The financial crisis made clear that, in addition to microprudential supervision of financial institutions, there is a need for macroprudential policy in order to improve the stability of the financial system as a whole. Many countries have therefore assigned an authority to be responsible for this policy. Several countries have meanwhile also started using macroprudential instruments. For instance, due to the strongly rising house prices, Swedish and Swiss supervisors demand additional capital buffers for real estate loans. Austria sets conditions for the local funding of foreign bank subsidiaries. Another example is the loan-to-value (LTV) limit on mortgages, which was introduced in countries such as Sweden and the Netherlands.
Macroprudential policy will also benefit the Netherlands. If banks build up additional capital in times of excessive credit growth, they will be more resilient to shocks. This will prevent strong fluctuations in lending. Besides, the Netherlands has a large and concentrated banking sector. Additional capital requirements for systemic banks will make the Dutch financial system less vulnerable. Based on European legislation, DNB will have several new macroprudential instruments for banking supervision at its disposal from the start of 2014, such as buffers for systemic banks and counter-cyclical buffers.
ESRB recommendation on policy framework
The effective use of the new instruments requires a clear policy framework. Within the European Systemic Risk Board (ESRB), agreement has been reached on such a framework for European countries. A striking feature of this framework is that it explicitly leaves room for differences among countries. The nature and size of systemic risks strongly depend on the structure of national financial systems and other national characteristics and policy decisions. For example, in the Netherlands the high mortgage debt constitutes a financial vulnerability, while in several central and eastern European countries loans in foreign currencies pose a threat to financial stability. Macroprudential policy will have to encompass these national differences. In this respect, the ESRB framework will ensure a consistent approach, which will increase the policy's predictability and transparency. Countries will have to coordinate their measures and take into account any cross-border consequences.
In a recommendation published last week, the ESRB gives guidelines to Member States, central banks and supervisors for drafting specific macroprudential policies. In these guidelines, the ESRB emphasizes that by the end of 2014 the authorities must have sufficient instruments to realize five concrete targets. The first target is to prevent or reduce excessive lending. For this purpose, tools such as the counter-cyclical capital buffer and an LTV limit can be applied. In addition, too large differences in the maturities of loans and funding of banks will have to be prevented. This could be achieved through a gradual decrease of the deposit funding gap of Dutch banks, which would diminish their dependence on market funding. The third target is addressing the too big to fail issue. Setting higher capital requirements for systemic banks will reduce any perverse incentives originating from an implicit government guarantee. Fourthly, concentration risks, such as the substantial exposures of banks in the euro area to their own governments, will have to be reduced and concentration limits can help to achieve this. Finally, the financial infrastructure will have to be strengthened, for instance by setting requirements for the manner in which financial transactions are settled. In addition, authorities will have to determine how decisions will be made about the use of these instruments. In the case of counter-cyclical buffers, for example, it should be determined when credit growth is excessive and which buffer requirements should apply.
Macroprudential policy in the Netherlands
In the Netherlands, DNB, the Ministry of Finance and the Authority for the Financial Markets (AFM) are involved in the execution of macroprudential policy. In the Financial Stability Committee these parties discuss the main systemic risks and coordinate policy. The use of instruments, however, is the responsibility of the individual authorities. For macroprudential instruments forming part of the directive on capital requirements for banks, DNB is the relevant authority. In the coming years, DNB will gradually be setting additional capital requirements for systemic banks. Four times a year DNB will assess whether credit growth necessitates the imposition of a counter-cyclical buffer. In determining the LTV limit various parties may be involved, as the scope of this instrument is wider.
The new instruments available to DNB as of the beginning of 2014 are an important step towards effective macroprudential policy in the Netherlands. The ESRB recommendation emphasizes that further expansion of the macroprudential toolbox is required. This will allow DNB to take real measures to strengthen the stability of the Dutch financial system.