains tight. First of all, therefore, action should be taken to address this scarcity. This alone will not be sufficient, however, as high house prices and strong demand are both still being supported by fiscal stimulus, such as mortgage interest relief, loose borrowing rules and subsidies for first-time buyers. The government would be well advised to halt this stimulation of demand.

We also note that interest-only mortgages have become more popular again in the past six months. Whereas interest-only mortgages were previously taken out mainly by older homeowners because they were still entitled to mortgage interest relief on interest-only debt, we are now seeing younger households increasingly opting for interest-only loans. We believe this is undesirable because interest-only mortgages pose a greater financial risk to households and financial institutions. We will therefore step up our prudential supervision of financial institutions’ risk control of interest-only mortgage portfolios. We also want to see a decrease in the size of these portfolios.

Finally, any undue delay in the normalisation of monetary policy could pose risks to financial stability. After a long period of accommodative financial conditions and a search for yield, an adjustment of the economy and the financial system is ultimately both inevitable and desirable. On the other hand, a sudden tightening of financial conditions could have a negative impact on financial stability. Monetary policy adjustments must therefore always be timely and predictable. The large-scale purchase programmes are already being phased out, after which interest rates will be raised.

Now that the medium-term inflation outlook has converged towards target, a more neutral interest rate level is appropriate that will neither slow nor stimulate the eurozone economy. The precise path will of course depend partly on the further evolution of the inflation outlook.

This concludes my introduction. I would be happy to answer any questions you may have.