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Ten years after the crisis: lessons learnt and forward risks for the Belgian economy and the financial sector Jean Hilgers Directeur Authors: De Prest, E. Deroose, M. Dresse, L. Schepens, Th. DS.18.09.374 Overview I. Flashback: A crisis

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DS.18.09.374

Jean Hilgers Directeur

Ten years after the crisis: lessons learnt and forward risks for the Belgian economy and the financial sector

Authors: De Prest, E. Deroose, M. Dresse, L. Schepens, Th.

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Overview

  • I. Flashback: A crisis in different stages called for strong monetary policy

actions

  • II. National and EU authorities also took their part in the policy response to

the crisis

  • III. Where do we stand? Risks and challenges going forward for the

Belgian economy

  • IV. Outlook for the financial sector and risks going forward
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2 4 6 8 10 12 14 2005 2008 2011 2014 2017

United States Euro area

Sources: OECD, Thomson Reuters Datastream.

American property market Worldwide money markets Euro area government debt Euro area macro- economy

House prices

(real indices 2010 = 100)

Money market

(spread between unsecured and secured loans; 3 months; percentage points)

Government debt securities

(spread against 10-year Bund; percentage points)

Unemployment rate

(%) 70 80 90 100 110 120 130 2005 2008 2011 2014 2017

United States Euro area

  • 0,5

0,5 1 1,5 2 2,5 3 3,5 4 2005 2008 2011 2014 2017

United States Euro area

2,5 5 7,5 10 12,5 15 2005 2008 2011 2014 2017

IT IE ES PT BE

A worldwide crisis in different phases

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Sources: OECD, Thomson Reuters Datastream.

American property market

PHASE 1

House prices

(real indices 2010 = 100) 70 80 90 100 110 120 130 2005 2008 2011 2014 2017

United States Euro area

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Build-up of vulnerabilities in the pre-crisis period …

Microeconomic factors

  • Search for yield
  • Financial innovation (e.g. securitisation)
  • Underestimation of bank risk
  • (Too) easy regulation
  • Weak internal risk management
  • Inadequate supervision

Macroeconomic environment

  • Strong growth and low inflation

(Goldilocks economy)

  • Rising global imbalances
  • Low interest rates à buoyant lending to

households and companies

Annual GDP growth (%) Inflation (%)

Euro area US

Source: OECD.

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6

Tensions spread globally in Summer 2017

  • Increased uncertainty and risk repricing
  • Liquidity crisis

… amplified the triggers of the financial crisis

‘Subprime’ crisis in US mortgage market in 2006

(following Fed interest rate hike)

September 2008:

Bankruptcy Lehman Brothers Financial unrest escalated

Source: JP Moran Chase.

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Sources: OECD, Thomson Reuters Datastream.

Worldwide money markets

Money market

(spread between unsecured and secured loans; 3 months; percentage points)

  • 0,5

0,5 1 1,5 2 2,5 3 3,5 4 2005 2008 2011 2014 2017

United States Euro area

PHASE 2

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In a context of financial turmoil, the ECB is "lender of last resort"

Normal times Liquidity problems

► Concern about the quality of bank balance sheets and collapse of Lehman Brothers lead to major turmoil on international money markets ► Borrowing money on the financial markets becomes virtually impossible for many banks ► Central banks and governments have to put together support measures

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Between 2008 and 2012, the central bank balance sheet fluctuated along with the financial tensions and thus demand for liquidity from banks

  • 0,2

0,2 0,4 0,6 0,8

  • 40
  • 20

20 40 60 2008 2009 2010 2011 2012

Source: ECB.

Eurosystem balance sheet total (year-on-year growth, left-hand scale) Indicator of systemic stress in the financial system (CISS) (moving average over 5 weeks, right-hand scale)

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The government also aided the banking sector (e.g. through capital injections), contributing to a rising debt ratio

60 70 80 90 100 110 120 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 Euro area Belgium

Government debt

(in % of GDP)

Source: EC.

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Sources: OECD, Thomson Reuters Datastream.

Euro area government debt

Government debt securities

(spread against 10-year Bund; percentage points) 2,5 5 7,5 10 12,5 15 2005 2008 2011 2014 2017

IT IE ES PT BE

PHASE 3

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12 400 800 1200 1600 2008 2010 2012 2014 2016 2018

Mutual contagion between banks and sovereigns is finally halted in summer 2012 …

(Credit Default Swaps (CDS), 5 year, senior, basis points)

Governments Banks¹

Source: Thomson Reuters Datastream.

1 Banks’ country average.

400 800 1200 1600 2008 2010 2012 2014 2016 2018 DE BE ES IT PT

Banking Union Whatever it takes OMT

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13 2 4 6 8 2012 2014 2016 2018

DE BE FR IT ES PT

… after which the financial fragmentation in the euro area was greatly reduced

Sources: ECB, Thomson Reuters Datatsream.

Yields on 10-year government bonds

(%)

Interest rate on NFC loans

(lending up to €1 million, up to 1 year, %) 2 4 6 8 10 12 14 16 18 2012 2014 2016 2018 0,3 0,6 0,9 1,2 1,5 2012 2014 2016 2018

Money market

(spread between unsecured and secured loans; 3 months; percentage points)

Banking Union Whatever it takes OMT

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2 4 6 8 10 12 14 2005 2008 2011 2014 2017

United States Euro area

Sources: OECD, Thomson Reuters Datastream.

Euro area macro- economy

Unemployment rate

(%)

PHASE 4

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Double-dip recession in the euro area caused considerable economic slack …

  • 6
  • 4
  • 2

2 4 6 2000 2004 2008 2012 2016 Recovery

GDP

(year-on-year growth)

Employment

(index: peak 2008Q1 = 100)

Output gap

(% of potential GDP)

Sources: EC, ECB.

  • 4
  • 2

2 4 2000 2004 2008 2012 2016 80 85 90 95 100 105 2008 2012 2016

Total gross fixed capital formation

(index: peak 2008 = 100)

90 92 94 96 98 100 102 2008 2012 2016 In hours worked In persons employed

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… that pushed inflation down.

APP announcement APP announcement

Sources: Bloomberg, ECB. 1 Total HICP inflation excluding energy and food. 2 Implicit inflation rate derived from swap contracts hedging the inflation risk in the euro area during a five-year period starting five years after conclusion of the contract. 3 Average of the aggregate probability distribution of five-year inflation expectations. The data were obtained from the ECB’s quarterly survey of professional forecasters.

  • 1

1 2 3 4 5 1999 2003 2007 2011 2015 Headline inflation Underlying inflation¹ 0,5 1 1,5 2 2,5 3 2005 2007 2009 2011 2013 2015 2017 From financial markets² From surveys³

Euro area inflation

(%)

Euro area long-term inflation expectations

(%)

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Monetary stimulus intended to support the economy and bring inflation in line with its target

  • 1

1 2 3 4 5 6 2007 2009 2011 2013 2015 2017 Deposit facility rate Main refinancing rate Marginal lending facility rate Eonia 1000 2000 3000 4000 5000 2007 2009 2011 2013 2015 2017

Start APP

Eurosystem balance sheet

(billion €)

Key policy rates and money market rate

(%)

Source: Thomson Reuters Datastream.

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Recessions associated with financial crises are longer and more severe than other recessions

94 96 98 100 102 104 106 1 2 3 4 5 6 7 8 9 10 11 12 Years Recessie met financiële crisis Andere recessies All other Recessions

Output following financial versus other recessions

(pre-recession peak = 100)

Source: IMF.

Financial crisis

► How can we prevent them from happening again?

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Overview

  • I. Flashback: A crisis in different stages called for strong monetary policy

actions

  • II. National and EU authorities also took their part in the policy response to

the crisis

  • III. Where do we stand? Risks and challenges going forward for the

Belgian economy

  • IV. Outlook for the financial sector and risks going forward
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Increasing resilience in the medium term: reforms have been achieved but further steps may need to be taken

Realised Unfinished agenda

Fiscal policy and surveillance reform of Stability and Growth Pact (SGP) increase transparency of the rules and improve implementation need for a fiscal stabilisation function? Macro-economic surveillance Macroeconomic imbalance procedure (MIP) and European Semester improve implementation of country specific recommendations (CSR) Emergency financial assistance European Stability Mechanism (ESM) Strengthening and further development of the ESM Banking union Single Supervisory Mechanism (SSM) Single Resolution Mechanism (SRM) and Single Resolution Fund (SRF) last resort fiscal backstop for the Single Resolution Fund European Deposit Insurance Scheme (EDIS)

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Overview

  • I. Flashback: A crisis in different stages called for strong monetary policy

actions

  • II. National and EU authorities also took their part in the policy response to

the crisis

  • III. Where do we stand? Risks and challenges going forward for the

Belgian economy

  • IV. Outlook for the financial sector and risks going forward
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In Belgium, activity has been growing at a continuous (but moderate) pace for 5 years

Sources: EC, NAI.

GDP profile since the crisis

(Index 2008Q1 = 100)

90 95 100 105 110 115 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Belgium Euro area Germany France The Netherlands Worldwide Great Recession Euro area sovereign debt crisis

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  • 1,0
  • 0,5

0,0 0,5 1,0 1,5 2,0 2012 2013 2014 2015 2016 2017 2018e Net export¹ and changes inventories Public expenditures Private investment¹ Private consumption GDP (%)

Sources: NAI, NBB.

1 Data adjusted for major specific transactions.

Contributions to GDP growth

(percentage points)

  • 30
  • 20
  • 10

10 20 30 40 50 60 70 2012 2013 2014 2015 2016 2017 2018e Administration and education Employees: Non-market sector Self-employed people Employees: Industry and market services Total

Economic growth is supported by domestic demand and strong job creations

Changes in employment

(thousands of people)

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Activity is firming, but risks are looming: Mounting policy uncertainties worldwide…

Uncertainty index of US trade policy1

Sources: Policy Uncertainty. Baker, Bloom et Davis (2016), EC.

1 Number of articles refering to the uncertainty of US trade policy in American newspapers.

  • 8
  • 7
  • 6
  • 5
  • 4
  • 3
  • 2
  • 1

2012 2013 2014 2015 2016 2017 2018 2019 US Euro Area

Policy-mix: structural fiscal balance

(in % GDP)

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Currencies of many EMEs depreciated substantially in 2018

(EUR / EME currencies; 1 Jan. 2017 = 100)

Sources: Thomson Reuters, ECB.

… already impacted vulnerable emerging economies

30 40 50 60 70 80 90 100 110 01/2017 04/2017 07/2017 10/2017 01/2018 04/2018 07/2018 10/2018 Argentinean peso Brazilian real Chinese yuan renminbi Indian rupee Indonesia rupiah Mexican peso Russian rouble Turkish lira South African rand

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Risks in Europe: Brexit, Italy

5 10 15

Ireland Netherlands Belgium Cyprus Spain Germany Denmark France Portugal Poland Sweden Slovakia Italy Czech Republic Latvia Finland Romania Luxembourg Malta Greece Lithuania Hungary Austria Estonia Bulgaria Slovenia Croatia

Sources: EC, NAI, NBB, Thomas Reuters.

Share of UK in the export of goods

(in % of total export, 2015-2017)

50 100 150 200 250 300 350 01/17 03/17 05/17 07/17 09/17 11/17 01/18 03/18 05/18 07/18 09/18 11/18

Italy: 10-year sovereign bond spread

(basis points, with respect to German Bund)

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Debt levels are still elevated, as the deleveraging is slow and uneven across countries

Debt of the non-financial private sector

(in % of GDP)

Sources: ECB, EC. ¹ Between 2008 and 2018. ² EC 2018 Spring forecast.

100 200 300 400 DE IT EL ES FR PT BE IE NL EA Non-financial corporations (2018 Q1) Households (2018 Q1) Peak of total private debt¹ Total private debt in 2000 Total private debt in 2007 20 40 60 80 100 120 140 160 180 200 NL DE IE FR ES BE PT IT EL EA 2018² Peak 2000 2007

Public debt

(in % of GDP)

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The crisis intensified the downward trend in potential growth in Belgium…

Sources: NAI, NBB.

28

  • 0,5

0,0 0,5 1,0 1,5 2,0 2,5 3,0 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 TFP Capital Labour Public sector Potential growth (%)

Contributions to potential growth

(percentage points)

Pre-crisis period Crisis period Post-crisis period

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29 22 24 26 28 30 2010 2015 2020 2025 2030 2035 2040 2045 2050 2055 2060 2065 2070

…intertwined with the unfolding of population ageing

Source: Study Committee on Ageing.

Budgetary cost of population ageing

(social benefits in % of GDP)

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Employment rate of risk groups

(2017, in % of the corresponding population aged between 20 and 64 years)

Source: EC (LFS).

BE EU Total 68,5 72,1 Women 63,6 66,4 Low skilled 45,9 54,9 55-64 years 48,3 57,1 Non-EU citizens 41,6 57,4

The employment rate should increase further in Belgium

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The transition towards the labour market should be enhanced, in a context of shortages

6 7 8 9 10 1987 1990 1993 1996 1999 2002 2005 2008 2011 2014 2017

Unemployement rate

(in % of population aged 15-64 year)

Difficulties in matching supply to demand

(breakdown of employment by skill level and unemployment by level of education, in % of the population aged between 15 and 64 years, 2016)

Source: Eurostat.

2018 Q1

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Overview

  • I. Flashback: A crisis in different stages called for strong monetary policy

actions

  • II. National and EU authorities also took their part in the policy response to

the crisis

  • III. Where do we stand? Risks and challenges going forward for the

Belgian economy

  • IV. Outlook for the financial sector and risks going forward
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Main drivers of restructuring in the banking sector

► Measures imposed by the European Commission on a number of Belgian financial institutions in return for the state aid received ► Fundamental revision of the regulatory frameworks for banks (Basel 2.5 and Basel 3) and insurance companies (introduction of Solvency II) which integrated the lessons of the crisis ► Lessons learned during the crisis by bankers as regards the weaknesses in the business models of the pre-crisis period ► Combination of an unusually low interest rate environment with the increasing digitalisation of finance

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Ten years after the crisis - outlook for the financial sector and risks going forward

► Belgian banking and insurance sectors are back to a relatively sound financial situation, thanks to major restructuring efforts in the post-crisis years ► Bank restructuring significantly reshaped the business model :

  • back to basics : increased focus on financial intermediation
  • back to Belgium : sharp reduction in non-core foreign assets
  • more robust balance sheet (less leverage; more liquidity)

► Insurance restructuring mainly driven by the low interest rate challenge for traditional life insurance

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Bank restructuring and deleveraging ...

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... but dynamic domestic lending

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Banks recovered their profitability ...

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... and raised their resilience

► Key ratios for the banking sector

In % 2016 2017 2018 (June) Return on equity 9.2 8.9 8.1 Return on assets 0.6 0.6 0.5 CET1 capital ratio 15.7 16.2 15.3 Liquidity coverage ratio 140 138 133

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Risks / challenges going forward

► Adverse interest rate scenarios :

  • Low-for-long
  • Snapback

► Belgian residential real estate market ► Digitalisation

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Adverse interest rate scenarios : banks

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Adverse interest rate scenarios : insurance

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Residential real estate market

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Digitalisation

► Opportunities :

  • Cost savings / efficiency gains
  • Improved customer relationship

► Risks :

  • « Miss the boat »