I. Background²

1. In 2002 the Dutch authorities adopted an objective-based “twin peaks” supervisory model. Under this model, DNB became a single prudential supervisor for all financial institutions (banks, insurance companies, investment firms, pension funds, and securities firms), and an AFM was created as supervisor responsible for conduct-of-business supervision including supervision of security market activities, with a strong focus on market behavior and consumer/investor protection.

2. The “twin peaks” model replaced the sector-based supervision model with multiple supervisors, which included a banking supervisor (DNB), a pension and insurance supervisor (PVK), and a securities supervisor (STE) carrying out conduct-of-business supervision related to security market activities. The coordination of micro-prudential and conduct-of-business supervision between the sector-based supervisory agencies was conducted by the Council of Financial Supervisors (RFT), which was set up in 1999 specifically for this purpose. With the introduction of “twin peaks,” a “covenant” between DNB, PVK and the AFM was established to facilitate a smooth transition toward the objective-based supervisory framework. The full transition was completed in 2007—shortly before the country was hit by the global financial crisis—with the introduction of the AFS and the Pension Act.

3. The design of the “twin peaks” model was based on several considerations. In particular,³

• The preference for a unified prudential supervisor was driven by changes in the Dutch financial industry structure. Following the global trend, the Dutch financial system had become dominated by a few very large financial conglomerates operating across bank/insurance/pension lines, and offering increasingly complex financial products that blurred the conventional credit/insurance/securities boundaries (e.g., credit swaps and investment/linked insurance policies). The decision to bring the prudential supervision of banks, securities, pension funds, and insurance companies therefore responded to the regulatory challenge posed by large financial conglomerates. This approach also has the benefit of minimizing regulatory arbitrage. Even before the recent financial crisis, the number of unified supervisory agencies worldwide had increased rapidly (see Table 1).⁴

• The preference for objective-based supervision led to the separation of prudential and conduct-of-business supervision under different agencies, or “twin peaks.” Another approach to the challenges posed by financial conglomerates would have been the creation of a single regulator for both prudential and conduct-of-business supervision, justified by synergies between them.⁵ The Financial Services Authority (FSA) in the United Kingdom is one example, although it will soon be replaced by a “twin peaks” structure. But the view of the Dutch authorities (and supporters of “twin peaks”) was that the objective of prudential supervision, which is safeguarding financial stability, is very different from that of conduct-of-business, which is protecting consumers. The arguments are (a) prudential and conduct-of-business supervisions simply do not mix, despite synergies between them, because they require different skill sets and different tools to achieve their individual objective; and (b) in normal times, consumer protection is likely to have more political attention than prudential supervision, possibly diverting resources away from prudential supervision.⁶

• The decision to locate the unified prudential supervisor within DNB was based on several factors. There are synergies between prudential and monetary policy aspects, and macroeconomic stability and financial stability are closely linked. It was expected that prudential supervisors could benefit from the central bank’s macroeconomic analysis, as well as from the central bank’s long standing credibility. The long standing independence of the central bank could also be an asset during times when difficult decisions would have to be made. DNB’s role was enhanced with new responsibilities at the time when monetary policies became the responsibility of the European Central bank (ECB). This was expected to limit the potential conflict of interest between monetary policy and financial stability objectives.⁷

Table 1.

The Netherlands: Selected Examples of Objective-Based Supervisions

Table 1.

The Netherlands: Selected Examples of Objective-Based Supervisions

	Before Recent Crisis	After Recent Crisis
Integrated prudential and conduct-of-business supervision (One Peak)	Austria (2002), Belgium (2004), Germany (2002), Switzerland, Sweden, U.K. (FSA), Hungary (2000), Poland (2006), Japan, Korea, Singapore, Colombia, Nicaragua	Finland (2009), Germany, Switzerland, Sweden, Hungary, Poland, Japan, Korea, Singapore, Colombia, Nicaragua
Separated prudential and conduct-of-business supervision (Twin-Peaks)	Australia (1998), Netherlands (2002)	Belgium (2011), Italy (planned), Spain (planned), France (planned), U.K. (planned), U.S.* (with multiple prudential supervisors), Australia (1998), Netherlands (2002)
Unified prudential supervision integrated with central bank	Netherlands, Hongkong, Singapore, Switzerland	Belgium (2011), Italy (planned), Spain (planned), France (planned), U.K. (planned), Netherlands, Hongkong, Singapore, Switzerland
Unified prudential supervision outside central bank	Australia, Belgium, U.K. (FSA), Japan, Hungary, Germany	Australia, Japan, Canada, Hungary

View Table

Table 1.

The Netherlands: Selected Examples of Objective-Based Supervisions

	Before Recent Crisis	After Recent Crisis
Integrated prudential and conduct-of-business supervision (One Peak)	Austria (2002), Belgium (2004), Germany (2002), Switzerland, Sweden, U.K. (FSA), Hungary (2000), Poland (2006), Japan, Korea, Singapore, Colombia, Nicaragua	Finland (2009), Germany, Switzerland, Sweden, Hungary, Poland, Japan, Korea, Singapore, Colombia, Nicaragua
Separated prudential and conduct-of-business supervision (Twin-Peaks)	Australia (1998), Netherlands (2002)	Belgium (2011), Italy (planned), Spain (planned), France (planned), U.K. (planned), U.S.* (with multiple prudential supervisors), Australia (1998), Netherlands (2002)
Unified prudential supervision integrated with central bank	Netherlands, Hongkong, Singapore, Switzerland	Belgium (2011), Italy (planned), Spain (planned), France (planned), U.K. (planned), Netherlands, Hongkong, Singapore, Switzerland
Unified prudential supervision outside central bank	Australia, Belgium, U.K. (FSA), Japan, Hungary, Germany	Australia, Japan, Canada, Hungary

4. The consolidation of macro- and micro prudential supervision within the central bank is another feature that distinguishes the Dutch model from other variations of “twin peaks,” such as the Australian model.⁸ With the consolidation, macro-prudential surveillance (to ensure financial stability) becomes closely linked to (micro-prudential surveillance (to ensure the financial soundness of individual financial institution). It has become evident during the recent crisis that, with all prudential oversight located in DNB, it is able to take a view of systemic issues across the financial sector as a whole, and react quickly and decisively in a crisis.

II. Twin Peaks Model in Practice

5. The AFS, which came into force on January 1, 2007, provides the legal framework for the supervisory authorities under the twin peaks. The AFS is supplemented by various Royal and Ministerial Decrees. Under this law, DNB is vested with the power to issue rules and policy guidelines that mainly concern the interpretation of the law. The structure introduced by the AFS does, however, provide for a larger role for the Ministry of Finance (MoF) than in most comparable systems. For example, both DNB and the AFM have relatively limited rule-making authority of their own, since most regulation is either directly contained in the AFS itself or in Decrees that are the responsibility of the MoF.

6. The establishment of a “Covenant” between DNB and the AFM has facilitated the implementation of the AFS. The “Covenant” set out a practical framework for division of responsibility and cooperation between them, which includes: (1) the designation of DNB as the lead agency with overall responsibilities for supervision (including licensing) for all financial institutions, and the designation of the AFM as the lead agency for securities firms; (2) an agreement that the lead supervisor would defer to the judgment of other supervisor; and (3) rules for consultation and information sharing.⁹

7. Consequently, the clarity of mandates and objectives for the supervisory authorities has been improved substantially. With an exception of a few isolated incidents, both DNB and the AFM appear to have a clear understanding of their respective roles and responsibilities under the “twin peaks” model, and in general cooperation and coordination between the two agencies seem to have functioned well in practice, including during the period of greatest financial stress during the crisis.

8. The supervision of conduct-of-business, especially related to the securities markets, has been strengthened. In recent years, the AFM has put considerable emphasis on improving the aspects of supervision related to consumer protection and transparency, using a risk-based approach for onsite supervision, complemented with institution-based on-site and off-site supervision for high-impact firms. The AFM’s conduct-of-business supervision has been complemented by DNB’s prudential supervision. For example, DNB has implemented a program for the supervision of investment firms in cooperation with the AFM, in which most supervisory resources are spent in the investment firms that conduct “risky activities,” such as proprietary trading. Such firms are subject to on site inspections by DNB on an annual cycle, while the remaining firms are visited under a three year cycle.

III. Twin Peaks Model During the Crisis

9. The “twin peaks” model worked well during the crisis, as decisions were able to be made in timely manner to contain the banking crisis, in part because of laws permitting information sharing. The laws allowed for information sharing in the context of crisis management, both between DNB and the AFM, and between DNB and the MoF. The pre-crisis institutional setup also helped. The MoF and DNB have codified their roles regarding crisis management in a well-designed MoU, which gives the MoF the ultimate responsibility for financial stability and DNB the task to contribute to this objective, through actions falling under its jurisdiction. In addition, a coordination group on financial stability that used to meet 3-5 times a year began to meet weekly during the crisis, and it was quickly expanded to include representatives from DNB’s markets, payments, and legal divisions. Based on this, a crisis management group was set up to include also representatives from the MoF and the AFM, and met daily. The coordination between DNB and the AFM also went smoothly based on specific arrangements under the AFS.

10. Clear divisions of powers and responsibilities were instrumental in achieving effective coordination between key institutions during the crisis:

• DNB was the lead authority for all bank resolution measures before any public solvency support was involved. It provided emergency liquidity assistance (ELA) to illiquid but solvent banks and imposed corrective measures to problematic banks. Moreover, DNB was responsible for changing the management of the failing banks and initiating bank restructuring.

• Whereas the AFM has no specific competences regarding crisis management and bank resolution, it contributes to the effectiveness of bank resolution by supporting discrete bank resolution measures while requiring transparency when and if necessary.

• The MoF (in charge of overall financial stability) was in the lead when it came to official solvency support for ABN-Amro, ING, and the other institutions.

11. Nonetheless, the financial sector has been severely affected by the global financial crisis of 2007/08. In addition, the credibility of DNB has been tested in view of some high profile bank failures. DSB Bank with a concentrated regional customer base, was closed in 2009. A government report looking into the failure of this bank criticized its handling by DNB. The failure of IceSave, an internet branch of an Icelandic bank with a substantial Dutch customer base led to difficult international negotiations. Conduct-of-business problems have negatively affected confidence in the integrity of the financial institutions, particularly in insurance. Extensive selling of products with high commission has reduced public confidence in insurance companies. With the settlement of the resulting claims likely to take many years, supervisors have taken proactive measures to ensure that financial institutions rebuild confidence in the industry, which remains an immediate priority.

12. The crisis revealed certain areas within the “twin peaks” model that could be strengthened to realize the full benefits of the model going forward. In part, these may have reflected a learning process as the transition to the model was completed only in 2007, but they also point to issues related to the supervisory approach, the scope of supervision, limited macro-prudential tools for reducing systemic risks, and weaknesses in supervision of financial institutions engaging in large cross-border businesses. More specifically,

• Prior to the crisis, micro-supervision tended to rely on “moral suasion.” Although the AFS provides DNB with an extensive range of legal sanctions and powers to ensure compliance with laws and regulations, bank supervisors seem to have been reluctant to use enforcement powers to the full. This may reflect a traditional bank supervision culture as well as a learning process on the part of supervisors about the extent of their powers under the recently introduced AFS. As the crisis has shown, the supervision that has largely relied on moral suasion has become progressively less effective, as elsewhere, given the rapid changes in the Dutch banking system.

• The crisis exposed areas for improvements in the prudential supervision for internationally active LCFIs, such as Fortis and ING Group, especially with regard to their international business activities. Although the “twin peak” model was designed specifically in response to the emerging dominance of LCFIs, resources and supervisory instruments available for the supervision of LCFIs international activities are relatively limited, as is the case in many other countries.

• DNB’s legal authority over financial holding companies is constrained. For mixed financial conglomerates, its power is limited to giving instructions, not imposing penalties, when the holding companies are judged as lacking inadequate risk management and internal control procedures. For insurance groups, there are explicit legal restrictions against DNB imposing broadly applicable limits on intra-group exposures. In addition, DNB has limited enforcement power against non-regulated holding companies. These problems prevail also in other European Union (EU) countries, and work is underway to issue new EU directives to deal with them.

IV. Twin Peaks Model Going Forward

13. DNB is taking decisive steps to achieve a more proactive and conclusive supervision. These include the establishment of an enforcement department for corrective actions and sanctions and a major cultural change project (“VITA”), one component of which is to encourage supervisors to make more use of their formal powers and to bring supervisory tools more into line with supervisory best practice and ensure their more consistent application. Pension fund supervision appears to have been more pro-active in recent years; further integration of the staffs conducting supervision in the various sectors should enhance the synergy potential of having a single prudential supervisor, and should help foster the incorporation of the new supervisory culture.

14. The crisis underlines the importance of macro-prudential regulation and supervision. The “twin peaks” model has the potential benefit of fully integrating macro-and micro-prudential supervisions. The AFS explicitly assigns to DNB the responsibility to safeguard the stability of the financial system. Within DNB, the Financial Stability Division (FSD) is primarily responsible for this task. However, macro-prudential analysis would need to be fully fed into policy changes and prudential surveillance. In the run up to the crisis, comprehensive analytical work conducted by the FSD was able to detect emerging systemic risks, but it had not been fully translated into surveillance work, in part because of the lack of sufficient macro-prudential tools.¹⁰ In response, a separate Department for macro-prudential supervision was created within this Division in 2010 to further improve the monitoring of macro-prudential risks.

15. For DNB to act more promptly to any emerging systemic risks and mitigate boom-and-bust cycles, it would need to expand its macro-prudential policy instruments. In line with the Financial Stability Board (FSB) framework, the proposals under discussion include a resolution framework for going-concern banks, higher capital requirements, countercyclical buffers, and the use of contingent capital and bail-in instruments. In this context, there is a case for greater DNB involvement in the rule-making process, or at least to have discretion to adjust the levels of the designated instruments, so that these macro-prudential instruments can be more responsive to market developments. Under the AFS, DNB (and the AFM) has relatively limited rule-making authority of its own, since most regulatory requirements are either directly contained in the AFS itself or in Decrees that are the responsibility of the MoF. For example, currently the MoF is responsible for setting the limits for mortgage loan-to-value (LTV) ratios. Given the important link between housing sector health and financial stability, the supervisors could be allowed to change the LTV ratio within a range set by the MoF, or to require more capital to be held against high LTV loans.¹¹

16. To avoid regulatory arbitrage, the perimeter of regulation will need to be extended to enhance the surveillance of shadow banking activities. Stricter capital requirements and regulations for banks could invite off-balance-sheet regulatory arbitrage (e.g., loan securitization). Therefore, rigorous regulation and supervision should also apply to the shadow banking system and to cover off-balance sheet entities. DNB, as the single regulator and supervisor, is well positioned to closely monitor the activities of non-banks such as hedge funds and insurance companies, apply uniform regulations to prevent regulatory arbitrage between banks and non-banks, and to coordinate closely with other regulators to minimize cross-border regulatory arbitrage.

17. In recognition of the problem related to cross-border supervision, DNB has recently taken measures to enhance the functioning of supervisory colleges in line with the recommendations of the FSB. For the large banks operating on a cross-border basis, a multilateral written agreement is signed between members of the respective colleges to provide for further formal arrangements for home and host supervisors. In the context of securities market, the AFM has been actively participating in the college of supervisors for Euronext N.V., and engaging other EU supervisors through the European Securities Market Authority. The “twin peaks” model thus seems well suited to the international aspects of supervision, with the central bank able to bring its wider international experience to handling cross-border issues, and the AFM able to bribng specialized conduct-of-business expertise to bear in its international relations. However, greater international cooperation (e.g., ex-ante burden-sharing agreements), beyond the colleges of supervisors, may be necessary.

18. The “twin peaks” model provides scope to redeploy resources to the part of the financial sector that is judged most susceptible to systemic risk. In that regard, the resources devoted to banking supervision require further attention. The frequency of visits to individual banks has been determined according to available resources and risk analysis. The relatively fewer resources devoted to banking supervision seems to have had an influence on the extent of DNB’s pre-crisis oversight of the activities of the overseas subsidiaries of some large Dutch banks. The extent of their activities would have justified a greater commitment of resources to their monitoring than was actually the case. The allocation of supervisory resources thus needs to be evaluated according to the potential systemic impact of regulated firms.

19. Growing awareness that problems concerning conduct-of-business supervision can rapidly develop into a prudential problem highlights the importance of closer cooperation between DNB and the AFM. The “Covenant” agreement (Article 1.5) set out general guidelines that the lead supervisor would defer to the opinions of other supervisor; but falls short in specifying a formal procedure for resolving differences in opinions. Such procedure should help avoid escalation of conflicts in public, which could harm the credibility of both institutions, as shown by a recent incident in which DNB and the AFM had opposite views concerning a fit-and-proper test result. In this case, the “Covenant” agreement should set out specific guidelines as whether such test should be passed by both DNB and the AFM.

V. Conclusions and Recommendations

20. The global financial crisis has tested the effectiveness of supervision under the “twin peaks” model. The crisis has severely affected the Dutch financial institutions, resulting in extraordinary official support. The crisis revealed the strengths of the “twin peaks” model, as decisions were able to be made in timely manner to contain the crisis and clear divisions of powers and responsibilities were instrumental in ensuring effective coordination between key agencies. However, the crisis also exposed certain areas where improvements could strengthen the “twin peaks” framework going forward.

21. The supervisory authorities are making intensive and well-focused efforts to strengthen the supervisory framework. More specifically, DNB has issued two comprehensive studies “DNB Supervisory Strategy 2010—2014” and “From Analysis to Action” that set out concrete steps which can lead to a more pro-active and conclusive financial supervision (Box 1).

22. Staff recommendations focus on measures to further strengthen the macro- and micro-prudential supervision and DNB/AFM coordination to reduce systemic risks; the twin peaks model would look to be particularly suited to carry this agenda forward:

• Strengthening macro-prudential supervision, perhaps by introducing financial stability as an explicit mandate for DNB and by expanding the macro-prudential toolbox accordingly to enable DNB to take prompt actions against any emerging systemic risks without having to resort to legislative changes first.

• Intensifying supervision of LCFIs, with greater emphasis on group supervision and soundness of business models. Recent steps toward a more proactive and decisive approach—which includes timely on-site inspection and corrective actions that rely less on moral suasion—are welcome. Greater international cooperation, beyond the colleges of supervisors, to maintain sound institutions is also necessary.

• Further clarifying the division of responsibilities and cooperation between DNB and the AFM, through the enhancement of the existing “Covenant” and a formal procedure for resolving differences in views, thus avoiding escalation of conflicts which, as the shown by the recent experience, could harm the credibility of both institutions.