DNB: COVID-19 could affect financial sector for the next four years.

The COVID-19 outbreak is likely to affect the Dutch financial sector, including pension funds, severely and the hit could be felt for a four-year period, a survey by supervisor De Nederlandsche Bank (DNB) has suggested.

The watchdog, which first assessed the potential impact of a pandemic back in 2006, concluded that the Dutch economy could decline by more than 5% this year, and could suffer further in the three subsequent years.

The survey was triggered by the outbreaks of the SARS and bird flu epidemics at the start of the century.

Ronald Bosman, an independent risk management adviser at Amsterdam’s Free University (VU) and one of the co-authors of the study, said: “The outcome was that the financial sector would be seriously hurt, and we have urged the sector to take this into account.”

“But, as the scenario was that extreme, it was largely ignored,” he added.

The survey correctly predicted, in addition to collapsing equity markets, the closure of schools and international air traffic coming to a standstill.

“But this was no rocket science,” said Bosman, who wrote the report with Jurriaan Eggelte and David-Jan Jansen.

The authors modelled their most extreme scenario on the Spanish flue outbreak in 1918, when one-quarter of the Dutch population fell ill and 2.5% of those died.

In 2006, more players assessed the potential impact of a pandemic on pension funds and insurers, but focussed particularly on mortality rates.

The DNB survey, however, also took the economic effects into account.

“We are still in the first phase of the pandemic, and the measures taken by the government are logical”

Ronald Bosman, an independent risk management adviser

In the most extreme scenario, the Dutch economy would decline by 5.3% in the first year, followed by drops of 2.2%, 1.4% and 0.9%, respectively, in the three subsequent years, Bosman, Eggelte and Jansen forecasted.

Bosman, who has previsouly worked for DNB as a senior economist, said a drop of more than 5% was still a realistic assumption.

He noted that the assumption at the time, that equity markets would fall by 25%, had already been surpassed, and that markets could still drop further.

“As recent valuations had been very high, a correction of 50% would be possible,” he said, adding that markets would remain extremely volatile as long as uncertainty about the stabilisation of the pandemic persists.

Bosman said that, so far, he hadn’t seen any totally unexpected developments. “We are still in the first phase of the pandemic, and the measures taken by the government are logical.”

Buffers

Bosman said that an important lesson to learn from a risk management perspective is the importance of financial buffers.

“At the financial crisis in 2008, capital buffers of many financial institutions turned out to be wafer thin. Subsequently, they have been increased.

“What we see now is that, for example, the care sector is lacking reserves, such as the shortage of face masks. This is logical in a way, as buffers are expensive.”

The 2006 survey also predicted that the potential financial advantage to pension funds caused by higher mortality rates, was likely to be offset by declining markets.

At the time, however, interest rates as an important factor for pension funds’ funding ratios were not an issue.

Bosman said that avoiding a depression is the most important goal now.

The DNB concluded that the Dutch economy could decline by more than 5% this year

“This means that the economy must be sufficiently supported financially, and that healthcare risks are properly managed,” he noted.

According to Bosman, little has been done with the survey’s recommendations and with DNB’s encouragement of institutions to make themselves “pandemic proof”.

“I think that at the time, organisations had mainly focussed on their own continuity and had paid insufficient attention to financial risk management, including extreme equity, interest and credit shocks.

“A pandemic was such an unlikely scenario that everybody tended to ignore it. However, the essence of proper risk management is that extreme shocks are also being taken into account.”

Bosman added that pension fund trustees often indicated that a 30% market drop would be the most extreme scenario.

“But this is an average crash,” he stressed. “Although pension funds invest for the long term, they are also susceptible to short term events such as the current one.”


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