17 May 2013

IMF: Belgium - Financial System Stability Assessment

The impact of the crisis on Belgium was substantial, resulting in a sharp output contraction, wide-spread instability in financial markets, and an abrupt deterioration in banks' financial positions requiring substantial state support.

Much has been done to address the fallout from the financial crisis in Belgium, but  important vulnerabilities linger. Following a determined response by authorities, a radically changed and downsized financial system emerged. Its ongoing transformation involves significant downside risks,  and the policy momentum should be sustained to preserve stability.

Low profitability and macro-economic prospects remain a source of vulnerability. The growth outlook for Belgium is weak, with risks skewed to the downside. For banks, structurally high costs are compounded by the diminishing earning capacity and the impact of regulatory reforms, while a downturn in housing prices would further exacerbate capital pressures. As firms refocus on the domestic market and core activities, increased competition puts pressure on profits. Prolonged low interest rates will create vulnerabilities for banks and life insurers. In combination with legacy portfolios, this might call into question the viability of business models for some firms in both sectors  necessitating close supervisory monitoring.

The links between banks, insurers and Belgian sovereign have intensified, posing additional risks. Market confidence remains fragile in the euro area and domestic political risks will persist as 2014 elections approach. A widening of the sovereign spread would raise funding costs and worsen capital and liquidity positions of banks and insurers in an environment of constrained profitability. The large public debt limits the government’s capacity for remedial measures, making it important to guard against inaction and supervisory forbearance.

These vulnerabilities are confirmed by the stress tests. Banks’ initial capital levels are solid in aggregate, but several banks would experience significant deterioration of profitability under stress. Given the forthcoming additional capital requirements, capital pressures could emerge in the medium term. Bank capital buffers should thus be strengthened. Credit risk appears limited, owing to historically low loss rates, but potential vulnerabilities from real estate overvaluation warrant a closer examination.

The new regulatory structure is functioning well, but remaining concerns should be addressed. Compliance with international standards for regulation and supervision of banks and insurers is generally high. Good risk-based practices are employed, particularly for large groups. A proportionate supervisory approach should be espoused also for smaller institutions. The decision to adopt elements of Solvency II ahead of schedule is welcome. However, strengthening the conduct of business regime for insurers and intermediaries as well as increasing supervisory resources remain a priority. The NBB and FSMA show strong commitment to home-host cooperation. Operational cooperation framework between the NBB and FSMA needs to be finalised.

Financial stability risks underscore the need for a more intensive and intrusive supervision. Promoting a supervisory culture in which the “will to act” is both expected and rewarded will be key to managing the complexities still present in the rapidly transforming system. A more uniform approach to the identification and assessment of cross-sectoral risks is necessary to improve conglomerates supervision, as well as a more consistent application of group-wide governance requirements.

Effective regulation, supervision and oversight of Euroclear Bank—a systemically important FMI—is in place. The authorities should work more closely with the Luxembourg counterparts responsible for Clearstream Bank Luxembourg, to ensure a level playing field in risk management practices. Broadening this cooperation, with the involvement of the ECB, would allow the authorities to coordinate recommendations and to seek their parallel implementation in both entities.

Full paper

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