Paul Hilbers is Division Director of Supervision Policy with De Nederlandsche Bank. In this interview, he explains about the themes of prudential supervision in 2012.
DNB has just published its brochure on Supervisory Themes for the year 2012. On what topics will DNB focus especially this year?
This year we will pay special attention to the restoration of financial buffers and the sustainability of financial institutions’ business models. Also, we will be homing in on improvements in risk management, board effectiveness, integrity and the quality of the supervisory data that institutions report to DNB.
That’s a long list. Will there be any time left for ‘ordinary’ supervision?
The thematic approach is an integrated element of DNB’s supervisory effort. This approach is especially effective in tackling issues or addressing developments that span a large number of supervised institutions and thus merit a more comprehensive approach. A financial institution is not an island. Thematic supervision enables us to compare institutions, to identify outliers, to detect and promote best practices and to gauge the industry-wide effects of macroeconomic developments. Therefore DNB deploys a substantial part of its supervisory capacity towards this thematic approach, as a complement to its supervision of individual institutions.
While the crisis rages outside, the supervisor pursues its supervisory themes. Does DNB set the right priorities? Let me be clear on this: right now the European debt crisis is a severe threat to financial stability. So a major element of our current supervisory effort is directly associated with that crisis. This also applies, of course, to the thematic supervisory approach: the supervisory themes address potential vulnerabilities of supervised institutions and industry-wide risks as identified in late 2011 in DNB’s Overview of Financial Stability in the Netherlands. Not by coincidence, but as a conscious element in the concerted exercise of macro and micro supervision. In addition, the implementation of new regulations and new supervisory points of focus as formulated in response to the financial crisis in DNB Supervisory Strategy 2010-2014 and the DNB Action Plan for a Change in the Conduct of Supervision constitute important elements of the theme-driven supervisory approach.
One of the themes is ‘restoration of financial buffers’. Can you elaborate on that?
One lesson learned from the financial crisis is that many financial institutions had insufficient capital buffers, in terms of both quality and quantity. The Basel Committee of Banking Supervisors last year reached an accord on higher capital requirements for banks, known as Basel III. Especially relevant to the Netherlands is the European implementation of Basel III. At the European level, Basel III will be incorporated in the Capital Requirements Directive IV (CRD IV), which is expected to take effect on 1 January 2013. This year will be dominated by the relevant preparations, both as regards the adjustment of national legislation and regulation and the banks’ migration towards compliance with the new requirements. It is essential that the Dutch banks should ensure timely compliance with the new requirements. In 2012, DNB will monitor progress in the implementation of the planned measures, provide feedback to the sector and, where necessary, instruct individual institutions to tighten up their targets and measures.
Capital requirements for insurers are to be upgraded as well. A new regulatory framework called Solvency II is being drafted at the European level. In 2014, the new framework will come into full force. Solvency II marks the transition to a risk and market-value-based solvency regime, including integrated group supervision. The preparations for the introduction of Solvency II will continue apace in 2012.
And how about the supervision of business models? That was already one of last year’s themes.
Supervision of business models is and continues to be an important theme for DNB. The crisis revealed that flaws in an institution’s business model often herald future difficulties. And no financial buffers in the world can survive a moribund business model. But changing one’s business model is not a matter of a few months – it takes stamina.
In the case of banks, the big challenge is funding. Dutch banks depend heavily on market funding. Before the crisis, market funding used to be universally available at low rates. But those times are over and won’t return any time soon. Banks will have to learn to live with that reality and must move towards sustainable and future-proof business models. This will benefit the health of the banks, but of their clients as well. It may lead to less buoyant lending policies, especially in the residential mortgage market. This is a point for particular attention in DNB’s supervisory work this year.
Compromised business models are also found in the insurance industry, particularly in life insurance. A contracting market has put profitability and solvency under increasing pressure. Also, the reputation damage sustained on account of investment-based life policies has not yet been overcome. Life insurers must respond to the changed market conditions characterised by low returns, low interest rates, falling sales, competition from tax-relieved savings plans, population ageing et cetera. Currently there is excess capacity in the life insurance market. Insurance companies face a major challenge in matching their cost levels to falling sales figures. Their success in doing so will, in the next few years, be crucial for firms’ profitability. At the same time, it is important that life insurers should modify their business models so as to remain viable into the future and to add value to society.
Other returning supervisory themes are governance, conduct and culture. What will DNB do on those counts in 2012?
Governance, conduct and culture are of major influence on the soundness and integrity of financial undertakings and pension funds. Therefore they are major focal points for supervision by DNB. ‘Govern with strength, remunerate with restraint’ is our maxim here. In the first place, DNB will see that institutions actually implement their restrained remuneration policies. Secondly, DNB will, on the basis of the new Policy Rule on Expertise, assess whether management boards have sufficient expertise. Later in the year, when enabling legislation has come into force, DNB will likewise assess the expertise of supervisory board members. Third, DNB will examine a large number of institutions for the quality of their decision-making and the effectiveness of their management and supervisory boards.
