Keeping Afloat

The Dutch financial sector, which has undergone rapid growth and internationalisation over the past few decades, has been hit hard by the financial crisis. Over the past quarter of a century, financial markets have grown enormously as a result of deregulation, internationalisation, rapid development of IT and increased prosperity. Their recent collapse has dealt a heavy blow to financial institutions including many in the Netherlands, which have had to rely on government intervention to keep them afloat. Discussions on how best to manage the situation once it has calmed down are in full swing, particularly regarding structure and regulation. It is, for example, recognised that the scope and execution of regulation will have to change. In these efforts, however, we must not lose sight of the fact that properly functioning financial markets are essential for economic growth.
This year the Dutch Government has had to ensure its country’s deposit guarantee scheme was extended, new bank loans were guaranteed and capital was made available. It paid €16.8 billion to Fortis/ABN AMRO by the end of January, and extended €13.75 billion in capital to various banks. At the beginning of February the capital injections totalled €10 billion for ING, €3 billion for AEGON, and €0.75 billion for SNS REAAL. On 31 March, the European Commission temporarily authorised a transaction between the Dutch State and ING Group, involving the transfer of 80 per cent of the cash flows from ING’s Alt-A mortgage portfolio to the state. The move was necessary because the impact of uncertainties surrounding the group’s capital and results was much greater than anticipated credit losses warranted. The transaction largely removed these uncertainties. In return, the Dutch state will receive a reasonable fee, and has a considerable chance of receiving positive cash flows. In total the transaction adds up to five per cent of the Dutch GDP.

The problems in the financial sector are accompanied by a decrease in the growth of credit, caused by the cyclical downturn which led to a decline in demand. The situation remains precarious for many Dutch financial institutions, as evidenced by high insurance premiums against bankruptcy on their bonds. In order to minimise market disruption, it is wise to reduce bank interest rates as quickly as possible, in line with the Dutch Government’s plan, although this will not completely succeed from one day to the next in the current circumstances.

As a small, open economy, the Netherlands is extremely sensitive to developments abroad. In the current situation, there is a risk that countries will take measures to protect their own economies. This could damage international trade and the functioning of the markets, with correspondingeffects on economic growth in the long term. Financial crises usually prompt the banking sector to withdraw within national borders; banks must secure the coverage of a credible government, because account holders might otherwise be tempted to pull out their money. At the same time, such a retreat leads in the long-term to a loss in prosperity, resulting in higher capital costs. It is hoped that recapitalisation by the government can ensure that credit issuing continues.

More generally, reorganisation of the banking sector remains an important priority. Problems within Dutch banks contributed to the current situation, and these must be addressed. On the banks’ part, concerted efforts are needed to manage risk and ensure regulatory compliance. At the same time, via its shareholdership, the Government has a new role for which it certainly was not prepared.

The credit crisis begs international coordination on a European or even a world level in at least four different areas. First is fiscal policy. A certain degree of cooperation is necessary, as fiscal stimulation in one country has positive consequences for others. Second, protectionism must be avoided. Stating good intentions does not suffice; coordinated sanctions against offenders are necessary to successfully fight protectionist reflexes. Third, regulation and supervision should be harmonised, at least on a European level, and there is a need for arrangements on burden sharing of the cost of supporting the financial sector.

The fourth point has not yet been addressed: In addition to a policy for rescuing the financial sector, thought must be given to a coordinated European response in case an E(M)U member state unexpectedly finds itself in substantial financial problems. However hard the credit crisis hits the Dutch economy, for many people the effects will remain limited for the time being. The banks have been kept afloat, which is to say that all account holders (except for those who held very large deposits at Icesave) have been spared the effects of the crisis. Shareholders of many banks, on the other hand, have all but lost their entire investment. In addition, as share prices have fallen the coverage ratios of pension funds have declined sharply, so that pensions are not expected to be indexed in the coming years.

Lower inflation means that the effects on purchasing power are relatively mild in most cases, at least for those who keep their jobs. However, the effects of the crisis on the real economy will become more noticeable with time, particularly on the labour market. Unemployment will rise sharply, especially among young people, immigrants and unskilled workers. Focused initiatives to keep these groups in work by means of training or internships are therefore a good way of targeting the stimulus policy, for the short and long term.

Source: community.dynamics.com