High inflation, rising interest rates, the war in Ukraine and looming global recession have increased the risk of financial instability and will put the financial sector to the test, the Dutch central bank (DNB) said on Monday.

At the same time, Dutch financial institutions are in a healthy position with solid buffers, the bank said in its latest financial stability report.

‘Inflation is high and interest rates are rising, while economic growth is slowing,’ said central bank president Klaas Knot in a statement. ‘We have not seen this mix of factors to this extent since the 1970s.’

The central bank chief said the economy is in better shape than back then. ‘I have confidence in the resilience of our financial sector,’ he said, adding that ‘but this combination of adverse developments undeniably increases financial stability risks’

In particular, households, businesses and governments with high levels of debt may face difficulties if interest rates rise further and income growth lags behind. An abrupt change in market expectations may also lead to sudden corrections in financial markets, the central bank said.

Buffers

Banks will benefit from higher interest rates but must also expect increasing losses on outstanding loans, for example to energy-intensive industries. At the same time, rising mortgage rates and the deteriorating economic outlook are increasing the likelihood of price falls in the overheated housing market, the central bank said.

‘Banks should, therefore, keep their buffers above regulatory requirements as much as possible and exercise restraint in dividend payouts and share buybacks,’ the central bank said.

Inflation in the Netherlands is currently between 14% and 17%, depending on which way it is calculated. There are also signs that house prices are now coming down.

Dutch banks have had to hold extra capital since the beginning of this year to cover their outstanding mortgage loans and that measure will now be extended to December 1, 2024, the central bank said.

Debt levels

British forecasting agency Oxford Economics said in a report last week that Canada, New Zealand, the Netherlands, and Australia are among the housing markets most at risk.

‘In these markets, price increases since 2019 have been large, valuations are elevated, debt levels are high, and floating-rate debt is often prominent,’ the report said.