Dutch households have a higher exposure to the financial sector than the euro-area average. This is for two reasons. First, the Dutch pension system is capital-based, and pension savings are currently running at 178 percent of gross national product; this excludes life insurance policies which, if added, would amount to 200 percent of GNP (CBS Statline, own calculations). Second is the high proportion of interest-only mortgages with a high LTV. Early in one’s career, these high LTVs are needed since mandatory pension premiums run high at around 20 percent of one’s income. Over one’s lifetime, the two exposures may net out, but they expose Dutch households to consider-able uncertainty regarding their future flow of funds during the period of the mortgage. This is one of the reasons why Dutch consumption is more pro-cyclical than in other euro-area countries where pensions are based on a pay-as-you-go system (SER, 2013). However, with the baby boomers now retiring, pro-cyclicality may become a problem in
those countries with a pay-as-you-go system because of pressures on government budgets.
Before the 1990s, Dutch mortgages were primarily funded by life insurers and pension funds. Given the long duration of the liability structure of these institutions, it is only natural that this should be matched on the asset side with mortgages of similarly long duration.
More recently, Dutch pension funds have massively shifted their investments outside the Netherlands for purposes of diversification.
Banks have stepped in and built up large mortgage portfolios over the past two decades. The demand for mortgages also grew because of considerable pension premium hikes and the favourable income tax treatment of debt financing, which explains the high proportion of interest-only mortgages. Demand was further spurred by the growth in two-income households, which can typically apply for larger mortgages. As a result, Dutch banks have come to hold large portfo-lios of mortgages with high LTV ratios, which are often interest-only mortgages.
Until recently, Dutch banks under the internal ratings-based (IRB) approach were operating with a capital weight of around 18 per-cent for mortgages. This is considerably lower than the standardised approach under current Basel regulations, which requires a 35 percent risk weight up to 80 percent of the market value and a 75 percent risk weight for the part of the exposure above 80 percent. Under the cur-rent standardised approach, KPMG (2015) estimates that the capital requirements of all Dutch mortgages would have a risk weight of about 30 percent.
The combination of high LTVs and low risk weights caught the attention of the ECB, which started to ask questions about the mort-gage portfolios of Dutch banks. This did not lead to adjustments in the comprehensive assessment in October 2014, but the ECB is closely monitoring Dutch mortgages. To gain further evidence about the risks and performance of Dutch mortgages, European banking supervision (spurred by DNB) has started an on-site review of mortgage portfolios.
Prompted by the US supervisors, who prefer simplicity over internal models, the Basel Committee is currently reviewing risk weights for mortgages and has proposed a floor in the IRB approach based on a revised standardised approach. For the Dutch banks, this would increase the risk weighing to 40 percent (KPMG, 2015), a considerable hike from the current 30 percent given the large mortgage portfolio.
For this reason, Dutch banks are currently selling parts of their mortgage portfolios, partly to pension funds and insurers, and have reduced the supply of mortgages. In anticipation of this, and of other housing-related regulation, which requires new homeowners to repay the loan through an annuity, the Dutch housing market has stalled for a number of years. It is only now recovering thanks to the very low interest rates.
Two years ago, about 30 percent of mortgages were in nega-tive equity according to CBS (2015), but that number is declining.
Furthermore, mortgages with negative equity are concentrated in the more recent mortgages of younger families. Nevertheless, the loss rates are less than 0.1 percent, and foreclosures are even lower. The number of households in arrears is also very low. Expected default rates are among the lowest in the EU. One reason for the low loss rates on mortgages is the strong legal position of lenders in relation to borrowers under the Dutch civil code. For this reason, Dutch banks complain that the new rules do not take into account the high-quality payment history on Dutch mortgages and the legal environment. Here the one-size-fits-all approach, which mainly comes from Basel and EU legislation in the aftermath of the credit crisis, is biting. The DNB, however, has not (yet) been able to convince the Basel Committee to take the specific situation of Dutch mortgages into account. It appears that banks will have to live with this new reality, and should continue slimming down their exposure to residential housing or increase their capital. Given this, a revision of the Dutch bankruptcy law might also be considered to make defaults on mortgages easier, which would arguably contribute to the EU objective of capital markets union. In
this sense the one-size-fits-all supervision in the banking union is not promoting the best standards, and supervisors appear to promote a race to the bottom with their unconditional approach that neglects local institutional factors. Recently, DNB has threatened to block stronger capital requirements (in the form of capital floors for mort-gages) in the Basel Committee.