The impact of the Basel III capital requirements on Dutch banks will be less severe than anticipated, but it will still be significant, according to analysts.
Given that they assign relatively low risk cover to their sizable mortgage books, Dutch banks have long been expected to suffer a comparatively hard blow from the recently finalized Basel III rules. These will require lenders to broadly align their internal risk-assessment models to the standardized approach devised by regulators, which means that the greater the current discrepancy between the two approaches, the more capital a bank will have to set aside in future to bridge the gap.
Using their own internal models, Dutch lenders have a relatively low level of risk-weighted assets, or RWAs, which help determine a bank's common equity Tier 1 ratio, a key measure for its capital strength. The banks arrive at these low RWA density ratios — that is, RWAs as a proportion of total assets — despite offering mortgages with higher loan-to-value ratios than most of their European peers, especially in the residential segment.
The higher the LTV ratio, the lower the amount the borrower has paid up-front for the property, so in case of default on the loan, the bank needs to cover a higher loss. This makes high LTV ratios riskier for lenders. But due to low default rates in the Netherlands — where 50% of all mortgages had an LTV ratio of more than 100% at the end of 2016, according to the Dutch Banking Association, NVB — Dutch banks assign low risk weights to mortgages.
This means their internal models for calculating risk could differ significantly from the standardized approach used by regulators. The four largest Dutch banks — ING Groep NV, ABN AMRO Group NV, Rabobank and Volksbank NV — have RWA density ratios ranging from 16.5% to 36%, according to S&P Global Market Intelligence data. By contrast, the largest Danish banks, which are also expecting a serious capital hit related to Basel III, have RWA density ratios ranging from 21.7% at Danske Bank A/S to 49.2% at DLR Kredit A/S.
As a result, Dutch lenders may take a comparatively big hit from the new Basel III output floor, which is the required minimum level of convergence between the internal risk assessment and the standardized model. Dutch banks will likely have to make greater adjustments to their internal risk assessments than many of their European peers to reach the output floor, meaning they will have to assign higher risk weights to mortgages with high LTV ratios and therefore use more capital to cover those risks.

'Substantial increase in risk weights'
The Basel III output floor was set at 72.5%. This compromise and the fact that implementation of the new rules has been postponed until 2022 — after which there will be a five-year phase-in period until 2027 — will lessen the impact on Dutch banks. The Dutch central bank now puts the expected total capital shortfall for them at €14 billion, compared to the previous estimate of €50 billion, Rabobank Research credit analysts Claire McNicol and Ruben van Leeuwen wrote in a Dec. 18 report.
The drop is due to some earlier assumptions about Basel III — such as a potential 90% output floor — not having materialized. Nevertheless, even with the lower capital-shortfall estimate, the impact on Dutch banks will remain significant, the analysts said.
"Several adjustments have been made to the final standards, which should soften the overall effect on banks' capital ratios," they noted. "However, relatively high [loan-to-value ratios], in combination with the revised standardized approach for credit risk/residential exposures and the capital floor, will still result in a substantial increase in risk weights on mortgage portfolios of Dutch banks and therefore have a considerable impact on their capital ratios."
The risk weights on Dutch banks' mortgage portfolios are expected to rise 1.5x to 2.5x as a result of the new Basel III regulations, McNicol and Van Leeuwen said in their report. Yet, the capital-shortfall estimate just relates to banks meeting the regulator's minimum capital requirements, while their actual target is likely to be higher than that, so the impact from the reforms will be even bigger, they added.
The CET1 ratios of the four biggest Dutch banks are expected to be most affected. ABN AMRO's CEO, Kees van Dijkhuizen, said in early November that Basel III could have an impact of 600 basis points on the bank's CET1 ratio.
ING's CEO, Ralph Hamers, also warned of a "significant impact" for the sector at around the same time, without giving specific guidance. Rabobank CFO Bas Brouwers said at the beginning of the year that the bank would seek to raise €1 billion to help boost its CET1 ratio to at least 14% in preparation for Basel III.
In August, Volksbank CFO Annemiek van Melick also expressed concerns about the impact of Basel III on the bank's CET1 ratio despite it standing at 32.8% at the end of June. Volksbank expects its CET1 ratio to drop drastically after the implementation of Basel III and has set a medium-term target of 15%.
