Banks must hold more capital for their mortgage portfolios
Due to low historical losses, Dutch banks tend to assess the risks inherent in their mortgage loans as low. Risk weights assigned to Dutch mortgage loans are currently among the lowest in the EU. From a macroprudential perspective, we consider them insufficient, given the increased systemic risk in the Dutch housing market. This is why we intend to introduce a floor for risk weights of domestic mortgage loan portfolios of Dutch banks. The floor increases with the loan to value (LTV) ratio of the underlying mortgage loans. Loans partly or fully covered by the Dutch National Mortgage Guarantee scheme will be exempt from the measure. Due to this measure the risk weights of mortgage loans will on average increase from 11 to 14-15%. Our estimates indicate that, taken together, Dutch banks that use internal models to calculate risk weights must hold an additional EUR 3 billion against their mortgage portfolios. This will enable them to better absorb the impact of a potential house price correction. With this measure we also follow the recommendation which the European Systemic Risk Board (ESRB) published on 23 September. We expect the measure to have a limited impact on mortgage interest rates in the Netherlands. It is therefore expected to affect home buyers only marginally.
In principle, the measure will become effective in the autumn of 2020 for a two-year period, following public consultation and consultation of the European institutions. It is therefore not an add-on on top of the new capital requirements under the Basel 3.5 accord, which will most likely be phased in from 2022 onwards. We expect risk weights for mortgage loans to start moving in a similar direction under the Basel 3.5 accord going forward.
Systemic risk inherent in the Dutch housing market has increased
In the Netherlands, systemic risk inherent in the housing market has increased over the past few years. House prices have gone up sharply for several years in a row – by almost 8% annually on average in the past three years. While sluggish supply and declining interest rates partly account for the price increases, there are also signs of overvaluation. House price increases have significantly outpaced income growth in recent years. As a result, price/income ratios in the major cities are now much higher than at the peak of the previous housing market boom. Moreover, home buyers engage in riskier borrowing behaviour, and mortgage indebtedness remains elevated.
Dutch households and banks are vulnerable in the event of a house price correction
High indebtedness makes Dutch households vulnerable to a downward correction in the housing market. Underwater homeowners consume less, which means a potential housing price correction could have major spending effects. A further reduction in the loan to value limit, which links the amount of a loan to the home's appraisal value, would mitigate the economic impact of a house price correction. Banks, too, can be hit by a house price correction. Stress tests show that banks’ expected mortgage loan losses could surge in an adverse scenario. This could be the case if the probability of default were to increase, for instance due to a sharp rise in unemployment, while collateral values simultaneously decrease due to the house price correction. A house price correction will also hit Dutch banks indirectly, due to the Dutch economy's high sensitivity to house price developments. Lastly, Dutch banks still rely relatively heavily on market funding, which dried up completely during the crisis. This also contributes to their vulnerability to a house price correction.
For further information, contact Bouke Bergsma (phone + 3120 524 37 97/ + 31653 25 84 00).