Introductory statement by Klaas Knot during the public session in the Dutch House of Representatives with DNB, the Dutch Authority for the Financial Markets (AFM) and the Netherlands Bureau for Economic Policy Analysis on macro-economic risks for the Dutch financial system

I would like to thank the Chair and the House of Representatives for their invitation. Together with my colleagues from the CPB and the AFM I would like to discuss with you the most important risks for the financial system. I will base this on the Financial Stability Report, which was sent to you.

The risk outlook for the Dutch economy and financial system is much better than it was a year ago. With vaccination campaigns now in full swing, the COVID-19 virus seems to be gradually coming under control. The end of the economic crisis is therefore also coming into view. Despite a contraction of historic magnitude last year, at De Nederlandsche Bank we believe the outlook for the Dutch economy is decidedly bright. The world economy also appears to be recovering sooner than we had expected. As social distancing measures are further reduced, we expect economic recovery to gain significant traction in the second half of the year.

The global financial sector has so far proven resilient to the impact of the COVID-19 crisis. No doubt the extensive support measures taken by governments, central banks and supervisory authorities have made this possible, among other factors. After all, their measures have mitigated the economic fall-out and its spill-over to the financial sector. Similarly, buffers in public finances and at banks helped absorb the shock. So far, financial institutions continue to play their role the way they should, keeping up lending to businesses and individuals.

While the outlook is bright, uncertainties surrounding economic recovery remain more prominent than usual. After all, it is too early to discount the possibility of a global resurgence of the pandemic. So we need to realise that the world economy can only recover on a lasting basis once the virus is under control around the globe. Obviously, the same applies to the Dutch economy.

Although the extensive crisis measures were sorely needed and have proved to be effective, they have unwanted side-effects, most prominently in the longer run. They disrupt regular market dynamics and fuel the build-up of vulnerabilities in the financial system. Governments around the world spent USD 16 trillion - which is sixteen thousand billion euro – on budgetary support measures. This has driven up worldwide public debts from just below 85% of global GDP to almost 100%. Private debt levels have also increased in spite of the support measures. Governments, firms and banks have become more interconnected – also financially – due to the measures. Furthermore, investors are inclined to take more risks under the current accommodative financing conditions. Financial market prices may become out of line with their fundamental values.

Let me express another word of caution about our upbeat risk overview. The pace of recovery could differ substantially between countries. This is already reflected in the different growth projections. Divergent recovery fuels further risks. If developed countries recover rapidly, this will drive up interest rates across the world. Emerging countries will suffer as a result, as they have a continued need for finance as long as they do not control the virus. There are similar risks of unequal recovery and further divergence in terms of growth in the euro area. For instance, some economies are hit harder by social distancing measures than others, and euro area countries burdened by high public debts have less room for manoeuvre to cushion the blow.

So what does this risk overview mean in policy terms?

As we get the virus under control and the economy is picking up, we are approaching the juncture in the Netherlands when support must be scaled back to allow market dynamics to take over again. Cutting support too soon could nip the current recovery in the bud, but I believe we will be past that point after the third quarter of this year. So I wholeheartedly subscribe to the policy line the government described in its letter to the House of Representatives last Thursday, informing the House it planned to scale back support in the fourth quarter.

I believe mounting debts and overdue payment obligations among firms, most notably small and mediums-sized firms, warrant attention. Viable firms in badly affected sectors will need debt relief and must be granted enough time to work out arrangements with their creditors. In my view, private creditors are best placed to determine the specific type of debt restructuring needed in each case, as they are after all most familiar with these businesses. Tax and Customs Administration could nudge them a little by making a prior commitment to match this private debt restructuring. This would allow it to rely on privately-conducted assessments of businesses’ viability while preventing other creditors from profiting from its leniency.

Dutch public finances show that the government continues to be able to finance its budget deficits. This means austerity measures and tax hikes are unneeded and undesirable in the short term as they could stand in the way of recovery. At the same time, the economic outlook does not imply the need for further budgetary stimulus either.

What must be done now, however, with economic recovery under way, is to decisively address structural weaknesses in the Dutch economy. To my mind, the most urgent issues are making the economy more sustainable and addressing imbalances in the housing market and  the labour market. The formation of a new coalition government provides the perfect opportunity to create a clear perspective in these areas.

The transition to a carbon-neutral economy must not be delayed. Procrastination drives up the cost of future measures and increases the likelihood of damage to the economy. This may also harm the stability of the financial system. The sooner the Dutch government adopts predictable and credible transition policies, the better the financial sector will be capable of anticipating them, manage risks and help finance the required investments. This urgency means such policies must be an integrated part of measures aimed at economic recovery.

So let me turn to the housing market. The Dutch housing market is overheated and on the brink of grinding to a halt. Part of the Dutch population find it increasingly difficult to buy or rent a home. First and foremost, new houses must be built to address the current scarcity, which drives up prices and keeps them high. But building houses is not enough. Mortgage interest tax relief, lenient underwriting standards and grants for first-time buyers fuel the self-reinforcing spiral of soaring house prices and mounting mortgage debts. The housing market would function much more smoothly in the absence of these facilities and with a gradual transition of home equity from box 1 to box 3 for tax purposes.

In an overheated housing market, the risk of a price correction is always looming. Banks, however, have not sufficiently taken into account the systemic risk inherent in the housing market  for some time now. This is why we have decided to no longer delay the introduction of a floor for mortgage loan risk weighting. This is a measure we announced in the autumn of 2019 but postponed after the pandemic broke out. Provided economic recovery continues as expected, the measure will take effect on 1 January 2022. While it does not address overheating in the housing market, it makes the banks more resilient against a potential downturn.

Let me conclude by turning to Europe. As you may know, I am concerned about the risk of imbalanced growth in the euro area and potential ramifications for financial stability in the Netherlands. If all euro area countries want to recover from the COVID-19 crisis in a balanced way, they need sufficient budgetary headroom, targeted investments and reforms that promote growth. These elements are at the heart of the European recovery fund, and that is why I fully support it. It allows us to kill two birds with one stone: we narrow the gap between those leading the way and those lagging behind, and we invest in the sustainable growth capacity of the euro area.

This concludes my introduction. I would be happy to answer any questions you may have.