4. An Appraisal of the Financial Monetary System

The payment system is crucial for society’s functioning.³ We evaluate the Dutch payment system using five criteria: its cost, accessibility, convenience, security and reliability. Studies have found that the total cost of the Dutch payment system (relative to GDP) is lower than that of most other countries. At approximately 0.92% of GDP, the Netherlands is just behind Denmark, Sweden and Finland – the top three in Europe – where costs amount to approximately 0.80% of GDP.⁴ The cost of payments in the Netherlands is also declining. Although cash payments have become more expensive (from €0.30 per transaction in 2002 to €0.39 in 2009), the cost of giro payments has fallen sharply, from €0.49 to €0.33.⁵ Given the shift from cash to giro/electronic payments – most payments in the Netherlands are now made with debit cards – the total social costs have most likely decreased even more.⁶

How are these costs allocated? Dutch consumers incur relatively few direct costs: they must often pay a fee to maintain a bank account, but pay little or nothing in the way of transaction charges. The direct costs are borne by businesses and banks. Businesses incur costs for both cash and electronic payments. For cash payments, these include the cost of transport, deposit and security systems; for electronic payments, charges levied by the bank. While banks incur costs to process payments, they also derive benefits from their position in the payment system, including the possibility to link services (such as loans and payment accounts), the relatively low interest paid on payment account balances and the government’s implicit or explicit support of banks (see Sect. 4.3). Nevertheless, a study by McKinsey & Company on behalf of the Dutch Banking Association (NVB) and De Nederlandsche Bank (DNB) shows these benefits did not offset the costs banks incur when handling cash and electronic payments.⁷

The second factor is accessibility. Here, low payment account charges encourage the use of the electronic infrastructure. The NVB signed in 2001 a pledge with the Salvation Army and the Ministry of Finance that all permanent residents aged 18 and above with a valid identity card (or a postal address at a recognized welfare or government agency) have the right to a basic payment account.⁸ Under European rules, there is now a statutory obligation for banks to provide people with a payment account (Section 4:71f of the Financial Supervision Act). All consumers lawfully resident in the EU must have access to a bank account with basic functions and reasonable charges.

The dominance of electronic payments raises concerns about the accessibility of the cash payment system.⁹ While it is relatively easy to obtain cash – 99.65% of all Dutch residents live within five kilometres of an automated teller machine – some stores and municipalities no longer accept cash payments. It is particularly problematic in case of public bodies, as there is often no alternative.¹⁰ Although most places still accept cash, DNB has raised concerns about its declining use.¹¹

A third aspect concerns payment convenience. The payment system is an area of constant innovation. As discussed in the previous chapter, in the Netherlands it was mainly the public bodies – particularly the Postcheque en Girodienst and Gemeentegiro Amsterdam – that led with innovations such as ATMs and POS terminals and promoting giro transfers. Dutch consumers today enjoy a high level of convenience due to innovations such as internet banking and contactless payments. One issue of concern is the ease with which consumers can switch banks: although there is a switching service that eliminates some of the inconvenience, switching banks poses difficulties as account numbers are not portable.

A fourth factor is security. According to the National Forum on the Payment System, safety has been improving with declining incidences of bank card skimming and fraud in internet banking.¹² Whereas the damage caused by this type of fraud amounted to around €81 million in 2012, by 2016 it had fallen to €10 million. But despite improvements, there remain grounds for concern. Protecting people from online threats (cyber-crime) remains a constant challenge. The more we use internet banking and online payments, the more criminals will operate online.¹³

Finally there is the issue of reliability, or disruptions to the system. Although the payment system is generally reliable, the 2008–2009 financial crisis revealed its dependence on the banks: large-scale government intervention was necessary to ensure that the banking sector and hence the payment infrastructure remained operational. Apart from financial instability, cyber problems appear to pose the main danger, with banks in recent years facing major DDoS (distributed denial of service) attacks that disrupted access to internet banking. The digital payment infrastructure also depends on other critical infrastructure such as telecoms and electricity. DNB recently cited increased digitization and cyber-attacks as risks that continue to grow with the shift from cash to electronic payments.¹⁴

Seen historically, global debt levels are exceptionally high.¹⁵ According to BIS statistics, the total volume of private debt in the Netherlands (by consumers, businesses and other non-financial institutions) has risen from less than 40% of GDP in 1960 to over 250% today. This is high compared to other countries (see Fig. 4.1).

A line graph of percentages versus years. It illustrates increasing curves for the Netherlands, Germany, France, Italy, the United Kingdom, and the United States of America.

The sharp rise in private debt has many causes. Combined with financial liberalization and deregulation, the fact that banks can create money when granting loans implies that constraints on bank lending are limited. Financial innovations such as the securitization of loans have also contributed to high levels of private debt.¹⁶ The deductibility of interest charges makes debt finance cheaper than equity finance. Another factor is compulsory saving through pension funds, meaning that first-time home buyers must borrow more.

Before the crisis, credit growth was largely seen as a positive development. Despite limited empirical evidence, economists broadly assumed that increased lending (as a percentage of GDP) was positively correlated with economic growth and even contributed to it.¹⁷ Rising levels of individual indebtedness were also largely seen as positive, with economists framing it as the democratizing of financial services.¹⁸

There has been much more attention for the downsides of high private debt in the wake of the crisis. A new consensus holds that private debt can be excessive, with recent research showing an ‘inverted U’ relationship between lending and economic growth.¹⁹ This implies that although financially underdeveloped countries may benefit from increased lending, this does not apply to financially developed countries where lending above a certain limit may constrain economic growth.²⁰ Although the precise turning point remains elusive, the OECD concludes that most OECD countries – including the Netherlands – will not benefit from any further rise in private debt.²¹

Nevertheless, many economists still argue that high debt levels – given the low incidence of default – do not pose a problem for the Netherlands. Although it is true that Dutch banks’ loan losses have been limited, high debt levels can still create macroeconomic problems. First of all, high levels of debt entail stability risks. A crisis is often preceded by strong credit growth,²² while high debt levels can constrain recovery after a financial crisis.²³ High debt levels also make spending more volatile. Dutch household consumption is highly volatile compared to that of other countries.²⁴ Due to high private debt and savings tied up in pensions, consumption patterns in the Netherlands are heavily influenced by house prices and interest rate fluctuations. In principle this works in both directions: with rising property prices homeowners feel wealthier and spend more; with downward movements the reverse occurs. This fuels pro-cyclical trends in the economy, the overall effects of which are negative.²⁵ The same phenomenon occurs in business. When debt levels are high relative to equity, business viability will more likely be threatened by a cyclical downturn. Debts must always be paid, whereas equity can be used to absorb losses.

High debt levels in society are therefore detrimental to economic development. Many authors point out that the allocation of credit also matters a lot (see Box 4.1).

Current levels of private debt increase the risk of financial instability and may well be constraining economic growth. Reducing outstanding debt – referred to in the jargon as deleveraging – may seem the obvious solution. How to accomplish this is far from self-evident, however. Total private debt in the Netherlands now exceeds pre-crisis levels in both absolute and relative terms. In absolute terms, it has risen from €1400 billion just before the credit crisis to €1600 billion in 2016 (BIS statistics). As a percentage of GDP, it has risen over the same period from around 230% to around 280% (see Fig. 4.3). Despite increased awareness of the risks, private debt is currently no lower than before the crisis.

An area graph of percentages versus years. It plots data for households and non-financial companies. The non-financial companies have the maximum area.

Reducing debt levels in the wake of crises is no easy task. When households and businesses pay down their debts, their scope for spending shrinks, slowing economic growth, triggering unemployment and paradoxically increasing the volume of private debt as a percentage of GDP. There may also be deflationary (price-reducing) effects, further impeding economic growth. In short, although debt repayment can have economic advantages by increasing stability, it can cause short-term economic damage.³¹ Still, there are ways to reduce debt levels without undermining consumption. For example, if debt is repaid through a transfer of wealth from parents to children, the negative effects on consumer spending are less severe.

While repayment is not the only way to reduce debt, alternative methods have shortcomings or may not be feasible in the current system. After a crisis one could restructure problematic household and business debt. Depending on the method, private debt levels could be reduced without directly leading to deflation and lower economic growth. While such debt reduction could stimulate consumption and investment, it would create losses for lenders (in particular banks) and could lead to financial instability.³² One option would be for the government to play an active role in the restructuring. Either way, it would have distributive effects, with debtors receiving preferential treatment over non-debtors and lenders. It is also questionable whether this strategy would be feasible in our internationally interconnected financial system. Restructuring between debtors and creditors within a single legal system is already difficult³³; spread across countries, the task becomes even more onerous.

We can also aim to reduce debt in relative rather than in absolute terms. If the economy grows but outstanding debt does not, debt levels decrease as a percentage of GDP. This can happen when growth is financed through equity and the broad money supply grows more slowly than the economy (because money creation always involves debt creation). The relative debt burden can also decrease due to inflation. In the long run, however, inflation implies a larger money supply. In our current system, where money creation takes place largely through lending, it is generally accompanied by increasing debt (regardless of whether monetary growth is caused by bank lending or quantitative easing).

There are ways to stimulate demand without rising private debt levels. It can be done through greater government spending (which would increase public debt) or through the monetary financing of government spending and ‘helicopter money’ (which would not). Monetary financing means that government spending is financed directly by the central bank, currently prohibited under Article 123 of the Treaty on the Functioning of the European Union. In the case of ‘helicopter money’, the central bank directly credits household accounts with new money. It is unclear whether this would also fall within the prohibition on monetary financing. Either way, these options raise issues that we only address later (in Sect. 7.​1.​3). What is clear is that reducing the debt burden following a crisis is a complex affair, made no easier by international interdependencies. In a system where money and debt creation are inextricably linked, it is even more difficult.

The fragility of individual banks is primarily linked to the maturity transformation and risk transformation that take place within a bank. While both can positively affect the availability of finance and the return generated on savings deposits, they also make banks inherently unstable.

The bank will then have to sell some of its assets or borrow (against collateral) from the central bank.³⁷ Whether the bank succeeds depends on the extent of the withdrawals, whether it is able to borrow from other parties and whether it has sufficient assets to sell. Selling assets will be less problematic in normal times than during a crisis. In a crisis many markets dry up, meaning that either there are no buyers or a bank can only sell its assets at prices far below their book value.

There are various ways to discourage runs on a bank. Central banks can provide emergency liquidity, while deposit insurance schemes guarantee account holders’ deposits (in Europe currently up to €100,000).³⁸ But deposit guarantee schemes often only guarantee certain types of deposits and only up to a certain amount; they thus cover only part of a bank’s liabilities.³⁹ The large sums managed by professional parties are generally not covered by deposit insurance and are often the first to be withdrawn. The risk of a bank run therefore remains.

The maturity mismatch between banks’ assets and liabilities widened in the years preceding the crisis as banks increasingly financed their activities through short-term borrowing in money and capital markets. Confident that they could always obtain new funds, individual banks felt protected against liquidity risks. But the crisis revealed that these funding markets can dry up.⁴⁰ While this risk has received more attention since the crisis, Dutch banks still depend fairly heavily on market finance and are therefore vulnerable to turbulence in financial markets.⁴¹

Risk transformation means that one side of a bank’s balance sheet contains risky assets that can fluctuate in value while the other side has debts of fixed amounts. While a bank can make losses on its loan book and financial assets, it has promised its creditors to repay debts in full. A bank with an account on its books with a balance of €1000 must always be able to pay out €1000, plus any interest.

Losses can be absorbed by the bank’s equity; when equity is wiped out, the bank is bankrupt. The bank’s solvency determines whether it has sufficient equity to absorb shocks in the value of its assets. The risks of insolvency and illiquidity are intimately linked. In times of crisis, liquidity problems can rapidly turn into solvency problems and vice versa.⁴²

Banks’ equity levels declined sharply in the decades before the crisis as growing bank balance sheets were financed mainly through additional debt. In other words, the share of equity relative to the total balance sheet (the leverage ratio) declined. Low leverage ratios make banks more susceptible to shocks and fuel pro-cyclical behaviour. When ratios are low, relatively small losses (or gains) translate into major reductions (or increases) on the balance sheet.⁴³ Since the crisis, we have seen efforts to increase banks’ equity, with Dutch banks’ leverage ratios rising from around 3% in 2007 to around 6% today.⁴⁴ Elsewhere in Europe it is not much better.⁴⁵ Improvements notwithstanding, bank equity levels remain low, especially when compared to non-financial companies: around 33% for SMEs and around 48% for large firms.⁴⁶

As we saw during the 2007–2009 crisis, systemic stability is not simply the aggregate of the stability of individual banks. The financial system must also contend with systemic risks, “a risk of disruption to financial services that is caused by an impairment of all or parts of the financial system and that has the potential to have serious negative consequences for the real economy”.⁴⁷ The literature usually distinguishes between vulnerabilities resulting from: (1) the build-up of large imbalances, such as high debts and the development of bubbles; and (2) the structure of the sector, including interdependencies and financial institutions being too big to fail.⁴⁸

Economic and financial cycles are accompanied by periods of collective optimism and pessimism. As Rien Nagel, former director of Rabobank, puts it: “As a bank we’re part of the herd. You can linger on the edge of the herd, but if you move too far away you won’t survive. So if favourable economic developments suddenly lead everyone to grant mortgage loans of five times annual salary, instead of the maximum of three times, you’re bound to go with the herd”.⁴⁹ Market players’ expectations crucially affect the functioning of financial systems, both in the run-up to crises and during their aftermath.⁵⁰ Banks grant loans with expectations about future income streams and the value of collateral, while the price of other financial instruments also depends on future expectations. Shares drop in value when profit outlooks are adjusted downwards; bonds fall in value when the future looks less rosy.⁵¹ These forecasts are not only based on calculations of known risks. The financial world is beset by uncertainty; decisions are often based on intuition, narratives and social norms. Changing expectations or declining trust can lead to very different judgements, affecting people’s willingness to purchase financial assets.⁵²

Changing expectations about the future fuel the pro-cyclicality of the financial system. In times of confidence, estimates of future incomes are positive, loans are readily granted and financial assets are highly valued. Rosy expectations also mean that households and businesses are willing to incur greater debt. This can inflate the value of assets such as houses and shares, reinforcing the optimism and increasing the value of collateral. Rising house prices and credit growth are thus mutually reinforcing. All this contributes to higher profits and growth, further reinforcing the overall trend. A financial boom is born, fuelled by strong credit growth.

Relatively minor, unexpected changes such as disappointing profits can undermine general confidence. This can cut into the value of banks’ financial assets, leading to a disruption of financial markets, thereby reinforcing banks’ problems. Doubting their investments, financial actors will try to sell them off. Panic can ensue. Previously positive, self-reinforcing effects now operate in reverse, only more strongly as asset values collapse and market liquidity dries up.⁵³ Financial institutions lose access to funding, with accompanying doubts about their solvency. As the boom turns into a crisis, banks become less willing to grant loans. Households and businesses become reluctant to take on more debt or attempt to pay down what they have already borrowed. Homeowners see a collapse in housing prices while their mortgages are fixed. They feel compelled to consume less, often with further negative effects on the economy. The financial crisis turns into economic turmoil.⁵⁴

Alternating waves of collective optimism and pessimism recur in history. Although designing a crisis-proof financial system may be unrealistic, the system should be able to absorb moderate shocks. But this has become less and less the case over the past decades as imbalances have accumulated, the probability of shocks has grown and shock-absorbing capacities have declined. After decades of relative calm, financial instability has returned since the 1970s as a structural problem (see Fig. 4.4).⁵⁵

A graph of the percentage of economies in a financial crisis versus years. It depicts fluctuating trends for high income economies and low and middle income economies.

Imbalances in our current system are evident in the financial and non-financial private sectors’ ballooning levels of debt. Private debt is at historic highs. Limited equity relative to this debt means that all actors have less scope to absorb shocks. We observed that despite post-crisis improvements, banks still have little equity, while corporate and household debt-to-equity levels have also risen in recent decades.⁵⁶ Small economic fluctuations can thus rapidly create problems for financial institutions, businesses and households. A society in which all economic actors are highly indebted is more sensitive to systemic shocks.⁵⁷

Systemic fragility has also been fuelled by structural changes in financial markets. Financial globalization, the blurring of boundaries between financial institutions, and the growing uniformity of major banks have changed financial sectors markedly. Previously national financial systems have been internationalized with the liberalization of capital flows and the dismantling of other barriers. Although financial globalization has some major benefits, it allows local problems to spread rapidly to the global level and vice versa. Financial activities have also become interwoven. Whereas financial systems in the post-war period remained segmented, the lines between different types of financial institutions have been blurred. Banks today combine a wide range of financial activities; although this may bolster the ability of individual banks to absorb shocks, the system as a whole is more susceptible to instability.⁵⁸ Day-to-day movements in banks’ share prices are more interrelated than those of businesses in other sectors, indicating that investors are aware of these systemic risks.⁵⁹ Banks have become intertwined not only with other banks but with other financial institutions (see Box 4.2). Finally, we see the emergence of institutions that are so big or important for the system – institutions that are too-big-to-fail – that their problems can threaten the entire system.

Financial instability may also be caused by very different factors, such as cyber-attacks on crucial parts of the system. These are occurring with increasing frequency and are becoming more dangerous. Cyber security is now a top priority for banks. Cyber risks can threaten the overall system and, like financial risks, are exacerbated by high levels of interconnectedness in the financial system.⁶²

Profits before the crisis went to the bank whereas the costs were borne by the government and the general public – this is what many said in the wake of the crisis.⁶³ How valid is this statement? We first consider the costs of a financial crisis before discussing the allocation of benefits in the pre-crisis period.

Financial crises have major economic and social consequences. These include the evaporation of wealth, business bankruptcies, increasing unemployment and house evictions. To stop further deterioration and prevent systemic collapse, public authorities (governments and central banks) normally intervene in various ways – through liquidity or capital injections, taking over problematic loans, issuing guarantees or even nationalizing financial institutions.

While the idea that public authorities must intervene during a crisis is far from new, the size of implicit or explicit public guarantees has mushroomed in recent decades. This is largely due to the greater size of banks relative to GDP,⁶⁴ while the growth of the shadow banking system and its interconnectedness with banks means that central banks must also worry about the stability of financial institutions that are not strictly speaking banks. The collapse of Lehman Brothers in September 2008 triggered a global crisis. Since then, no government has seriously considered allowing a major financial institution to fail.⁶⁵

The enormity of public guarantees became evident during the crisis as public authorities had practically no choice but to provide financial support. Support to banks from the Dutch state – in the form of capital injections, acquisitions of problematic financial assets and guarantees – amounted to 27.3% of GDP or approximately €174 billion.⁶⁶ Providing support does not immediately imply losses for the government: if a government purchases bank shares or takes over problematic loans, it obtains financial assets that may ultimately generate value. The Dutch government, for example, benefitted from its guarantee for ING.⁶⁷ Moreover, guarantees do not always have to be called on.

Still, the net costs of support are often substantial.⁶⁸ This was certainly true for the 2007–2008 crisis. Between 2008 and 2014, the direct losses borne by euro area governments for supporting financial institutions amounted to 4.7% of GDP or roughly €470 billion. There were substantial differences between countries, with the outliers being Ireland (30% of GDP), Greece (22% of GDP) and Cyprus (19% of GDP). The Netherlands, with losses of 4.8% of GDP, was close to the average.⁶⁹ Direct government support led to the deterioration of government finances, rapidly rising public debt and often to austerity.

Alongside the direct costs, a crisis also entails indirect costs for the government. Recessions, bankruptcies and unemployment cause government finances to deteriorate due to both lost tax revenues and higher social security expenditures. During recessions households and companies decrease spending and investment, often encouraging governments to stimulate the economy through greater spending, thereby impairing public finances (in any case in the short term).

Although the direct costs of a bailout are highly visible, the indirect costs are generally much higher.⁷⁰ Unemployment in the Netherlands doubled from 3.7% before the crisis to 7.4% in 2014 (Statistics Netherlands). Dutch government debt rose from €260 billion in 2006 to €450 billion in 2014 (Statistics Netherlands). For all euro area countries together, government debt as a percentage of GDP rose by 27 percentage points, with only 4.7 percentage points resulting from the direct costs.⁷¹ The total growth of government debt in the Netherlands (25 percentage points) was around the average, with Ireland (86 percentage points), Greece (73 percentage points), Spain (62 percentage points) and Cyprus (53 percentage points) being the negative outliers.⁷² Figure 4.5 shows the growing post-crisis government debt for selected EU countries.

A line graph of percentages versus years. It illustrates increasing curves for the Netherlands, Germany, Spain, Italy, the United kingdom, Ireland, Greece, Cyprus, and Eurozone. The curves initially decline and then increase after the middle of 2007.

Social discontent with the enormity of the crisis’ costs was – and remains – high. Discontent was also fuelled by the broadly shared sentiment that the boom’s benefits accrued disproportionately to a select group of employees, managers and shareholders in the financial sector. But bankers were not the only ones to benefit from the preceding boom: governments, businesses and households did so as well.⁷³ Who benefits from a boom is difficult to calculate with any precision. For governments, it is clear that the negative effects of a financial crisis exceed the preceding positive effects of a boom on government finances. Overall, the cycle of boom and bust leaves countries worse off.⁷⁴

Before the crisis, employees in the financial sector earned substantially more than those in other sectors (even when controlling for education). This certainly applied to executive remuneration.⁷⁵ Bank shareholders also enjoyed golden times, rapidly earning large sums from profit distributions and share repurchases.⁷⁶ Nevertheless, the claim that profits are private and losses are public is overly simplistic: the benefits of the pre-crisis boom spread beyond the banking sector, while those directly involved in finance also suffered losses. Still, there is truth to the notion that the benefits disproportionately accrued to the financial sector while the costs were borne more widely.⁷⁷

Measures taken following the crisis sought to address this problem, including the European Bank Recovery and Resolution Directive (BRRD) which aimed to reduce the direct public costs of crises by making shareholders, bondholders and large savers responsible for the cost of future bank bailouts; public support should only be a last resort. While an important step, the BRRD has yet to prove itself in practice (see Chap. 7).

The financial sector enjoys financial advantages that are not available to other sectors. According to DNB, Dutch banks benefit “from an abundance of […] subsidies, arising largely from tax regulations”.⁷⁸ DNB argues that such subsidies “stimulate oversupply and lead to lower welfare” since “activities need only be subsidized if they would otherwise be less available than is socially desirable”. These advantages for banks can lead to a financial sector that, from a societal perspective, is larger than optimal.

What benefits do banks enjoy? Since banks rely heavily on debt finance – the payment and savings account deposits of private individuals and businesses as well as other debts – they benefit from the tax deductibility of interest expenses more than ordinary businesses. Moreover, business and household demand for loans is greater than it would be without such interest deductibility, while mortgage interest deductions enable people to borrow more than they could otherwise afford. All this provides indirect support to the sector. The value added tax exemption enjoyed by the financial sector means that demand for bank services is higher than it would otherwise be.⁷⁹ Tax-friendly savings, government guarantees for SME loans, the national mortgage guarantee and first-time buyer schemes are other forms of indirect support for the banking sector.⁸⁰

Banks also receive government support because of their social and economic importance. With crucial functions in the field of payments, finance and insurance, some banks are simply too big to fail and will always be supported in case of problems. Account holders’ deposits are also guaranteed up to a certain level.⁸¹ These implicit and explicit public guarantees mean that individuals and companies are prepared to accept lower interest rates on their bank accounts than if they incurred greater risks.⁸² This latter point bears on the broader issue of financial benefits for commercial banks given their role as money-creating institutions (see Box 4.3).

Banks and bank services receive implicit or explicit support through a number of channels. This, however, does not determine who benefits. Benefits may be passed on to bank customers through the interest rates they pay and receive. But given the concentration of the financial sector, it is doubtful that banks pass on these advantages to customers in full. The OECD states that high implicit support contributes to the “financial sector wage premia”, with employees of financial institutions earning substantially more than employees of non-financial institutions with comparable profiles in age, education, etc.⁹¹

Benefits are also unevenly distributed within the financial sector, with funding advantages mainly accruing to systemically important banks. Since the government has no choice but to bail out banks that are vital to the system, these banks are not allowed to fail. This is the too-big-to-fail problem. CPB, the Netherlands Bureau for Economic Policy Analysis, estimates that this advantage for the systemic banks amounts to 0.4% of GDP, or approximately €2.5 billion annually. The OECD puts this number higher at around 0.5% of GDP.⁹² The advantage for systemic institutions derives from credit rating agencies taking into account implicit government support. This leads to lower interest costs and hence a funding advantage.⁹³ Given that large banks know that they will receive public support, also means that they incur more risks by providing riskier loans and operating with lower equity buffers. This can have self-reinforcing effects, making these crucial institutions ever larger.⁹⁴

Policymakers have sought to address the too-big-to-fail problem since the crisis, opting for a strategy of dissuasion by imposing levies or taxes on systemic relevance. European bank regulation allows regulators to impose higher capital requirements on systemically relevant institutions. The idea is that banks see this as a ‘tax’ on systemic relevance while higher requirements reduce risks of failure. Policymakers have thus far avoided more direct approaches such as splitting banks into different units, while a European plan to ‘ring-fence’ their crucial parts to make it easier to save them has been shelved. Instead, regulators are drawing up bank resolution plans to facilitate their winding up in crises or to keep their vital parts in operation. The too-big-to-fail problem has been addressed but has not disappeared. Then G30 Executive Director Mackintosh describes the situation as follows: “If a major international bank once again teeters on the brink of collapse, no one in finance believes they would be allowed to fail.”⁹⁵ The ECB’s recently expressed preference to create even larger banks is of no help in this respect.⁹⁶

How are the benefits, costs and risks of increased private indebtedness allocated? Theoretically, rising debt levels could be pointing to a ‘democratization of financial services’ as less prosperous people can now obtain funding and shape their lives as they wish.⁹⁷ While few would argue against broader access to secure and affordable financial products, this ‘financialization’ of society has its associated risks. Various studies have suggested that the financialization of society can contribute to increasing economic inequality and that economic inequality and people’s reliance on financial services are mutually reinforcing.⁹⁸ People with higher incomes and more assets benefit more from the ability to make lucrative investments and obtain cheap finance.⁹⁹ People with lower incomes and fewer assets often have higher interest expenses (in relation to their income), have to go take on relatively higher debts and are often the first to lose their jobs in a downturn. If people have problems to pay interest and must borrow more to make ends meet, the problem gets worse.¹⁰⁰ Indebtedness causes stress, affecting people’s ability to perform well, exacerbating the debt problem. While access to credit can help households shape their lives, problematic debt makes it more difficult.¹⁰¹

These problems appear to be especially severe in countries such as the United Kingdom and the United States where many people borrow for private consumption and where social security benefits are modest.¹⁰² But in the Netherlands as well, a growing number of households – currently more than one million – have problematic debt, although these more often concern payday loans, debt collector’s fees and taxes than bank debt. People regularly fall below the subsistence minimum due to problematic debt, while applications for debt assistance continue to rise (see Fig. 4.6).¹⁰³ This brings to the fore the issue of rights and obligations of creditors and debtors. Debtors have a relatively weak position vis-à-vis creditors in case of difficulties in redeeming loans.

A line graph of numbers versus years. It illustrates an increasing tendency, with the highest value of 94% in 2017. The values are approximated.

Mortgage debt likewise raises questions about the distribution of risk between creditors and debtors. This is an important issue in the Netherlands. Fitch Ratings describes the Netherlands (alongside the UK) as the European country with the “the most lender-friendly legal system”.¹⁰⁴ This means that mortgage borrowers must do their utmost to meet their obligations. Should they fail to do so, the bank can sell their home while any residual debt is still owed and the bank has a claim on the debtor’s income for years to come. The debtor can only escape payment obligations by filing for personal bankruptcy.¹⁰⁵

It goes without saying that debtors must fulfil their obligations and should only be able to escape them in exceptional circumstances. But this statement requires qualification. Financial products such as mortgages are long-term products with which the customer has only occasional experience. The borrower thus has a major disadvantage in information and experience, while the risks can have far-reaching consequences.¹⁰⁶ For mortgage debt there is an additional factor: the uncertainty surrounding house prices over time. The dynamics of the housing market reflect the combined actions of a large number of players: consumers, estate agents, mortgage lenders and policymakers. When a homeowner is left with residual debt after being forced to sell her home, it is doubtful whether this is entirely her own fault. Measures since the crisis have reduced these risks by limiting the value of loans relative to that of the home and through financing rules that consider the ratio of income to mortgage expenses.

Society needs an efficiently functioning financial monetary system. The Dutch Parliamentary Committee of Enquiry into the Financial System (the De Wit II Committee) that investigated the financial crisis for the House of Representatives formulated it as follows: “The financial sector is not an ordinary sector and banks are not ordinary companies. The economy depends greatly on the stability of the financial system. Payments, the development of personal reserves in the form of savings, pensions and insurance, the system of social services and lending to business rely on the financial sector. Hence there is a strong public interest in a stable financial sector”.¹⁰⁷

The discipline of economics has various criteria for designating something as a public interest. The existence of a public good or service is one criterion. This requires that two conditions are met: no one can be excluded and its use by one person does not prevent its use by someone else. An example are the dykes that protect everyone in the Netherlands from floods. The payment infrastructure likewise has the characteristics of a public good. No one can be excluded from the use of cash, and while exclusion would be possible from the electronic infrastructure, legislation requires that all people in principle have access to a bank account (Section 4:71f of the Financial Supervision Act). The use of the electronic or cash payment infrastructure by one party does not hinder its use by another, but rather promotes it. With the declining use of cash, the electronic infrastructure for payments has become crucial for the functioning of society.

A well-functioning system for credit provision is also in the public interest. Lending has far-reaching positive and negative external effects. It can contribute to economic development, but both excessive lending and the limited availability of credit can damage the economy. Precisely because of these external effects, an efficient lending system is vital.

The network effects between individual institutions distinguishes banking from other sectors. The functioning of bank A directly affects the functioning of bank B. This means that the actions of individual banks affect the banking system as a whole and hence its fulfilment of public interests: the bankruptcy of a systemic bank can threaten people’s savings, the payment system and lending. In other sectors, the (impending) insolvency of a private company is generally less problematic for the system as a whole. The proper functioning of a bank thus concerns not only the bank and its direct stakeholders but has wider social implications.

Banks thus have two faces. On the one hand, a bank is an organization with public functions essential for society. There are sound reasons to regulate the sector and for the government to bail it out during crises. The bank resembles a public organization and is expected to operate in the public interest and not lavish upper management with exorbitant salaries and bonuses. On the other hand, a bank is a private organization driven by market forces and competition, and customers should make informed decisions when buying financial products. The legal standards applying to public and private organizations also differ.¹⁰⁸ As these views are formulated in different contexts, it is understandable that expectations regarding bank actions at times clash.

Public involvement in the financial monetary system is unavoidable given its importance. The government even has a constitutional duty to regulate the monetary system (Article 106).¹⁰⁹ That public interests are at stake does not mean that services should be in public hands. In the Netherlands, education and healthcare are also provided by private institutions, while there are major public interests at stake. It does mean, however, that the conditions and policy goals should ultimately be determined democratically. In particular we can expect the public institutions responsible for the development and implementation of financial monetary policy to act within a democratic mandate and to be democratically accountable. Several developments, however, have limited the scope for democratic oversight.

First, financial institutions increasingly operate internationally, aided by the deregulation of international capital flows. Much of the policy is developed on the European or global levels, with the Basel Committee playing a central role in banking regulation. While international policies are necessary to prevent a legislative race to the bottom, it also means that it is increasingly difficult for national governments to deviate from the international standard without facing a loss (or threatened loss) of financial activities.¹¹⁰ This is partly due to a second trend: the sweeping liberalization of the financial sector since the 1980s. This included the abandoning of post-war policy instruments such as the separation of different banking activities, credit ceilings and restrictions on capital movements.

Third, technocratic decision making also limits democratic influence. Monetary and financial policy are complex issues, and policy development and implementation are increasingly outsourced to technocratic forums such as the Basel Committee. In such forums, trade-offs between political goals often disappear under a layer of expertise. Major financial players also have resources to influence policy developments at the supranational level, which is not the case for other stakeholders (smaller players, consumer organizations or NGOs).¹¹¹

Finally, many rules are enshrined in the European treaties (“constitutionalization”). Agreements in monetary and financial policy are set out in the Treaty on the Functioning of the European Union, including the goal of monetary policy (Article 127(1) TFEU) and the prohibition of monetary financing (Article 123 TFEU). Changes can only take place with the consent of all EU member states. Governments have boxed themselves in to such an extent that they have limited scope to take different paths based on new insights or changing circumstances.¹¹²

Internationalization, liberalization, technocratic decision making and constitutionalization introduce specific problems for democratic accountability and control. Key institutions in the field of monetary and financial policy are remote from politics, while policy-making within central banks is hermetically isolated from parliamentary influence. This applies in particular to the European Central Bank, but also to national central banks. Although politics still influences central banks through appointments to governing boards and various accountability mechanisms, participation in economic and monetary union requires the central bank to be formally independent of day-to-day politics. A lot of financial sector policy is also developed within the same policy forums that are largely independent of national and European politics. The scope for political control and influence appears to be limited.¹¹³

A somewhat different problem is that changing laws and regulations can more rapidly create problems in contexts of high debt, limited equity and limited social capacity to absorb change. Policy adjustments must be made with great caution. For example, abolishing the tax advantages of debt may lead to long-term gains but also to greater short-term uncertainty and instability for highly leveraged households and institutions. For banks as well, improvements will be more difficult starting from low equity levels. High debt therefore also limits policy discretion.

Finally, we need to consider people’s ability to exert influence on the system. Consumers can reward or penalize specific banks by taking their business elsewhere. But the exit option in the financial sector is impeded by various factors. Switching from one bank to another poses administrative hurdles; especially the lack of account number portability makes it unattractive for many consumers to change banks. It is also almost impossible for uninitiated consumers to assess whether banks are behaving appropriately when it is already difficult for regulators and direct stakeholders to understand what banks are doing. Finally, the highly concentrated Dutch banking landscape offers consumers little in the way of alternatives.

People can also exert influence on the workings of the financial system by means of voice, for example when they organize into NGOs. But their resources and capabilities are dwarfed by the resources of large financial players to organize and exert influence on politics and policy. The fragmentation of policy across many different forums is also advantageous for large players; they can be active in numerous areas, while counterforces with less capacity can only focus on a few.¹¹⁴

The limited scope for influence takes another dimension when we consider the gulf between the perceptions of citizens and banks. Haldane, Chief Economist at the Bank of England, calls it a “Great Divide”.¹¹⁵ Many bank and financial institution mangers perceive the post-crisis period as one in which they have been overwhelmed by new legislation and regulations, but are again on track to regain the trust of consumers. Many people, however, associate the period with the absence of fundamental change and the financial sector with greed and corruption. There is a gulf between how post-crisis developments have been perceived.¹¹⁶