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May 28, 2018

IMF published its staff report and selected issues report on the 2018 Article IV consultation with the Kingdom of the Netherlands. The IMF Directors commended the authorities for enhanced financial sector oversight. While they noted that the banking sector is well-capitalized on a risk-weighted basis, they stressed that a continued buildup of capital buffers remains warranted to cope with challenges associated with high leverage, low interest rates, and significant reliance on wholesale funding. They welcomed the continued close monitoring of financial conditions in the insurance and pension sectors. Directors also welcomed the principles laid out in the prospective reform of the second pillar pension system to promote more transparency and inter-generational fairness.

The staff report highlights that tighter global financial conditions and pressure on traditional bank models, including from the new “Basel III.5” requirements, may stress the financial position of leveraged firms and households and raise the risk of distress in major banks due to their heavy reliance on wholesale funding. With an aggregate loan-to-deposit ratio of 136% at the end of 2017, banks remain vulnerable to an increase in their funding costs. Furthermore, Dutch banks should continue to build capital buffers to prepare for the new regulatory requirements on internal risk models. Given the significant share of highly leveraged mortgages in bank portfolios, own fund ratios in the banking sector will be impacted by the introduction of new risk-weight floors on mortgages, combined with the revisions to the standardized approach under the Basel III.5 framework. Dutch banks had already started this process in anticipation of new regulations and the process should continue. In parallel, a stronger focus of bank supervision, both at the national level and by the Single Supervisory Mechanism (SSM), should be directed toward banks’ evolving business models and risk management frameworks, as the low interest rate environment and increased competition from shadow banking activities may encourage excessive risk taking in the financial sector.

The IMF assessment reveals that insurance sector merits continued close supervision, as it remains vulnerable to possible losses from rising interest rates. The financial situation of defined benefit second pillar pension funds remains fragile. By the end of 2016, about 90% of the pension funds had been forced to adopt recovery plans intended to bring back their solvency ratios above minimum regulatory coverage requirements. Furthermore, stress tests performed in 2017 by EIOPA reveal that Dutch pension funds are more vulnerable to financial market shocks than their European peers. In the absence of a sponsor to provide a financial backstop, the funds have been increasingly combining the disadvantages of defined benefit schemes with those of defined contribution schemes, as most of the investment risk is actually borne by participants. Therefore, the second pillar of the pension system should be overhauled to ensure more clarity for participants by setting up notional personal accounts while preserving some risk sharing and financial security at retirement. The authorities are contemplating a new system whereby mandatory personal defined contribution contracts would be complemented with provisions for pooling the micro longevity risk and some financial risks.

The selected issues report examines the issues of wage moderation, fundamental drivers of house prices, healthcare reforms, and options for carbon mitigation and transportation policy in the Netherlands.

 

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Keywords: Europe, Netherlands, Banking, Insurance, Basel, Internal Models, Pension Funds, Article IV, IMF

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