The BoP current account ended the fourth quarter of 2012 on an EUR 17 billion surplus, broadly equal to the position one year earlier. From a year-on-year perspective, the current account stabilised also in 2012, coming out at EUR 60 billion (10% of GDP), roughly equal to the 2011 amount. Net external assets of the Netherlands – the balance of external assets and liabilities – rose by EUR 90 billion in 2012, to over EUR 300 billion at end-December. A growing share in external assets has been taken up by financial derivatives, as is evident from figures published today on the website of De Nederlandsche Bank (DNB).
At end-2012, the market value of cross-border claims and liabilities in the form of financial derivatives had reached levels of EUR 350 billion and EUR 320 billion, respectively (see Chart 1). Never before did DNB record such elevated positions. The value of these cross-border claims and liabilities more than doubled in the space of one-and-a-half years. Over the same period, the balance flipped from EUR -8 billion to EUR +30 billion, thus contributing to the strong growth of the Netherlands' net external assets.
The rapid growth from mid-2011 accounted for in particular by interest rate derivatives. At end-2012, the market value of interest rate swaps and future rate agreements (the most common types of interest rate derivatives) took up 85% of total cross-border derivatives holdings. By market value, cross-border claims and liabilities in interest rate derivatives had increased, at end-2012, to EUR 297 billion and EUR 285 billion, respectively – that is roughly half the size of Dutch GDP. In mid-2011, those respective positions had been as low as EUR 90 billion and EUR 108 billion. The reason why interest rate positions could soar to such heights is that there is hardly any trade in existing derivatives contracts. A party that wishes to cancel a derivatives position will do so by making a further, opposite contract rather than by selling the existing contract. As a result, the supply of outstanding contracts may in theory grow indefinitely. Strong movements in interest rates will cause the value of interest rate derivative contracts to turn positive or negative, depending on the position taken. For an interest rate swap, the market value equals the discounted cash value of the difference between expected interest payments and interest receipts. As market rates dropped considerably in recent quarters, the difference between the expected cash flows has strongly increased, causing the market value of interest rate derivatives to soar. In addition, the current low rates have led to a concomitant drop in the discounting rate used to determine the cash value of future payments and receipts. As a result, that cash value has increased.
In part, the large interest rate derivative positions are also the result of the structure of the Dutch economy. The Dutch banking industry is relatively large, while the Netherlands also has an extensive pension sector. Given the nature of their business, banks and pension funds make extensive use of interest rate derivatives as a risk management instrument. However, banks and pension funds run very different interest rate risks. Pension funds hedge against a decline in long-term rates. Because the duration (average maturity term) of their liabilities is longer than that of their investments, the former are more sensitive to interest rate fluctuations than the latter. This implies that a pension fund's financial position will weaken in the event of an interest rate decrease. Banks, by contrast, tend to hedge against interest rate increases. They depend, by and large, on short-term funding (such as savings deposits) while their lending exposures are relatively long-term.
In principle, therefore, the fall in market rates seen since mid-2011 is favourable for banks and unfavourable for pension funds. Since pension funds hedge against falling rates, they recorded a profit on their interest rate derivatives. Conversely, banks lost money on their hedges against rising interest rates. To mitigate counterparty risk, that is the risk that a counterparty may fail to meet all or part of its obligations, it is important to spread derivatives contracts across several counterparties. This is why financial derivatives are typically of a cross-border nature. From about mid-2011, pension funds' net external claims therefore increased, whereas banks saw their external liabilities soar.