Dutch banks strengthen capital buffers but weak economic recovery remains a risk

Dutch banks strengthen capital buffers but weak economic recovery remains a risk

The Dutch banking sector strengthened its capital buffers considerably during the past year. The current level of capitalisation puts the Dutch banking sector in the European vanguard. Dutch banks are well on course to fully meet the future, higher capital requirements. However, the weak economic recovery may impede further efforts to strengthen balance sheets. Furthermore, investors remain doubtful about the solidity of European banks. In order for market confidence and the economy to improve, it is therefore crucial that a strict balance sheet assessment is carried out in Europe. This follows from the Overview of Financial Stability (OFS) as published today by De Nederlandsche Bank (DNB).

Strengthening buffers without restricting lending
“I am satisfied with the progress Dutch banks are making in the area of strengthening their balance sheets,” said Klaas Knot, President of De Nederlandsche Bank, on the findings of the OFS.This process is vital for supporting the economic recovery in the Netherlands.” According to DNB, banks should strengthen their balance sheets predominately through cost savings and retaining profits. This will limit the impact on lending and enable the banking sector to support the economy.

Strict balance sheet assessment among European banks crucial for market confidence and economic recovery
DNB also contends that a thorough balance sheet assessment among European banks is necessary for economic recovery in Europe. In 2014, the ECB will conduct an asset quality review for large banks in the euro area. A stringent and credible balance sheet assessment, with a credible public safety net, will improve market confidence in European banks. This in turn will enable banks to play their role in the economy more effectively.

According to DNB, any potential capital shortfall revealed by the balance sheet assessment is first to be made up by private investors. A public safety net is necessary as a last resort and only under strict conditions. Events in the United States in 2009 showed that strict conditions provide the right incentive for banks to raise private funds to make up capital shortfalls, reducing the costs for the government.

Need to limit government guarantees for troubled banks
In its report, DNB emphasises how important it is that in the future, governments will not be the first to rescue systemically important banks that come into trouble. Implicit government guarantees create perverse incentives for investors and irresponsible risks for national government budgets. The recent European political agreement on the resolution of failing banks therefore represents a major step forward. It will limit the use of taxpayers’ money insofar as possible, as shareholders and creditors will bear the risks of a bank failure themselves under new bail-in rules. To improve the effectiveness of bail-in, there needs to be a European-wide harmonized minimum layer of equity and subordinated debt.

Tensions on financial markets not completely disappeared, rapid progress on banking union and structural economic reforms needed
Although the European financial markets have been relatively calm for over a year, tensions have not completely disappeared. These tensions are due to the poor economic outlook as well as market uncertainty regarding the implementation of announced reforms within the euro area. Given this, it is vital that progress is made in the area of the banking union and structural economic reforms. Without progress in these two areas, negative news may lead to a renewed rise in financial market stress.

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