Kingdom of the Netherlands—Netherlands: Selected Issues

This Selected Issues paper for the Netherlands highlights that Dutch cost competitiveness deteriorated significantly in the years prior to 2004. The relatively poor economic performance during the new millennium contributed to these concerns generally, as did restrained export performance more specifically. The deceleration of private consumption growth started earlier than the deceleration of per capita real disposable income growth, and occurred at a time when the unemployment rate has been at a historic low and interest rates had declined.


This Selected Issues paper for the Netherlands highlights that Dutch cost competitiveness deteriorated significantly in the years prior to 2004. The relatively poor economic performance during the new millennium contributed to these concerns generally, as did restrained export performance more specifically. The deceleration of private consumption growth started earlier than the deceleration of per capita real disposable income growth, and occurred at a time when the unemployment rate has been at a historic low and interest rates had declined.

V. The Financial Sector in the Netherlands: A Health Check and Progress Report on the FSSA Recommendations37

109. Following up on the 2004 Financial System Stability Assessment (FSSA), this paper has two purposes. The first is to review recent developments in the financial sector since the FSSA was completed last year. The second is to discuss the progress made on the recommendations from the FSSA. As noted in the staff report for the 2005 Article IV Consultation, staff found no reason to depart from the main conclusion of the FSSA—namely that the Dutch financial system is sound, resilient to potential adverse shocks, and well supervised.38

A. Recent Developments

110. Little has changed in the structure of the financial system since the publication of the FSSA (Table 1). There were minor changes in the number of banks and insurance companies. The downward trend in the number of pension funds continued as the sector consolidated in pursuit of further efficiency gains.

Table 1.

Netherlands: Financial System Structure

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Source: National authorities.

Number of institutions with 75 percent of total assets.

111. Banks improved their balance sheets and their profitability in 2004. The capital-to-asset ratio of deposit-taking institutions continued to increase, and the ratio of their trading income to total income followed a cyclical recovery (Table 2). Meanwhile, despite the flattening of the yield curve and a related reduction in banks’ margins, returns on both assets and equity increased as the volume of transactions rose and banks continued their effort to reduce costs (Table 3). Traditionally ample liquidity in Dutch banks increased further. With respect to financial derivatives, the pick-up in activity reflected market developments: credit default swaps and collateralized debt obligations (known as CDSs and CDOs in market jargon) have expanded exponentially on a global basis, and developments in the Dutch market followed this trend. The increase in loans to other financial institutions reflected a rise in interbank lending, which is typical during this phase of the cyclical upswing.

Table 2.

Netherlands: Encouraged Financial Soundness Indicators

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Table 3.

Netherlands: Financial Sector Indicators

(In percent)

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Three largest banks.

112. While house price growth moderated in 2004, mortgage lending continued to rise. This partly reflected growth in refinancing, with the market apparently holding the view that the trough in the current interest rate cycle had been reached. Loan-to-value (LTVs) ratios in recent times have been high for new loans, averaging about 105 percent (though the average for all loans is considerably lower).39 Activity was largely confined to the highly competitive banking sector (insurance firms and other financial institutions are also allowed to sell mortgages), with banks continuing to reduce their margins and offering interest-free initial mortgage periods.40

113. The performance of the insurance sector also improved in 2004. While a low interest rate environment continued to limit the returns of life insurance providers, both parts of the insurance sector improved their profitability, helped by better stock market performance, and with nonlife providers also benefiting from further reductions of costs and limits on claims. However, if the low interest rate environment were protracted, it may lead to concerns over firms’ solvency in the future.41 Because it operates on a low duration gap, these concerns are much less pertinent to the nonlife sector, as short duration liabilities make it easier to better match assets and liabilities.

114. Pension fund returns edged down in 2004—though they still remained high and the funds boosted their asset-liability (or coverage) ratio (Table 4). Although interest rates were low, pension funds benefited from higher equity prices and a shift in the composition of their portfolios to equities. Pension funds also increased contribution rates, and this contributed to the rise in their asset-liability ratio to 124 percent.42

Table 4.

Netherlands: Performance of Dutch Pension Funds

(In percent)

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Source: CPB, DNB.

115. The debt of households continued to move higher in 2004, albeit at a much slower rate than in previous years. The authorities indicated that nonperforming loans (NPLs) of households doubled (according to preliminary data), though from a very low base.

116. The liquidity and profitability in the corporate sector improved in 2004. Corporations reduced their debts at the same time that profitability rose. Meanwhile, firms also refinanced loans at lower interest rates. Consistent with the pickup in corporate profitability, the authorities indicated that NPLs of the corporate sector declined.

117. On the financial policy front, the Dutch integrated supervision scheme has already produced a number of benefits, both from a policy perspective and operationally. From a policy viewpoint, teams working on Basel II and Solvency II could beneficially be combined, and this has resulted in cross-group information and expertise-sharing.43 At an operational level, benefits have also been significant, particularly for supervision of large and complex financial institutions in the Netherlands, which are the critical components of the sector. Integration has also allowed for the institutional transfer of human capital and the use of risk assessment tools drawing on the best approaches adopted when supervising banks, pension funds, and insurance firms separately.

118. Reflecting the move toward integrated supervision, financial crisis management and planning have been restructured within the Netherlands’ central bank (DNB). The DNB has identified a crisis team that can become operational on short notice, and strengthened support for this team in order to further improve the DNB’s crisis preparedness. Plans have not been tested internally yet, although the DNB has participated in a euro system stress test and will also likely take part in another multinational financial sector crisis management “war game” foreseen for Spring 2006.

119. A new Financial Supervision Act is expected to become law on January 1, 2006. The new law (some key details of which are discussed in Section B below) is intended to be “super neutral”—i.e., implementing all EU legislation, while also incorporating additional national measures exceeding or extending EU minima.44

120. Key institutional changes to pension funds will also be introduced on January 1, 2006. Three main areas involved are: (i) solvency or coverage requirements;45 (ii) the introduction of “fair value accounting”, which will ensure that pension funds mark to market their assets and liabilities frequently; and (iii) increased transparency for beneficiaries over their anticipated payouts. With respect to the latter change, it is important that second tier pensions in the Netherlands are defined-benefit plans. While most funds attempt to provide full indexation, they do not guarantee it and they have had the flexibility to provide only partial indexation in years when returns are poor or assets are being built up. The new regulatory regime will ensure that nominal benefits, at a minimum, are guaranteed, and that pension funds are clear and explicit about the extent to which indexation is being guaranteed. In addition, higher coverage ratios will be required as the level of guaranteed indexation increases. All this implies that the average coverage ratio will need to be increased from its current level.

121. New legal requirements to increase pension fund coverage ratios could have macroeconomic consequences. In cases where full indexation is not guaranteed, the minimum requirements imply a coverage ratio, on average, of 130 percent, compared with the coverage ratio of 124 percent at end-2004. When the coverage ratio is lower than 130 percent, it needs to be restored, as agreed with the supervisor, within a period not exceeding 15 years (at end-2004, Dutch pension funds held roughly €505 billion in assets). Increasing the coverage ratio, depending on how it is spread out, could affect contributions in a way that affects savings and therefore consumption behavior, and the macro economy. At the same time, the new regulatory framework could lead to changes in the pension funds’ asset allocations. Hypothetically, for example, pension funds could pursue a more risk-averse investment strategy, shifting away from equities to bonds. Given that reduced returns over the long run could also have a macroeconomic impact, the potential implications of the new requirements will need careful monitoring.

B. FSSA Recommendations

122. This section elaborates on the actions taken with regard to the FSSA recommendations summarized in Box 2 of the Staff Report. It is organized by recommendation and draws heavily on material provided by the authorities.

123. Recommendation I: Spell out clearly the role of the minister of finance, as applicable, in those few areas where autonomy is not fully delegated to the supervisor.

  • Starting in 2004, the approval of the minister of finance has only been needed if one of the five largest banks or insurers takes a participation in each other. The requirement in those cases follows from the minister’s political accountability for the well-functioning of the financial system and the budgetary consequences of a potential systemic crisis. In the new Supervisory Act mentioned above, this task will be delegated to the supervisors directly by law, with the licensing of financial institutions done solely by the supervisory authorities.

124. Recommendation II: Ensure that the Authority for Financial Markets (AFM) has the power to cooperate with securities supervisors internationally even when there is no “domestic interest.”

  • Cooperation of the AFM with supervisory authorities in other Member States is part of the new Financial Supervision Act. For non-Member States, the Act stipulates that under certain conditions, information exchange may take place (this is not compulsory).

125. Recommendation III: Continue to work with cross-border counterparts to further improve securities settlement arrangements.

  • Improvements are being made through supporting Euroclear’s single settlement platform and promoting the use of delivery of securities against payment (DVP) in making settlements. However, DVP will not be used in all cases and there will always be some free of payments transactions (FOP). The AFM and the DNB have approved a proposal from Euroclear Netherlands to admit investment firms as participants, and they actively support the Euroclear initiative for building a Single Settlement Engine/Single Application Platform for cross-border DVP in 2007. While the first three parts of the new Financial Supervision Act come into effect at the start of 2006, the fourth part on market infrastructure is expected to be finalized by July 2006.

126. Recommendation IV: Ensure that the new pensions supervisory arrangements allow sufficient flexibility in the specified timeframe for making up shortfalls in the coverage ratio, to prevent procyclical effects, but without allowing unduly prolonged adjustment.

  • The new arrangements improve transparency, and the timeframe for making up shortfalls in the coverage ratio balances the goal of avoiding procyclical effects without unduly prolonging adjustment.

  • The most relevant parts of the Financial Supervision Act are the following:

  • The minimum coverage ratio (in which the present value of assets must equal at least 105 percent of the present value of liabilities) must always be satisfied. If it is not, the fund should immediately submit a recovery plan to the DNB for approval, explaining how the minimum requirement will be restored within one year. When a large number of pension funds are experiencing a sharp fall in capital, the DNB may allow a longer period. If the coverage ratio is lower than the required amount46, but more than 105 percent, the pension fund must immediately inform the DNB and submit a recovery plan, explaining how the requirement will be restored as quickly as possible but in any event within 15 years. The fund must implement the recovery plan and report annually to the supervisors on whether the measures in the recovery plan have been implemented and whether the intended effects have occurred.

  • In the event of a fundamental change in a fund’s volume of investments, or the composition of its investments or commitments, the situation should be reviewed, and if necessary, a new recovery plan drawn up. Departures from a recovery plan will be permitted only if the DNB approves a new recovery plan, in which case a new recovery term will also be observed.

  • Because applying resources to fund indexation (in full or in part) rather than to increase the coverage ratio influences the pace at which the fund meets solvency requirements, indexation will be allowed only if it fits in the recovery plan and is stipulated in advance.

  • The present value of liabilities will be calculated on the basis of a term structure of interest rates (instead of a fixed discount rate as it is currently done). For a three-year transitional period, the DNB proposes to allow the use of discount rates aligned as closely as possible with the maturity characteristics of the institution’s liabilities rather than the full term structure of interest rates.

  • Every pension fund is responsible for sound financial risk management and proper capital funding of its liabilities. The information provided to the DNB for regulatory purposes must give a transparent and reliable view of the financial position and risks of the fund. When it appears that a pension fund will be unable to meet solvency requirements in the future (continuity analysis), the DNB can intervene. Early intervention can be seen as a vehicle for preventing procyclical effects.

127. Recommendation V: Continue the development of the framework for dealing with crisis situations, both through further work with other supervisors internationally, and through completing the review of the domestic deposit guarantee scheme.

  • The DNB has entered bilateral discussions on signing another crisis management agreement. The agreement envisages a crisis management committee as a mechanism for consultation in crises, without prejudice to the formal responsibilities of each institution, and defines the information items which should be available within the signatory financial institutions. In addition, the DNB has critically reviewed its crisis management preparedness, decided to keep its approach pragmatic (since every crisis is unique), and identified several areas where improvements can be made. These areas pertain to internal coordination, communication, and documentation. Moreover, a bank-wide team at board/division level was reestablished to review and improve procedures (among others, with respect to emergency liquidity assistance). At the EU-level, a new memorandum of understanding (MoU) for financial crisis situations between the banking supervisors, central banks, and finance ministries of the EU has been agreed upon and signed in May 2005. The Financial Services Committee (a committee of EU ministries of finance) is reviewing current national crisis management arrangements in the EU to ensure their compatibility with the MoU.

  • The authorities are presently reviewing the Dutch deposit guarantee scheme, which is not ex ante capitalized, and considering the introduction of prefunding and risk-based premia. In order to minimize the burden on banks in circumstances in which the banking system is highly concentrated, it is likely that changes to the scheme will result in partial (rather than full) ex ante funding and risk-sharing.

128. Recommendation VI: Continue the development of macro prudential surveillance to help strengthen the early identification of risks and vulnerabilities.

  • The DNB has strengthened its macro prudential surveillance through a number of measures. It established the division of Financial Stability in May 2004, with the main task of identifying risks and vulnerabilities to financial stability. Several published papers have resulted from building up an analytical financial stability framework.47 Building on the FSAP stress test methodology, the DNB is also developing a framework for macro-stress testing as a regular tool for assessing financial stability. In addition, the DNB has been developing models and indicators to support analyses in various areas, such as the pension model PALMNET and a set of macro prudential indicators that results from a joint effort of various DNB divisions. Finally, Financial Stability reports are published regularly in June and December (an internal version includes policy recommendations).

129. Recommendation VII: Over the medium term, phase out tax deductibility of mortgage interest, preferably in a gradual fashion to avoid disruptive effects.

  • While the tax deductibility of mortgage interest payments had already been limited to some degree,48 additional measures were taken in 2004 and 2005. The so-called “bijleenregeling” was put in place in 2004. This meant that the capital gain made on a sold house was assumed to be used for the purchase of the new house, and that amount is not therefore no longer eligible for mortgage interest deduction. As of January 1, 2005, a fiscal incentive to pay off mortgage loans completely, or to a large extent, was also introduced.


Prepared by Francisco Nadal De Simone.


The Kingdom of the Netherlands—Netherlands: Financial System Stability Assessment, including Reports on the Observance of Standards and Codes on the following topics: Banking Supervision, Securities Regulation, Insurance Regulation, Corporate Governance, and Payments Systems, Securities Settlement Systems, and Anti-Money Laundering/Combating the Financing of Terrorism, IMF Country Report N. 04/312, September 2004.


LTV ratios are not regulated in the Netherlands. Regulations apply to the ability to pay rather than to the ability to reclaim value (i.e., income-to-value ratio as opposed to LTV). Moreover, the tax deductibility of mortgage interest payments has been factored into loan demand. Finally, it is also possible that the increased share of mortgages in banks’ portfolios observed in several countries reflects markets’ anticipation that Basel II will reduce capital requirement on mortgage lending.


A concern related to the mortgage market is the growing take-up in interest-only mortgages and the difficulty in tracking and assessing the risk related to the investment of associated funds to cover the future payment of principal.


The life sector is still recovering from the reduction in returns after the removal of tax deductibility of life insurance premia in 2001.


As discussed below, the solvency ratio starting in 2006 will be determined on the basis of market interest rates instead of a fixed discount rate as used now. Market rates would imply a decline in the solvency ratio from 129 percent in 2003 to 123 percent in 2004.


As Solvency I is not considered sufficiently risk based by the authorities, they are working to influence and accelerate the development and introduction of Solvency II within the context of the Insurance Committee of the European Commission.


At the same time, the authorities are striving to reduce the administrative burden on firms, an objective that also is taken into account in designing financial policy. Against this background, the authorities did not include in the Act, as suggested by the FSSA, audit committees for individual banks.


Coverage requirements—expressed in terms of the coverage ratio, which is defined as the ratio of the present value of assets over liabilities—depend on the risk profile of the individual pension fund’s investment portfolio and the degree of guaranteed indexation of benefits.


Under the new arrangements, pension funds will be required to achieve a coverage ratio (i.e., the ratio of the present value of assets over liabilities) implied by a 97½ percent probability of meeting their obligations. In cases where indexation is not guaranteed, the latter implies a coverage ratio, on average, of 130 percent. Under the increased transparency associated with the new framework, the authorities consider that the pension funds that intend to provide full indexation will have to clearly state that the funds available for that purpose are those that exceed the 130 percent required to provide only partial indexation.


See, for example, Houben, Kakes, and Schinasi, 2004, “Towards a Framework for Financial Stability,” DNB Occasional Study, Vol. 2, No. 1; Houben, Kakes, and Schinasi, 2005, “A Policy Perspective to Financial Stability,” Financial Regulator March 2005; and Van den End and Tabbae, 2005, “Measuring Financial Stability: Applying the MfRisk Model to the Netherlands,” DNB Working Paper No. 30).


For example, since 2001, interest on mortgage loans used for consumption or the purchase of a second home have not been deductible. In addition, the period for the deductibility of mortgage interest has been capped at 30 years.