The Dutch banks’ business model is mainly aimed at lending to households and businesses. This is reflected in the banks’ aggregate balance sheet, which consists to a large extent of traditional loans (about 68%), such as residential mortgages and loans to enterprises. Within the banks’ domestic lending, mortgage loans hold a prominent position, accounting for nearly 60% of total outstanding domestic loans. Internationally, Dutch banks’ mortgage lending is very high.
Mortgage lending makes banks dependent on market funding
|Date||6 June 2012|
The amount of domestic lending by the Dutch banking system exceeds the amount of domestic deposits of households and small-sized enterprises by some € 500 billion. The difference is accounted for by the strong growth of the banks’ mortgage portfolios over many years. In order to cope with this difference, banks must rely on market funding, thus making them vulnerable to developments in the financial markets. In the long run, the planned adjustments to the system of tax relief for mortgage interest payments may help to reduce this vulnerability. However, the banks will have to take additional measures to improve their funding profile over the next few years.
About one-third of the banks’ balance sheet is funded from savings. A large part of these savings is raised abroad. Domestic loans exceed domestic deposits of households and small-sized enterprises by some € 500 billion. Compared to the situation in other countries, Dutch households hold about the same amount of savings deposits with banks. Moreover, such savings deposits are marked by steady growth (historically about 5% per annum). Thus, the difference between the amount of domestic loans and that of domestic deposits is accounted for in large measure by the prolonged strong growth of mortgage lending. This growth is to a large extent attributable to the relatively generous tax relief for mortgage interest payments in the Netherlands and the ample availability of cheap market funding in the years preceding the financial crisis.
As a result of its large mortgage loans portfolio, the Dutch banking system is relatively dependent on market funding, including funding with short maturities. About two-thirds of the consolidated balance sheet of the Dutch banking system is funded in the financial markets. Even if the balance sheet were to consist in full of domestic loans to households and enterprises, the banks would still depend to the extent of more than one-half on this form of funding. Because short-term market funding increases banks’ vulnerability to developments in the financial markets, it is desirable to reduce this dependence. Hence, it is important that the size of the mortgage loans portfolio should be reduced. This may be achieved by encouraging households to repay their mortgage loans at a more rapid pace than in the past. This, in turn, may be attained by changing the system of tax relief.
The measures now announced in this area will not remove the risk of an ever larger mortgage loans portfolio in its entirety. For instance, the obligatory repayment of the full amount of the loan in 30 years’ time only applies to new contracts. Moreover, at first, annuity redemption does not lead to major repayments of the principal amount. Hence, it is also necessary to consider measures that improve the banks’ funding profile in the shorter term, that is, in a few years’ time. In this context, the following instruments are conceivable.
Strengthening the capital position in line with Basel III constitutes the principal instrument to improve the banking system’s funding profile. Capital is a risk-bearing stable source of funding which improves banks’ resilience and enhances their opportunities for raising unsecured long-term funding. This represents a welcome form of market funding in that it reduces dependence on short-term funding and constitutes an excellent supplement to savings.
External securitisations could again play a useful role in the funding of mortgage loans portfolios. The banking system could make a contribution in this respect by taking initiatives to improve the standardisation, transparency and liquidity of these instruments.
Covered bonds may also help to improve the banks’ funding profile. Covered bonds constitute a stable form of funding, which, thanks to the collateral provided, is highly crisis-resistant. However, banks provide more collateral than the face value of the bonds issued (overcollateralisation), thus detracting from the position of other creditors. As a result, an excessive dependence on this form of funding could restrict the banks’ opportunities for raising unsecured funding. Hence, issues of covered bonds should remain subject to restrictions. A lower degree of overcollateralisation might limit the drawbacks of covered bonds.