Case Study on Fortis/ABN AMRO and SNS Reaal

Faculty of Economics and Business

Bachelor thesis

Supervision of banks prior to their nationalization: case study on Fortis/ABN AMRO and SNS Reaal

Name: Agnes van Oudenaren Student number: 6045855 Specialization: Economics Field: Monetary policy Number of credits thesis: 12 EC Date: August 26, 2014 Supervisor: Christiaan van der Kwaak

Bachelor thesis by Agnes van Oudenaren (6045855): Supervision of banks prior to their nationalization: case study on Fortis/ABN AMRO and SNS Reaal

Index

1. Introduction 3 2. Literature review 4 3. Financial situation of the Dutch banks 8 3.1 Fortis/ABN AMRO in 2007-2008 8 3.2 SNS Reaal before 2013 10 4. Supervision 12 4.1 Supervision by DNB before nationalization of Fortis/ABN AMRO 12 4.2 Renewed supervision policy before nationalization SNS Reaal 14 4.3 New legislation by the Dutch government: Intervention Law 16 5. Evaluation of Dutch supervision 18 5.1 Inquiry committee De Wit on nationalization Fortis/ABN AMRO 18 5.2 Inquiry committee on the nationalization of SNS Reaal 20 5.3 IMF’s assessments 22 5.4 Evaluation of DNB’s supervisory policy 25 6. Discussion 27 7. Conclusion 32 References 34 Appendix I 37 Appendix II 39

Bachelor thesis by Agnes van Oudenaren (6045855): Supervision of banks prior to their nationalization: case study on Fortis/ABN AMRO and SNS Reaal

1. Introduction Since the credit crisis in 2007 banks have been suffering liquidity and solvency problems. This started with the subprime mortgage crisis in the United States, which led to making banks being less able to obtain credit. This crisis spread immediately from the United States to Europe, due to the financial system being intertwined at global level. Some banks went bankrupt while others were bailed out or nationalized by governments, for example Fortis/ABN AMRO by the Dutch and Belgian government (Deal, 2008), ING and SNS Reaal by the Dutch government. The Dutch authorities received a lot of criticism since the nationalization of Fortis/ABN AMRO (Onvoldoende, 2009) for example about the amount of money spent on nationalization and the speed of action in this process. Supervision is a key element before nationalization. The nationalization of SNS Reaal was easier than the nationalization of Fortis/ABN AMRO, partly because SNS Reaal was smaller (Letter from Minister of Finance, 2013). Also, new legislation in The Netherlands was introduced. This was an addition to the law on financial supervision. Banking supervisor De Nederlandsche Bank (DNB) is responsible for the financial stability in The Netherlands. Part of their responsibility is to supervise banks and other financial institutions by examining their risk management, integrity of the management, solvability, liquidity and compliance with rules and regulations (De Nederlandsche Bank, 2006). Supervision of banks already existed before the credit crisis in 2007, so one may ask why it was possible that a bank got itself in liquidity and solvency problems of such large size. In this thesis the focus is on supervision, regulation and measurements taken during the time before the nationalization of a bank which was in liquidity and solvency problems. The research question is: “What are the changes in the execution of supervision by Dutch supervisor DNB before the nationalization of SNS Reaal compared to the nationalization of Fortis/ABN AMRO?” This thesis is going to be a case study on the supervision and nationalization of Fortis/ABN AMRO and SNS Reaal by using already written literature, policy papers by DNB and by reviewing reports by inquiry committees and other criticisms concerning the nationalizations of Fortis/ABN AMRO and SNS Reaal.

Bachelor thesis by Agnes van Oudenaren (6045855): Supervision of banks prior to their nationalization: case study on Fortis/ABN AMRO and SNS Reaal

2. Literature review This literature review creates an introduction on banking, supervision and regulation. First a short introduction on the existence of banking is given, secondly the reasons for banking supervision are explained and thereafter the different types of regulation will be elaborated. The reason why banks exist has been put together by Merton (1977). The most important functions of a bank are to lend money to firms and individuals and as storage for money of the firms and individuals. This storage is riskless for the customers and provides interest payments and noncash services for the use of their funds. For the loans, customers have to pay an interest rate to the bank. Besides obtaining credit by the deposits of customers, banks also obtain capital by listings on the stock market. Banks are often listed companies. Bank stock returns are very sensitive to changes in real estate returns (Lu, 2005). The importance of supervision in the banking industry has been emphasized by Beck et al. (2006) by looking at the effect of banking supervision on bank lending. Bank supervisory policy forces the accurate disclosure of information. This reduces the obstacles that firms face in raising external finance. This suggests that active banking supervision can help ease information costs and improve the integrity of bank lending. Similar results have been found by Furlong (1992). Santos (2000) also wrote on banking regulation. He stated that depositors need to be represented by a regulator because information and surveillance costs are high for small depositors. Surveillance could be done by a government regulatory agency. An alternative put forward by Merton (1977) would be to have a third party who guarantees the deposits, where the third party has to be the government (agency) because the banking system is very large. Santos (2000) says that there is increasing evidence that financial intermediaries have influence in the economy. Because regulation by the government turns out to be necessary (Merton, 1977), you may wonder why banks are not government owned in the first place. Banks are private and regulated in most developed countries. An answer to the question regarding government ownership is given by Barth et al. (2004). They showed that government

Bachelor thesis by Agnes van Oudenaren (6045855): Supervision of banks prior to their nationalization: case study on Fortis/ABN AMRO and SNS Reaal

ownership of banks is negatively correlated with favourable banking outcomes and that it is positively linked with corruption. Greater regulatory restrictions on banks set by the government are associated with a higher probability of suffering a major banking crisis and lower banking sector efficiency. Government ownership does therefore not hold an association with bank development, efficiency or stability. According to Barth et al. (2004) there is no evidence that government-owned banks are associated with positive outcomes. What has been addressed by Kahn and Santos (2005) is that regulation often is not performed by one authority, but that there are overlapping authorities. They propose several arrangements in order to reduce a reluctant attitude from the regulator and to make the regulator intervene in crisis situations. The first arrangement is that one regulator is the lender of last resort, has deposit insurance functions and has supervisory powers. This arrangement did not turn out to be as effective as expected according to Kahn and Santos (2005). Actually it increases the extent of reluctance in regulation, especially when banks are in need of large liquidity loans. A second arrangement is that another authority is going to be the lender of last resort, while the deposit insurer still has the supervisory powers of the bank. This means that the liquidity support to a bank is separate from the insurance coverage. Therefore, the lender of last resort might still be willing to give liquidity support, whereas the regulator chooses to close this bank due to the financial developments. While the latter arrangement induces a reduced reluctance in regulation when the liquidity shock is severe, it will be more reluctant when the shock is moderate. Many countries have considered separating supervision of banks from central banks to other agencies, though Peek (1999) states that the conduct of monetary policy requires full excess to supervisory information, which is more difficult if supervision is placed under another agency, because this information is highly confidential. The financial sector is active on an international scale. Since banks can obtain a banking license in a large range of countries, they will move to countries with less regulation. This is called regulatory arbitrage (Houston et al., 2012). In response to fundamental changes in regulation and technology, financial institutions improved

Bachelor thesis by Agnes van Oudenaren (6045855): Supervision of banks prior to their nationalization: case study on Fortis/ABN AMRO and SNS Reaal

efficiency and attract new customers partly by increasing the geographical reach. Thereby, they aim to decrease average costs and obtain a better position in the market (Amel et al., 2004). Several solutions to prevent bank runs are stated by Santos (2000), for example developing narrow banks (which means that banks only invest in riskless securities), funding banks with equity rather than demand deposits and suspension of convertibility. Suspension of convertibility means that banks could pre commit not to liquidate more than the portion of their assets that is necessary to meet the liquidity demands of consumers that wish to consume early. By this pre commitment the bank would eliminate the other consumers’ incentive to run on the bank (Santos, 2000). The most common solutions to prevent bank runs are the following: the central bank should inform the depositors in advance that the central bank is prepared to lend any amount of money necessary for a solvent bank in liquidity problems, which has already been put together by Bagehot in 1873 and deposit insurance provided by the government to protect banks from runs, according to Diamond and Dybvig (1983). An explanation why a minimum capital level (where a financial institution is forced to have a required level of financing to provide their services) may be necessary as an additional regulation for banks is given by Rochet (1992). Rochet finds that under fixed-rate deposit insurance absence of capital regulations would lead to very risky behaviour of commercial banks. This is under the assumption of complete contingent markets, where banks are exposing value maximizing behaviour. Taking into account that financial markets are incomplete and using the portfolio model (where banks are utility maximizing), Rochet shows that insufficiently capitalized banks may exhibit risk loving behaviour. As a consequence it may be necessary to impose a minimum capital level as an additional regulation. Key finding of a research done by Furlong and Keeley (1989) is that regulatory increases in capital standards will not require greater efforts to limit risk in the asset portfolio. A value-maximizing bank prefers to increase additional capital to meet higher capital ratios required by the regulator. This means that the bank maximizes the amount of assets and thus the value of deposit insurance subsidy.

Bachelor thesis by Agnes van Oudenaren (6045855): Supervision of banks prior to their nationalization: case study on Fortis/ABN AMRO and SNS Reaal

Restrictions on bank activities set by regulators are negatively associated with banking development and stability (Barth et al., 2004). Strong official supervisory agencies, stringent capital standards and regulations that encourage private-sector monitoring of banks are not found to counterbalance moral hazard which is produced by generous deposit insurance. Moral hazard arises because there is a safety net for the banks in case they fail to pay back their debts. This safety net takes away the urge for bankers to care for future outcomes. Because there is a limited liability, the board of a bank is not forced to pay back debts in case of a bankruptcy. The deposit insurance system is for paying back debts. Because this system exists, bankers take more risk (Merton, 1977). Moreover, Barth et al. (2004) found that there is no strong relationship between a range of supervisory indicators and banking performance and stability. These results do not support the strategies of many international agencies that focus on greater official supervisory oversight of banks. Barth et al. (2004) found a negative relationship between diversification and the likelihood of suffering a major crisis, especially in small economies. Diversification in this matter means that there are no restrictions on making loans abroad. The moral hazard problem caused by deposit insurance is also the subject of research by Santos (1999). If there is deposit insurance and regulation is present, an increase in the minimum required capital-asset ratio reduces the bank's incentives to motivate risky behaviour by the firm to which it supplies funds. As a result, it reduces the bank's risk of failure.

Bachelor thesis by Agnes van Oudenaren (6045855): Supervision of banks prior to their nationalization: case study on Fortis/ABN AMRO and SNS Reaal

3. Financial situation of the Dutch banks This paragraph describes the situation of Fortis/ABN AMRO and SNS Reaal prior to their nationalization. Fortis/ABN AMRO and SNS Reaal are two Dutch banks which are nationalized in 2008 and 2013 respectively. In 2007, ABN AMRO Holding is acquired by three banks and is split up between Fortis Bank, Banco Santander and Royal Bank of Scotland (ABN AMRO, 2013). In October 2008, Fortis/ABN AMRO needed to be bailed out by the Dutch and Belgian government otherwise it would have gone bankrupt. Thus in 2008 the Dutch and Belgian government bailed out Fortis/ABN AMRO and it was split up between a Dutch and a Belgian part. In this thesis ‘Fortis/ABN AMRO’ is used to refer to the Dutch part of Fortis/ABN AMRO after the nationalization unless stated differently. In 2013 the Dutch government nationalized SNS Reaal, since SNS Reaal had major problems with its real estate portfolio. This section describes the period prior to the two nationalizations and serves as an introduction for the case study.

3.1 Fortis/ABN AMRO in 2007-2008 Before nationalization of Fortis/ABN AMRO it was unclear to the Dutch banking supervisor DNB what the financial situation of Fortis was because Fortis was as a Belgium-based bank, supervised by the Belgian supervisor CBFA (Committee for Banking, Finance and Assurance). The financial situation of Fortis was that Fortis’ portfolio contained a significant part of American sub-prime mortgages. Despite this, Fortis’ portfolio had high rated bonds (Inquiry Committee Financial System, 2012). ABN AMRO suffered a capital shortage of 1.9 billion euros before the takeover by the consortium. The acquirement of one of the three parts of ABN AMRO involved unforeseen costs of 0.6 billion euro which became visible (Letter to Congress, 2009). In 2007 the capital ratio was 12.42 per cent for ABN AMRO (ABN AMRO, 2008). This ratio met the capital requirements of minimal 8 per cent (BIS, 2006). Instead of the minimum equity/asset ratio of 8 per cent, the Belgian supervisor required Fortis to maintain a ratio of at least 10 per cent since before the takeover of ABN AMRO. The reason behind this stricter requirement was the structure of Group Fortis. Because of

Bachelor thesis by Agnes van Oudenaren (6045855): Supervision of banks prior to their nationalization: case study on Fortis/ABN AMRO and SNS Reaal

this stricter solvability requirement a plan of financing the takeover of ABN AMRO by Fortis Bank was needed (CBFA, 2009). Fortis came up with a plan of financing the takeover of ABN AMRO to meet the requirements set by the Belgian supervisor CBFA. Fortis investigated possibilities to improve its solvability equity/asset ratio. Intensions like capital enlargement, issuing of hybrid capital instruments, merging assets to sell as securities and sales of non- strategically assets were being investigated. Despite this plan there were several factors which had a negative impact on the solvability of Fortis. One of these factors was depreciations on the portfolio of structured credits. Another factor was expected losses because of transferring several activities to The Netherlands, which was required by European Committee. A third factor that had a negative impact on Fortis’ solvability was the depreciation of Fortis’ stock portfolio and as final factor the profitability of activities that are affected by the world wide credit crisis and some solvability improvement actions were not as effective. As a result of the above events and negative impacts on the market developments, there was an increasing risk that Fortis would not meet its solvability requirements after integration of ABN AMRO activities. That is why CBFA asked Fortis to take additional actions to meet the solvability requirement (CBFA, 2009). To meet the solvability requirement, Fortis announced its solvability plans by June 2008. These plans should increase solvability by 8.3 billion euros. The plan contained the following actions: 1.5 billion euros of additional capital was needed, no interim dividend emission, proposal to issue dividend in shares rather than in cash, sale of non-strategic assets and a sale and lease back transaction, where Fortis forecloses a lease contract to obtain credit. Additional problems for Fortis were the worsening liquidity position on the interbank market (CBFA, 2009). Since the credit crisis, the financial market is in a systemic) crisis, in which the problems of one party in the financial market can leap to the total market (systeem, 2008). According to the Bank for International Settlements (BIS, 2009), the amount of interbank credit lending in the euro area was still decreasing.

Bachelor thesis by Agnes van Oudenaren (6045855): Supervision of banks prior to their nationalization: case study on Fortis/ABN AMRO and SNS Reaal

Despite Fortis’ plans to improve solvability, bank runs started in October 2008 fed by public fears of insolvability. Fears of insolvability arose because of Fortis’ choice to takeover ABN AMRO without sufficient investigation regarding the situation of ABN AMRO. The fear of insolvability led to large float of savings that was brought to Rabobank, coming from Fortis Bank (Inquiry Committee Financial System, 2012). As a consequence the public withdraws their money which leads to a bank run. In general, the public observes banks over a longer period of time, when they detect that there is a possibility that a bank is about to fail, they could trigger a bank run. Fed by public fears of uncertainty bank runs may even occur if no one has any adverse information about future returns (Chari & Jagannathan, 1988). For example, consider a multinational company with large amounts of savings at a bank. This company observes that bank closely and because there is no deposit insurance for companies there is a large risk of capital withdrawal by the company if it fears bank uncertainty. When the company actually withdraws its savings, this could trigger other depositors to do the same. If many depositors withdraw their deposits this could induce a bank run. That is why in times of economic growth, markets seem to favor a bank capital structure that is heavily relied on short term debt, while in times of crisis (which means more fear of uncertainty) the costs of illiquidity seem to be more important. Markets then encourage a capital structure that is heavily relied on capital (Diamond & Rajan, 2009). In Appendix I a timeline around Fortis/ABN AMRO’s nationalization is shown.

3.2 SNS Reaal before 2013 Prior to the nationalization of SNS Reaal, SNS Reaal needed state support in 2008. In 2006 SNS Reaal was launched to the stock market and bought Bouwfonds Property Finance, which used to be a department of ABN AMRO (Kreling & Rosenberg, 2014). SNS Reaal was very ambitious, showing this by entering the stock market and several takeovers over the last couple of years (see Appendix II for a timeline). The acquisition of Bouwfonds Property Finance, which was a company that sold loans for real estate, was one of the reasons for the downfall of SNS Reaal. SNS Reaal received state support

Bachelor thesis by Agnes van Oudenaren (6045855): Supervision of banks prior to their nationalization: case study on Fortis/ABN AMRO and SNS Reaal

in 2008. SNS Reaal preferred solving the capital shortage by support from related party Stichting Beheer. After conversations with DNB, the board of SNS Reaal changed its rational (leent, 2008). SNS Reaal was in trouble because of bad investments in the insurance company. Moreover, SNS Reaal neglected the bad loans and risk management in Bouwfonds Property Finance. There was no complete investigation before the acquisition (Inquiry Committee Nationalization SNS Reaal, 2014). Due to the state support, SNS Reaal was under strict supervision of DNB which had led to plans to diminish the real estate portfolio in order to reduce the risks within SNS Reaal’s portfolio (Sijbrand, 2013). The real estate portfolio was diminished by significant percentages: first foreign investments and thereafter also domestic. However, in 2011 it became clear that the plans were not sufficient to attract additional capital which led to the nationalization of SNS Reaal in 2013. The real estate loans had large depreciations which SNS Reaal could not carry anymore. Despite negotiations with an additional investor, the Dutch government which was advised by DNB nationalized SNS Reaal at the beginning of 2013 leaning on the Intervention Law. According to research by DNB SNS Reaal needed at least 1.9 billion euros of additional capital. President Supervision of DNB, Sijbrand, mentioned in 2011 the figures of SNS Bank: despite shortening the real estate portfolio, it still had a value of 8 billion euros, whereas the equity was 1.5 billion euros which included the real estate bank (Kreling & Rosenberg, 2014). On February 1, 2013 SNS Reaal was nationalized by the Dutch government.

Bachelor thesis by Agnes van Oudenaren (6045855): Supervision of banks prior to their nationalization: case study on Fortis/ABN AMRO and SNS Reaal

4. Supervision In this paragraph supervision by De Nederlandsche Bank (DNB) in the Netherlands will be elaborated. First, the supervision (2006-2010) before the nationalization of Fortis/ABN AMRO in 2008 and thereafter the supervision policy (2010-2014) before the nationalization of SNS Reaal in 2013 will be described. DNB renews its supervisory policy every four years.

4.1 Supervision by DNB before nationalization of Fortis/ABN AMRO The supervision policy of DNB before nationalization of Fortis/ABN AMRO had four strategic goals in supervision. The first goal was to raise the stability of the financial system, for example by keeping the interest rate and inflation stable to diminish uncertainty in the financial markets. The second goal was to protect the financial assets of consumers, by monitoring the financial situation of financial institutions that accommodate these assets. Thirdly, DNB aimed to guard the integrity of the financial system where DNB tackled conflicts of interest and tried to avoid the Dutch banking system to be involved in criminal activities. The fourth strategic goal of DNB was to promote reliable and efficient movement of payments in The Netherlands. These strategic goals were targeted by focusing on risks. The three elements of this risk- orientation are: institution specific approach, generic risk analysis and thematic approach (De Nederlandsche Bank, 2006). In the institution specific approach the Financial Institutions Risk analysis Method (FIRM) was used. FIRM creates a risk profile of a financial institution which looks at the institution’s policy and behaviour in order to lower their risk levels. The FIRM score decides whether an institution needs a high or a low level of supervision. Independent whether an institution has a good or a bad FIRM profile they still have to report to DNB periodically about their core financial data. Also, DNB visits institutions for policy conversations and research on location. These conversations are influenced by the FIRM scores of the institution. By combining the FIRM profile and the conversations, this institution specific approach enables financial institutions to determine how they are going to be compliant to the rules set by DNB. By aiming to

Bachelor thesis by Agnes van Oudenaren (6045855): Supervision of banks prior to their nationalization: case study on Fortis/ABN AMRO and SNS Reaal

easily meet the required levels for example for solvability, the FIRM-profile can be low which means that the supervision of DNB can be reduced. This means that institutions can influence the intensity of their supervision (De Nederlandsche Bank, 2006). Next to the institution specific approach, DNB has a generic risk analysis. This analysis focuses on the type of financial institution, rather than the specific institution and is therefore fixed until the institution changes in size. Generic risk analysis is the instrument to compare different types of financial institutions systematically, for example ‘large bank’ or ‘very large pension fund’. The risk profile is determined by the valuation of the combination of probability of failure and the impact of a bankruptcy on society. Given the risk profile, a supervision package is being matched to the institution

(T1, T2, T3 and T4, where T1 is tiny risk and T4 is high risk profile). Because Fortis/ABN AMRO is a large bank, which holds medium to high probability of operational risks and integrity risks, it has a T4 risk profile (De Nederlandsche Bank, 2006). The third element of risk orientated supervision is the thematic approach. A theme can be the result of a development in society, an economic trend, a new financial product or the behaviour of a certain group of institutions. These themes have to be observed by DNB in time, which gives DNB enough time to create an adjusted policy to this theme. Next to DNB, the economic sector (banks, pension funds, insurance companies and investment (share) institutions) also has to adjust their policy to this theme according to DNB. Whether this adjustment is sufficient is monitored by DNB. A current example is the information security of the automated financial systems. There are a lot of technical developments, restructurings of banks and the increasing risk of cybercrime which asks for attendance of the financial institutions to maintain the quality of the information security. DNB examines this risk by looking at the quality of the security management and monitoring activities of this security. By using this thematic approach, DNB can react in time to developments in the sector (De Nederlandsche Bank, 2006). Next to the three above mentioned approaches, DNB also has some additional tools in case an institution violates the rules. If an institution does not follow the rules, DNB will first give an informal signal. This informal signal could be a conversation or

Bachelor thesis by Agnes van Oudenaren (6045855): Supervision of banks prior to their nationalization: case study on Fortis/ABN AMRO and SNS Reaal

letter to the board to push the institution into the direction of following up on the rules. If behaviour is not being adjusted after this signal, DNB is forced to use its other instruments: giving an instruction, forcing towards action under restriction of a penalty, a publication or appointing a trustee. DNB is very reluctant in using these instruments because of the important relationship of trust between supervisor and financial institution (De Nederlandsche Bank, 2006). This relationship is important because the supervisor partly is dependent of the financial institutions because these institutions provide information that can only be provided by them, not by other parties. The reluctant attitude in supervision of DNB is reflected in the bankruptcy of DSB Bank in 2009. DNB was too late in intervening at DSB Bank: financial data regarding DSB Bank was available for DNB and DNB also did not react to the construction within DSB Bank where the owner also was the CEO of DSB Bank (Van Wijnbergen, 2011).

4.2 Renewed supervision policy before nationalization SNS Reaal In this section, the renewed supervision policy by DNB will be elaborated. This policy is adjusted after the nationalization of Fortis/ABN AMRO. These adjustments were necessary in order to prevent the Netherlands from another nationalization. After analysis of the supervision before nationalization of Fortis/ABN AMRO, DNB stated to not have enough tools to react in the credit crisis. Moreover, they stated that there was an exaggerated decrease in regulation because of changes in the financial sector (for example globalization of markets and companies) and a critical public opinion about supervision. This adjusted supervisory framework was used in the run-up to the nationalization of SNS Reaal. In accordance with these observations, DNB renewed its supervisory policy. There are two main important changes. First, they have changed the focus from the institution solely into looking at the entire sector in which the financial institution is operating. This macro orientation is divided into three elements. One element focuses on risks and vulnerabilities in the sector and compares different institutions to see which institutions are significantly different from other institutions in their behaviour. In another element DNB focuses more on different risk areas, for example integrity risk. In

Bachelor thesis by Agnes van Oudenaren (6045855): Supervision of banks prior to their nationalization: case study on Fortis/ABN AMRO and SNS Reaal

this element, DNB evaluates the execution of the business processes. Yet another element includes the strengthening of macro prudential supervision. In this, DNB tries to reconcile micro supervision with macro supervision. All parts of micro and macro are involved in the analysis, prioritization and diminishing of risks. The difference between micro supervision and macro supervision is that micro supervision focuses on individual firm level while macro supervision focuses on the complete sector. The second main change is increased attention for the strategy of the institution and its business model. Also, more insight in behaviour and culture of the institution will be obtained (DNB, 2010). Behaviour by the board of an institution should not only be following the rules but should also be social desirable behaviour. In the past bankers’ behaviour was focused on its personal reputation, rather than on the best interest of the bank. DNB now has a bigger focus on integrity risks of institutions, for example bankers’ socially undesirable behaviour. DNB will improve its own personnel in order to obtain information concerning strategy and culture of the institutions. This is done by deepening the knowledge of its employees, for example regarding innovative financial products such as new types of mortgages in the United States, and to hire personnel with more specific knowledge and experience. Next to this, there are more in depth investigations, risk analysis is tighter and the macro orientation strengthened the analysis and decision making. Furthermore, DNB focuses on strengthening joint international supervision, risk analysis and DNB keeps existing quantitative measures by exerting additional reviews on financial institutions. Finally, in getting more into the strategy and culture of the institution, DNB is going to switch positions of employees and management on a regular base in order stay independent in decision making (De Nederlandsche Bank, 2010).

4.3 New legislation by the Dutch government: Intervention Law In pre-credit crisis legislation, the focus was on preventing a bankruptcy and to lesser extent on coordinating a bankruptcy. If banks are not able to pay off their debts anymore, they need guidance from their supervisor in order to obtain credit. If the supervisor failed preventing a bankruptcy the institution also needs to be guided during

Bachelor thesis by Agnes van Oudenaren (6045855): Supervision of banks prior to their nationalization: case study on Fortis/ABN AMRO and SNS Reaal

this bankruptcy, in order to keep the damage to the financial system (and economy) as low as possible. When it came to a bankruptcy during the credit crisis it turned out that there was not sufficient legislation for rescuing a bank in the last phase before bankruptcy. In order to overcome the gap in legislation between the prevention of a bankruptcy and bankruptcy itself, the Dutch Ministry of Finance implemented the Intervention Law (officially known as the law of specific actions for financial institutions). This intervention law can only be used by DNB or the Minister of Finance if the financial institution does not meet the required liquidity and solvability rates (Inquiry Committee Nationalization SNS Reaal, 2014). The intervention law contains two categories of controls: to begin with instruments for the supervisor DNB (for fast supervision for insolvent banks) and furthermore instruments for the Minister of Finance (with a focus on stability of the financial system). First of all, this law gives DNB a tool to prepare a transfer scheme for a company (excluding holding companies). This scheme includes an arrangement in which all shares of the company are sold and the financial institution is taken over. Creating a transfer scheme could ease a possible takeover because the transfer is already prepared. DNB can start preparing a transfer scheme if there are signals of negative developments regarding the institution’s equity, solvability or liquidity. Legislation does not mention any ratio but gives DNB responsibility for the rating of these developments (Wft, 2014). This negative development should be of real significance because the creation of such a scheme will give a signal of uncertainty to the market and this may cause a loss of trust in the financial institution. If DNB found an appropriate candidate for a transfer this party has to pay a reasonable price for the company which has to be approved in court (Baukema, 2012). Secondly, the Minister of Finance gets two new instruments from implementation of the intervention law. One instrument is the capacity to intervene in the board of the financial institution and the other instrument is the capacity to dispossess the properties of the financial institution. These capacities are only meant to be used in case of direct danger of the financial stability of the system. The Minister of

Bachelor thesis by Agnes van Oudenaren (6045855): Supervision of banks prior to their nationalization: case study on Fortis/ABN AMRO and SNS Reaal

Finance first has to look for other options. If case of dispossession, there has to be a compensation for the former owners, equal to the worth of the property in the future. In order to illustrate the intervention law, the case SNS Reaal will be elaborated. In December 2011 it became clear that SNS Reaal could not obtain credit by itself anymore. Therefore DNB and Ministry of Finance started a project to evaluate different scenarios for SNS Reaal (Kreling & Rosenberg, 2014). DNB and the Ministry of Finance created a transfer scheme for SNS Bank and reviewed possibilities of takeovers by third parties. Because of risks related to SNS Property Finance there was no party interested in a transfer. SNS Property Finance was an element of SNS Bank (Dijsselbloem, 2014). DNB did not have permission to create a transfer scheme for the holding SNS Reaal. Therefore they explored solutions for the bank only. If SNS Bank would not have been transferred this would have led to a bankruptcy of the entire holding SNS Reaal. On February 1st 2013 the Minister of Finance used one of its new instruments by intervening in the board of SNS Reaal. Also, the Minister of Finance arranged the dispossession of liabilities by transferring these to a new created foundation which eventually went bankrupt. Furthermore, the Minister of Finance nationalized the shares of SNS Reaal. This was done because it would have cost society more money and trust in the financial system if SNS Reaal went bankrupt. Within this intervention, DNB was co-responsible for the stability of the financial sector. Therefore, the Minister of Finance consulted DNB (Inquiry Committee Nationalization SNS Reaal, 2014). Currently, SNS Reaal still is a government-owned bank.

Bachelor thesis by Agnes van Oudenaren (6045855): Supervision of banks prior to their nationalization: case study on Fortis/ABN AMRO and SNS Reaal

5. Evaluation of Dutch supervision In this paragraph first the criticism stated by inquiry committee De Wit, who did an investigation to the nationalization of Fortis/ABN AMRO will be described. Thereafter, the criticism by evaluation committee of nationalization SNS Reaal will be set out. In sub paragraph 5.3 the assessments performed by the IMF in 2004 and 2011 regarding Dutch supervisory policy will be elaborated. To conclude this paragraph, criticism stated by several scientists on the Dutch supervision will be stated.

5.1 Inquiry committee De Wit on nationalization Fortis/ABN AMRO The Dutch Parliament formed inquiry committee of the financial system, informally known as Committee De Wit. This committee wrote a report on the financial situation in the Netherlands in the period 2007-2008, which was the start of the credit crisis. Also, the takeover of ABN AMRO by Fortis and the nationalization is part of this report (Inquiry Committee Financial System, 2012). To obtain more knowledge and insight for this report the committee interrogated involved persons (politicians, officials and key figures of the banking sector) and financial experts. This paragraph contains a summary of the committee’s conclusions. In 2007, a consortium consisting of Royal Bank of Scotland, Fortis and Santander was interested in buying ABN AMRO. DNB independently approved (by giving the intention of no objection) the request of the consortium to takeover ABN AMRO. In this decision, DNB relied on the judgment of international supervisors of the related parties instead of doing research themselves. The first point of criticism arises from a stage before the nationalization of Fortis/ABN AMRO. According to the committee, DNB and the Ministry of Finance brought negative effects to the Dutch economy and tax payer by giving the intention of no objection to the consortium. Financial stability was in danger because of this decision by DNB (Inquiry Committee Financial System, 2012). In the new situation, supervision by DNB became more complex because of the separation of ABN AMRO among the 3 banks of the consortium. The second point of criticism from the committee derives from the complexity of the supervision before

Bachelor thesis by Agnes van Oudenaren (6045855): Supervision of banks prior to their nationalization: case study on Fortis/ABN AMRO and SNS Reaal

approving the takeover by the consortium. During the takeover it became clear that DNB did not have insight into all elements of ABN AMRO, for example the negative results of ABN AMRO’s banking activity in London. Moreover, DNB relied too much on the contract between the consortium parties which did not divide all elements of ABN AMRO (Inquiry Committee Financial System, 2012). Right after takeover of ABN AMRO by Fortis, DNB started to notice negative trends in future capital ratios and communicated this to Fortis and the Belgian supervisor, CBFA. By communicating directly to Fortis, DNB locked out the Belgian supervisor. This led to a worsened relationship between Dutch and Belgian supervisors. Meanwhile, Fortis got into more difficulties (Inquiry Committee Financial System, 2012). Initiatives resulting from the signals of negative trends never led to actions that solved the insolvency problems at this bank. Because of the worsening situation of Fortis/ABN AMRO, DNB and the Dutch Ministry of Finance created a plan. ABN AMRO was a systemically relevant bank, therefore this plan focused on a private solution on the best interests for the most important Dutch parts of the institution. A private solution holds that the ABN AMRO part of Fortis will be taken over by a private party, in this case ING. All types of measures were taken in order to finance this merger and to organize the competition of the redesigned market after merger. A few weeks after this solution was first proposed ING got into big problems itself. Therefore, this plan was not executed. The third point of criticism by the committee is that it is unclear whether this plan was realistic (Inquiry Committee Financial System, 2012). In line with the plan created by DNB for a solution for ING, the committee also mentioned that DNB did not want a takeover by another foreign party because DNB wishes to keep ABN AMRO under Dutch supervision. DNB thought this was not appropriate because they did not have insight in the financial situation of the foreign parties that could possibly acquire ABN AMRO. Furthermore, they did not have time to do proper investigation on these parties. All together, this brought committee De Wit to its fourth comment: DNB’s view unnecessarily limited the alternative solutions regarding the rescue of ABN AMRO (Inquiry Committee Financial System, 2012).

Bachelor thesis by Agnes van Oudenaren (6045855): Supervision of banks prior to their nationalization: case study on Fortis/ABN AMRO and SNS Reaal

Right before the nationalization, the Dutch government hired a consultancy agency to make a valuation of ABN AMRO. The data used for this calculation was incomplete. In this valuation it was expected that there would have been enough liquidity and capital in the different parts, which was not true. Furthermore, this agency did not adopt an undefined share of ABN AMRO into this calculation (this had a value of minus 2.3 billion euros). This share of ABN AMRO contains all assets and liabilities which were not assigned to a specific owner at the acquisition by the original consortium (Letter to Congress, 2009). The committee’s fifth point of criticism is that the consultancy agency failed in making a proper valuation of ABN AMRO. In the end, the Dutch government nationalized Fortis/ABN AMRO in order to maintain financial stability in the Netherlands, Belgium, Europe and worldwide. For this nationalization the Dutch state paid 16.8 billion euros. This led the committee to their sixth point of criticism which was that the price paid for Fortis/ABN AMRO was too high. A final remark made by the committee was that not all information available at employees of DNB was communicated to the DNB President. Therefore, he was not able to inform the ministers sufficiently (Inquiry Committee Financial System, 2012).

5.2 Inquiry committee on the nationalization of SNS Reaal The introduction of SNS Reaal to the stock market fitted into a strategy of growth, especially in diversification of income/equity. The latter was heavily encouraged by DNB. After entering the stock market, DNB approved several takeovers by SNS Reaal, for example Bouwfonds Property Finance, Axa and Zwitserleven. DNB did not perform their own independent assessment, but relied on data and information provided by SNS Reaal. Moreover, DNB did not investigate the opportunistic view of the board of SNS Reaal (Kreling & Rosenberg, 2014). With obtaining Property Finance, SNS Reaal thought it would diversify its equity, but instead it turned out to be the attraction of a concentrated risk. What first has been addressed by the inquiry committee on the nationalization of SNS Reaal is that DNB gave correct signals on macro prudential level about the risks in the real estate market. However, these signals were not translated to supervision on

Bachelor thesis by Agnes van Oudenaren (6045855): Supervision of banks prior to their nationalization: case study on Fortis/ABN AMRO and SNS Reaal

individual level of SNS Reaal. Secondly, at the moment that DNB approved the takeover of Property Finance by SNS Reaal, DNB did not consider the possible integrity risks at Property Finance. DNB only took into account the information provided by the owner of Property Finance. DNB should have controlled the customers of Property Finance because they would become a part of SNS Reaal. The undesirable relations of customers in the real estate market were part of the integrity risk. There were links between the real estate market and influential criminals. DNB mentioned the need of removing these links, but did not monitor changes. All together this led the committee to state that DNB should not have given approval for the takeover of Property Finance by SNS Reaal (Inquiry Committee Nationalization SNS Reaal, 2014). In 2005 DNB investigated the internal risk management and control framework of integrity of larger financial institutions, including SNS Bank. At that time, SNS Bank scored weakly on these points. Despite these results, DNB did not give priority to the status of SNS’s risk management and control framework of integrity. In 2010 SNS Reaal met the requirements set by DNB. By the time SNS Reaal took over Axa in 2007, DNB did not perform a full assessment on Axa’s financial situation and possible risks. In the same period as the takeover of Axa, the takeover of Zwitserleven took place. DNB stated that SNS Reaal was working on too many unnecessary takeovers. Despite their view, DNB did give an intention of no objection. Furthermore, they wrote a supporting letter in which they mentioned some conditions. However, these were not compulsory in order to obtain the intention of no objection (Inquiry Committee Nationalization SNS Reaal, 2014). Besides not intervening in takeovers by SNS Reaal, DNB also failed to make a risk analysis according to the committee. Next to the just mentioned criticism regarding the unnecessary takeovers, there also was criticism about the state support SNS Reaal received. After SNS Reaal received state support in 2008 no additional requirements had to be met. This was decided by DNB because SNS Reaal used to be a solvent company. The state support was insufficient, but did show DNB the structural problems within SNS Reaal, such as Property Finance and insurances on investments. Moreover, after state support there still

Bachelor thesis by Agnes van Oudenaren (6045855): Supervision of banks prior to their nationalization: case study on Fortis/ABN AMRO and SNS Reaal

was a capital shortage in the insurance part. Furthermore there was double leverage in the holding SNS Reaal. This means that the insurer acquires the shares of the bank by issuing debt. In a response to these findings, DNB intensified supervision over Property Finance and SNS Reaal reduced the loan portfolio to 8 billion euros by the end of 2011. In the same year, DNB asked for an investigation in the intertwined relation of the insurance and banking part of the company. Despite the intensified supervision by DNB, the responsibility of the financial situation of SNS Reaal was given to the board of SNS Reaal. The board of SNS Reaal was reluctant in asking DNB for help. Therefore SNS Reaal needed to be nationalized in 2013. The inquiry committee concludes that, like in the case of ABN AMRO, there was not sufficient action from DNB and the Dutch government regarding guidelines for SNS Reaal to stabilize the company after recapitalization by the Dutch state (Inquiry Committee Nationalization SNS Reaal, 2014). Contrary to DNB showing insufficient action in the supervision of SNS Reaal, the committee also concludes that DNB did not have sufficient tools to intervene. The intervention law does contain an instrument of transfer, but this cannot be used for a holding company. Therefore SNS Reaal cannot be rescued using this intervention law. According to DNB SNS Reaal was a system relevant bank and bankruptcy would bring the financial system in danger. This is why the Dutch government nationalized SNS Reaal (Inquiry Committee Nationalization SNS Reaal, 2014).

5.3 IMF’s assessments DNB’s supervisory policy has been reviewed by the International Monetary Fund (IMF) before the credit crisis (2004) and in 2011. In 2004, the IMF’s overall conclusion regarding Dutch supervision was that it was already of high-standard quality. Despite the high quality, there still was room for improvement. The first element of improvement mentioned by the IMF was that national as well as international crisis management needs to be expanded. An example for additional crisis management on international scale would be to participate in simulation exercises and reviews with

Bachelor thesis by Agnes van Oudenaren (6045855): Supervision of banks prior to their nationalization: case study on Fortis/ABN AMRO and SNS Reaal

foreign supervisors. Furthermore as second element of improvement, the IMF stated that a more developed macro prudential supervisory framework was needed. By this the IMF aims for a more complete and explicit guidance to the financial industry regarding supervisory expectations. Thirdly, DNB has to investigate whether its personnel is in the right position. Specialized employees should work in the field in which they have the most knowledge. This will contribute to changes in supervision. A fourth element of improvement was that DNB had to expand the focus of its reporting activity. Besides looking at the composed status of the institution, also the single status of different elements of the financial institution has to be taken into account. DNB only focused on the overall status of the institution. The fifth point of supervisory improvement should be better organization of DNB’s risk assessment. This risk assessment should focus on the entire institution before getting into the more detailed aspects of the institution. The results of the overall risk assessment should be communicated to the financial institution. The sixth and final element of improvement addressed by the IMF in 2004 was that DNB could adjust its supervisory policy more to the policies of foreign supervisors (International Monetary Fund, 2004). In 2007 some points of criticism by the IMF given in 2004, have been implemented in Dutch legislation. This has been done by the introduction of the Law on financial supervision. This legislation provides DNB an extensive range of legal sanctions and powers to ensure compliance with law and regulation. Also, DNB had adjusted its 2006-2010 supervisory policy to the findings of the IMF. After implementation of these improvements, the IMF reviewed the Dutch supervisory policy again in 2011. In 2011, The IMF’s first main finding on DNB’s policy was that their informal approach in supervision has not been very effective in changing the behaviour of banks. DNB is already targeting this point of criticism since 2010 by cooperating in a program which encourages greater use of formal powers. The second main finding by the IMF is that the distribution of the amount of DNB employees on the different departments of supervision was not in proportion to the impact of failure of these different departments on society. The department on banking supervision needs more employees. Other

Bachelor thesis by Agnes van Oudenaren (6045855): Supervision of banks prior to their nationalization: case study on Fortis/ABN AMRO and SNS Reaal

departments of supervision are for example on pension funds and insurance companies. These other sectors have a smaller impact to society than the banking sector in a crisis. Revising the distribution of the amount of employees on these different departments is advised by the IMF (International Monetary Fund, 2011). The third finding by the IMF concerns the information about banks that is available to the DNB. This information includes management letters by internal and external auditors and other internal management information of each of the major banks. This information can be used in order to identify the performance trends of individual banks. Moreover, the information can be used for the analysis of developments in the banking system as a whole and comparative analysis between individual banks. Despite the access to this information, it is difficult for DNB to exert stress tests from this information. These stress tests are executed in order to obtain additional information on the situation of the system relevant banks. The reason for this difficulty is that the data have not been standardized and are quite limited (for example: there is no data on non-assets). Also, the reporting dates of the financial institutions are different. In order to be able to make better use of this data for their analysis, DNB needs to introduce more standardized data forms. The data of the relevant single elements within a composed group of entities also needs to be provided in these data forms. When a broader package of data is provided to DNB, it is easier to perform stress tests (International Monetary Fund, 2011). A fourth point of criticism by the IMF was that DNB does not have specific rules with respect to problem assets. The supervisor should aim to provide guidance and outline its expectations concerning the level of provisions that would be appropriate when assets are weakened. The fifth finding by the IMF is that DNB needs to install a more formal framework of limits and constraints on lending to related parties. These related parties are parties that the bank exerts control over or vice versa. A sixth point of criticism is that how DNB performs the risk assessment does not have adequately identified the main systemic vulnerabilities such as increased leverage. These vulnerabilities lead to the need for public sector capital support (International Monetary Fund, 2011).

Bachelor thesis by Agnes van Oudenaren (6045855): Supervision of banks prior to their nationalization: case study on Fortis/ABN AMRO and SNS Reaal

The seventh finding by the IMF in 2011 was that DNB did not sufficiently integrate the vulnerabilities identified in the financial stability assessments into its supervision of individual banks. The final finding by the IMF was that DNB relied on the supervision performed by a foreign supervisor. It would have been better to use its legal powers to do an extensive research to parties that are (partly) operating abroad (International Monetary Fund, 2011). Next to these findings that focus on improvement for DNB’s policy, the IMF also noted the role of the Dutch government. The IMF stated that DNB has relatively limited rule-making authority compared to other supervisors. In the Netherlands rules and regulations are the responsibility of the Ministry of Finance. Next to this the IMF observes that DNB does not have a full range of instruments to create a solution for the banks in financial distress. During the production of the current IMF report, the intervention law was already in design. The IMF mentioned that this renewed legislation could fill this gap in supervisory policy (International Monetary Fund, 2011).

5.4 Evaluation of DNB’s supervisory policy Regarding DNB’s supervisory policy, Dutch professor in economics Van Wijnbergen (2011) had a critical view. According to Van Wijnbergen, the board of DNB had to step back from its position because they failed in the period of crisis in 2007-2008. This board did not have enough knowledge about financial markets. DNB did not have a plan for crisis situations and was too reluctant in intervening in this situation. For the sale of ABN AMRO, DNB did not use all its tools on giving its intention of no objection. The intention of no objection is the formal approval of DNB for a takeover in the financial sector. Van Wijnbergen states that DNB should have asked for delay in giving their permission because of the initial disruptions at financial markets at the end of 2007 at the start of the credit crisis of 2007-2008. Also, the stress tests by DNB were not executed properly because not all risks were included in these tests. Overall, Van Wijnbergen concludes that DNB did not proactively react to the developments in the banking industry, such as the increased complexity, speed and aggressive attitude (Van Wijnbergen, 2011). In evaluating the nationalization of SNS Reaal by the intervention

Bachelor thesis by Agnes van Oudenaren (6045855): Supervision of banks prior to their nationalization: case study on Fortis/ABN AMRO and SNS Reaal

law, Bierens (2013), Koster (2013) and Baukema (2013) addressed that DNB needs additional tools to intervene in a holding, because entities within a holding are often intertwined. A side note is that this would not have contributed before the nationalization of SNS Reaal, because there was no interested party for (the holding) SNS Reaal. Another professor in economics, Arnoud Boot (2010), addressed the DNB did not react to the developments regarding their responsibilities. DNB lost its responsibility for the monetary policy because this now is a part of the supervision performed by the European Central Bank. This decrease in responsibility led to a loss of reputation. Next to this loss, also the characteristics of the banking industry changed into a more calculated system and bankers who behaved to another interest than before. Despite the loss of reputation of DNB, the importance of supervision increased. DNB did not intensify its supervisory policy, while the changes in the banking industry asked for more supervision.

Bachelor thesis by Agnes van Oudenaren (6045855): Supervision of banks prior to their nationalization: case study on Fortis/ABN AMRO and SNS Reaal

6. Discussion In this discussion paragraph, the following research question will be answered: “What are the changes in the execution of supervision by Dutch supervisor DNB before the nationalization of SNS Reaal compared to the nationalization of Fortis/ABN AMRO?” The first section of this paragraph focuses on the execution of supervision by DNB prior the nationalization of Fortis/ABN AMRO compared to the supervision before the nationalization of SNS Reaal. The second section highlights the changed legal capabilities of DNB in the nationalizations of both cases because of the implementation of the intervention law in 2012. This paragraph will be concluded with a short look on the future of banking supervision in The Netherlands. First, the execution of supervision by DNB will be elaborated. DNB was too reluctant in the execution of supervision by DNB before the nationalization of Fortis/ABN AMRO (Boot, 2010; Van Wijnbergen, 2011). The reluctant attitude was shown in the supervision before the bankruptcy of DSB Bank in 2009, where DNB should have intervened in the board earlier (Committee investigation DSB Bank, 2010). The construction of DSB Bank was doubtful because the CEO was also the owner of DSB Bank (Boot, 2010). Furthermore, the reluctance of DNB before the nationalization of Fortis/ABN AMRO became clear in the approval given by DNB for the takeover of ABN AMRO by the consortium of Fortis Bank, Santander and Royal Bank of Scotland. This objection of no rejection should not have been given by DNB (Van Wijnbergen, 2011; Inquiry Committee Financial System, 2012). The reason for this is that the investigation regarding the foreign parties was not sufficient. DNB did not do research on its own but relied on supervisory information provided by foreign supervisors. Because DNB had a disturbed relationship with the Belgian supervisor CBFA (Inquiry Committee Financial System, 2012) and there was no joint European supervisory institution (Toezicht, 2012) it was difficult to obtain full information on the consortium parties from the foreign supervisors. This incompleteness of information should have given a signal to DNB that they should not have approved but that they had to ask for a delay in giving their statement on this optional takeover (Van Wijnbergen, 2011).

Bachelor thesis by Agnes van Oudenaren (6045855): Supervision of banks prior to their nationalization: case study on Fortis/ABN AMRO and SNS Reaal

In supervising takeovers by SNS Reaal, DNB was also too reluctant and not alert (Kreling & Rosenberg, 2014). Before the nationalization of Fortis/ABN AMRO, DNB approved the takeover of Bouwfonds Property Finance by SNS Reaal in 2006. This takeover also should never have been approved by DNB. The research to Property Finance relied on input provided by Bouwfonds Property Finance instead of research by DNB. A few reasons why DNB should not have approved this takeover is that the integrity of customers of Property Finance was doubtful, the projects in which Property Finance invested money were not transparent and there was a disordered relationship between the customers and board of Property Finance (Inquiry Committee Nationalization SNS Reaal, 2014; Kreling & Rosenberg, 2014). The approval of this takeover by SNS Reaal was given in the time before the introduction of the new board of DNB and might not have happened in the new situation. After observing the supervisory policy by DNB in 2004, the IMF stated that DNB needed a special division in their organization which purely focuses on supervision (International Monetary Fund, 2004). In 2011 DNB introduced a new board, which was after the nationalization of Fortis/ABN AMRO (Inquiry Committee Nationalization SNS Reaal, 2014; Knot, 2011). The governing board now has a director with emphasis on supervision, Jan Sijbrand. Also, there is a new department with a special focus on supervision on banks (International Monetary Fund, 2011). Next to the governing board there is a supervisory board which since the renewed board has a more difficult job with more focus on the content of supervision. The supervisory board has to control the way the governing board executes supervision in the financial system (toezichtsteam, 2012). The change in the boards of DNB is an improvement in comparing the supervision by DNB before the nationalization of Fortis/ABN AMRO with supervision before the nationalization of SNS Reaal because there now is a particular focus on supervision. In 2012 the Inquiry Committee Financial System reported on the execution of supervision by DNB in the period before and during the nationalization of Fortis/ABN AMRO. The inquiry committee’s criticism regarding the involved foreign parties is remarkable. A first example is that the inquiry committee wrote that DNB did not have

Bachelor thesis by Agnes van Oudenaren (6045855): Supervision of banks prior to their nationalization: case study on Fortis/ABN AMRO and SNS Reaal

sufficient information before the takeover of ABN AMRO by the consortium. The reason the inquiry committee stated is because the foreign supervisors did not provide sufficient information to DNB about the consortium parties. On the other side, this inquiry committee criticized DNB for their short sided view regarding a takeover of Fortis/ABN AMRO. This takeover was necessary because of Fortis/ABN AMRO’s bad solvency and liquidity position. DNB’s view for this takeover was that they preferred a takeover by a Dutch institution, because DNB wanted to keep ABN AMRO under Dutch supervision (Inquiry Committee Financial System, 2012). All together, according to this inquiry committee DNB should not have given approval for a takeover because of a lack of information provided by foreign supervisors. Contradictory, the committee stated that DNB should have aimed for a foreign solution for Fortis/ABN AMRO. With incomplete supervisory information on foreign parties it would not have been a good idea to aim for a foreign takeover of Fortis/ABN AMRO. A second example of the inquiry committee’s criticism is that the committee stated that DNB did harm to the Dutch state by approving the takeover by the consortium. The reason the inquiry committee provided was that this was the main cause why Fortis/ABN AMRO needed to be nationalized by Dutch government. This was at cost of Dutch society. What the inquiry committee did not emphasize sufficiently in their report was that the losses in the non-Dutch parts of ABN AMRO (the parts in Royal Bank of Scotland and Santander) were very high. These losses were not the responsibility of Dutch supervisor DNB anymore. Financial Services Authority (FSA) is the British supervisor, which is responsible for supervision of Royal Bank of Scotland. The FSA was now responsible for former parts of ABN AMRO. The non-Dutch parts at the Royal Bank of Scotland had large losses of around 20 billion pound (ABN-activiteiten, 2009). The inquiry committee did not consider these losses in their report. If the takeover of ABN AMRO by the consortium would not have taken place these losses could have been added to the price paid for the nationalization of ABN AMRO. It is possible that Dutch society paid less for the nationalization of Fortis/ABN AMRO without the losses by the non-Dutch parts of ABN AMRO. This will remain uncertain, because the takeover by the consortium did happen. On the other hand, the fact that these losses within ABN

Bachelor thesis by Agnes van Oudenaren (6045855): Supervision of banks prior to their nationalization: case study on Fortis/ABN AMRO and SNS Reaal

AMRO within two years after the takeover by the consortium were of this large size (ABN-activiteiten, 2009), it shows that supervision by DNB prior to the nationalization of Fortis/ABN AMRO was not sufficient. Next to the view of execution of supervision by DNB, secondly this discussion focuses on the legal capabilities of DNB. Before the nationalization of Fortis/ABN AMRO DNB did not have legal capabilities to coordinate a (future) nationalization. This is the reason why the Dutch government had to pay the market price for the nationalization of Fortis/ABN AMRO. The Dutch government could not negotiate because involved parties knew that Fortis/ABN AMRO had to be acquired (Inquiry Committee Financial System, 2012). The only legislation that existed before the nationalization of Fortis/ABN AMRO focused on supervision by DNB (De Nederlandsche Bank, 2006). The existing legislation was the law on financial supervision, which was implemented in 2006 (Wft, 2014). In this law, one section mentioned additional measures for DNB: “In case of special circumstances DNB is allowed to implement temporary generally binding regulations in order to contribute to the stability of the financial sector.” (International Monetary Fund, 2011; Wft, 2014) Still, this section does not focus on a possible bailout or nationalization but only on supervision in times of possible financial instability. After the nationalization of Fortis/ABN AMRO, an addition to the law on financial supervision was made: the intervention law. This legislation was implemented in 2011 (Inquiry Committee Nationalization SNS Reaal, 2014). The intervention law provided new instruments for supervisor DNB as well for the Minister of Finance. The new instrument for DNB is that DNB has the option to create a transfer scheme for a single financial institution if it does not meet the required liquidity or solvency ratios anymore. A transfer scheme includes an arrangement in which shares are sold and the financial institution is taken over. Before the nationalization of SNS Reaal, DNB created a transfer scheme for the SNS Bank (which was a part of SNS Reaal) when it became clear that SNS Reaal could not obtain capital by itself anymore. There was no private party interested in SNS Bank, because of bad investments and high risks in SNS Property Finance (Inquiry Committee Nationalization SNS Reaal, 2014). In the end, the Minister of Finance dispossessed all

Bachelor thesis by Agnes van Oudenaren (6045855): Supervision of banks prior to their nationalization: case study on Fortis/ABN AMRO and SNS Reaal

SNS Reaal shares and nationalized SNS Reaal. Before the nationalization of SNS Reaal, DNB used its available instruments to avoid a bankruptcy or nationalization of SNS Reaal by creating a transfer scheme for SNS Bank. DNB was not allowed to create a transfer scheme for the holding SNS Reaal, this instrument is only created for the Minister of Finance (Inquiry Committee Nationalization SNS Reaal, 2014). Because the implementation of the intervention law, DNB has instruments to intervene earlier in situations of worsening liquidity or solvency of financial institutions. This discussion will end with a short future look on supervision. For the future of supervision by DNB on financial institutions, it might be helpful to intervene on the holding level of the company, rather than on the single entities within this holding. This is stated because a lot of single entities within one holding are intertwined on different levels (Baukema, 2013; Bierens, 2013; Koster 2013). The Dutch government chose to only give the instrument to intervene in holdings to the Minister of Finance because they did not want to make DNB too powerful (Inquiry Committee Nationalization SNS Reaal, 2014).

Bachelor thesis by Agnes van Oudenaren (6045855): Supervision of banks prior to their nationalization: case study on Fortis/ABN AMRO and SNS Reaal

7. Conclusion In this thesis the following question was addressed: “What are the changes in the execution of supervision by Dutch supervisor DNB before the nationalization of SNS Reaal compared to the nationalization of Fortis/ABN AMRO?” In the execution of supervision before the nationalization of Fortis/ABN AMRO DNB was too reluctant (Van Wijnbergen, 2011). This showed by approving the takeover of ABN AMRO and takeovers by SNS Reaal in the period before the nationalization of Fortis/ABN AMRO. These takeovers were approved without sufficient investigation by DNB whether the involved parties could carry these takeovers (Inquiry Committee Financial System, 2012; Inquiry Committee Nationalization SNS Reaal, 2014). Also, DNB did not perform supervision adequately for DSB Bank (Committee investigation DSB Bank, 2010). Before the nationalization of SNS Reaal, DNB renewed its supervisory policy and its board. In the board there is a director responsible for supervision only. Next to the renewed board, there is a supervisory board with renewed responsibilities. Their role is to focus on controlling the board on the supervisory policy (Toezichtsteam, 2012). Several inquiry committees investigated DNB’s role in supervision in the period 2006 until 2013. Inquiry Committee Financial System (2012) criticized the approval provided by DNB for the takeover of ABN AMRO while the supervisory information on the (foreign) consortium parties was insufficient. This committee contradicted its criticism by rejecting the aim for DNB to find a Dutch institution for a takeover of ABN AMRO instead of looking for a takeover by a foreign party. If the supervisory information from abroad is not sufficient, then it would not seem logical to aim for a takeover by a foreign institution. Another point stated by this inquiry committee is that DNB did harm to the Dutch society in approving the takeover by the consortium. Large losses of ABN AMRO parts were the responsibility of Royal Bank of Scotland since the takeover by the consortium. These losses of around 20 billion pound were not carried by Dutch society. A nationalization of ABN AMRO before the takeover by the consortium could have cost Dutch society more money than it did now. Therefore, the statement made by the inquiry committee is questionable.

Bachelor thesis by Agnes van Oudenaren (6045855): Supervision of banks prior to their nationalization: case study on Fortis/ABN AMRO and SNS Reaal

Legislation for DNB changed with implementation of the intervention law. DNB now has an instrument to intervene if a financial institution cannot meet its required liquidity or solvency ratios. This instrument was used by DNB before the nationalization of SNS Reaal. In the comparison of the attitude and action of DNB of the period before nationalizations of Fortis/ABN AMRO and SNS Reaal it can be said that before the nationalization of Fortis/ABN AMRO DNB did not use all its (informal) powers and had a reluctant attitude. With a change in legislation and a change in supervisory policy DNB used its instruments timely before the nationalization of SNS Reaal. This nationalization was inevitable because the supervision on SNS Reaal failed already before the changes in supervisory policy and legislation.

Bachelor thesis by Agnes van Oudenaren (6045855): Supervision of banks prior to their nationalization: case study on Fortis/ABN AMRO and SNS Reaal

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Bachelor thesis by Agnes van Oudenaren (6045855): Supervision of banks prior to their nationalization: case study on Fortis/ABN AMRO and SNS Reaal

Reserve Bank of San Francisco, 3, 23-33. Houston, J.F., C. Lin & Y. Ma (2012). Regulatory Arbitrage and International Bank Flows. Journal of Finance, 67, (5), 1845-1895. Inquiry Committee Financial System (2012). Verloren Krediet II – De balans opgemaakt. The Hague: SDU uitgevers. Inquiry Committee Nationalization SNS Reaal (2014). Het rapport van de evaluatiecommissie nationalisatie SNS Reaal. Amsterdam: Uitgeverij Balans. International Monetary Fund (2004). The Kingdom of the Netherlands—Netherlands: Financial System Stability Assessment, including Reports on the Observance of Standards and Codes on the following topics: Banking Supervision, Securities Regulation, Insurance Regulation, Corporate Governance, and Payment Systems, Securities Settlement Systems, and Anti-Money Laundering/ Combating the Financing of Terrorism. IMF Country Report No. 04/312. International Monetary Fund (2011). Kingdom of the Netherlands-Netherlands: Publication of Financial Sector Assessment Program Documentation—Detailed Assessment of Observance on Basel Core Principles for Effective Banking Supervision (BCP). IMF Country Report No. 11/206. Kahn, C.M. & J.A.C. Santos (2005). Allocating bank regulatory powers: Lender of last resort, deposit insurance and supervision. European Economic Review, 49, 2107- 2136. Knot (2011). Knot leidt vernieuwde top DNB. NRC Handelsblad, May 20, p. 1. Koster, H. (2013). De praktische gang van zaken rondom SNS. Ondernemingsrecht, 35. Kreling, T. & E. Rosenberg (2014). Giftig Krediet. Amsterdam: Uitgeverij Balans. Leent (2008). SNS Reaal leent met tegenzin. Het Financieele Dagblad, November 14, p. 1. Letter from Minister of Finance (2013). FIN/2013/395: Toekomstplannen financiële instellingen ABN AMRO, ASR en SNS REAAL. August 23. The Hague. Letter to Congress (2009). FIN/2009/1021 U: ABN AMRO - Fortis Bank Nederland. The Hague. Lu, C. & R.W. So (2005). Return relationships between listed banks and real estate firms: Evidence from seven Asian economies. The Journal of Real Estate Finance and Economics, 31, (2), 189-206. Merton, R.C. (1977). An analytic derivation of the cost of deposit insurance and loan guarantees. Journal of Banking and Finance, 1, 3-11. Onvoldoende (2009). Zware onvoldoende voor stappen om herhaling te voorkomen. Het Financieele Dagblad, August 3, p. 13. Peek, J., E.S. Rosengren & G.M.B. Tootell (1999). Is bank supervision central to central banking? The Quarterly Journal of Economics, 114, (2), 629-653. Rochet, J-C. (1992). Capital requirements and the behaviour of commercial banks. European Economic Review, 36, 1137-1178. Santos, J.A.C. (1999). Bank capital and equity investment regulations. Journal of Banking and Finance, 23, 1095-1120. Santos, J.A.C. (2000). Bank capital regulation in contemporary banking theory: a review of the literature. BIS working paper No. 90.

Bachelor thesis by Agnes van Oudenaren (6045855): Supervision of banks prior to their nationalization: case study on Fortis/ABN AMRO and SNS Reaal

Sijbrand, J. (2013). Statement by President Supervision DNB. February 1. Systeem (2008). ‘Het is een beroerd systeem, maar beter hebben we niet’. Het Financieele Dagblad, October 11, p. 9. Toezicht (2012). ‘Dit jaar nog geen Europees toezicht op banken.’ Trouw, September 3. Toezichtsteam (2012). DNB heeft zijn toezichtsteam compleet; Kees Goudswaard die van de commissie-Goudswaard is vierde verse kracht. Het Financieele Dagblad, September 12, p. 2. Upper, C. & A. Worms (2004). Estimating bilateral exposures in the German interbank market: Is there a danger of contagion? European Economic Review, 48, 827-849. Van Wijnbergen (2011). Van Wijnbergen: ‘Het enige wat DNB drie jaar deed, was twijfelen’. Het Parool, February 1. Wft (2012). Law on financial supervision. The Hague.

Bachelor thesis by Agnes van Oudenaren (6045855): Supervision of banks prior to their nationalization: case study on Fortis/ABN AMRO and SNS Reaal

Appendix I: Timeline Fortis/ABN AMRO

2007 September 17, 2007. Intention of no objection given by DNB for takeover of ABN AMRO by consortium of Royal Bank of Scotland, Santander and Fortis with the condition that financing this project was completely covered. October 4, 2007. Start of the EC-Remedy route by announcing the conditions set by the European Committee for the integration of ABN AMRO NL in Fortis NL to avoid a monopolistic position of Fortis. 2008: Separation and integration of ABN AMRO parts into the different consortium parties. January 29, 2008. Intention of no objection given by DNB for takeover of ABN AMRO Asset Management by Fortis. January – June, 2008. Increasing problems at Fortis: losses and depreciations on the portfolio of Fortis and problems to obtain sufficient credit for future integration of ABN AMRO. January – February, 2008. Increasing worries of supervisors about Fortis. The Belgian supervisor CBFA asks formally for clearness about the possible presence of toxic products near Fortis. February 18, 2008. DNB starts project Tristan: an internal research around possible scenarios regarding large financial institutions getting in serious problems. Case Fortis is used as an example in this project. June, 2008. DNB is concerned about Fortis’ situation. Belgian supervisor CBFA does not share DNB’s concerns on the same level. DNB interacts with Fortis directly about their situation. June 26, 2008. Fortis announces that there need to be additional measures to strengthen the capital position. 8.3 billion euros is needed for the integration of ABN AMRO in the future. September 22-26, 2008. Conversations to explore possible solutions for Fortis between DNB, Dutch ministries and financial institutions. September 26, 2008. Fortis almost collapsed. The trust in Fortis is under pressure (there is a high credit default swap spread; insurance rate for obligations) and the liquidity position is at such sever level that during the weekend more measures has to be taken. September 28, 2008. Decreasing trust in Fortis leads to capital injections of Benelux countries in Fortis to avoid a direct liquidity crisis. September 30, 2008. Leading figures of DNB and Dutch ministries desire a takeover of all Dutch parts of the Fortis company. October 3, 2008. Dutch State buys all Dutch Fortis elements for 16.8 billion euros and takes over 50 billion euros of short and long term deposits.

Bachelor thesis by Agnes van Oudenaren (6045855): Supervision of banks prior to their nationalization: case study on Fortis/ABN AMRO and SNS Reaal

2009 June 26 and November 19, 2009. Several capital operations ABN AMRO/Fortis for in total 6.5 billion euros. October 2, 2009. A letter sent by European Committee member of competition Kroes to the Dutch minister of Finance regarding the possible deal with BNP Paribas which the European Committee does not approve. A deal with Deutsche Bank is recommended. October 20, 2009. Announcement of a general agreement with Deutsche Bank for takeover of parts of ABN AMRO, which has been initiated because of the EC-Remedy. November, 2009. DNB starts the rating regarding integration plans of Fortis Bank Nederland and ABN AMRO. 2010 January, 2010. DNB gives a new bank license to ABN AMRO. April, 2010. Final recapitalization ABN AMRO and finalizing the EC-Remedy by selling New HBU to Deutsche Bank. June – July, 2010. Intention of no objection given by DNB for a legal merge of Fortis Bank Nederland and ABN AMRO bank.

Bachelor thesis by Agnes van Oudenaren (6045855): Supervision of banks prior to their nationalization: case study on Fortis/ABN AMRO and SNS Reaal

Appendix II: Timeline SNS Reaal

2006 May 16, 2006. SNS Reaal enters the stock market Euronext Amsterdam. This yields 1.368 billion euros. September 26, 2006. SNS Reaal asks DNB for permission to acquire Bouwfonds Property Finance. October 10, 2006. SNS Reaal signs an agreement with ABN AMRO for the takeover of Bouwfonds Property Finance for 810 million euros. October 19, 2006. DNB gives intention of no rejection to SNS Reaal to buy Bouwfonds Property Finance. December 4, 2006. SNS buys Regio Bank for 50.5 million euros. 2007 January 1, 2007. Implementation of Law on financial supervision. June - November, 2007. Acquisitions of Axa, Winterthur, DBV (1.750 billion euros), Zwitserleven and Swiss Life België (max. 1.535 billion euros) by SNS Reaal. 2008: The financial crisis. July 17, 2008. Intensive supervision on solvability of SNS Reaal. October - November, 2008. Several discussions of DNB about urgent solvability of SNS Reaal, also with the Ministry of Finance which designed a crisis structure. November 13, 2008. The Dutch State injects 750 million in SNS Reaal as additional capital. 2009: DNB focuses on risks in the real estate portfolio of SNS Bank. February 19, 2009. Annual report 2008: reduction of foreign project financing. May 19, 2009.Trading update Q1: broad evaluation on international projects of SNS Property Finance. May 29, 2009. First draft of the Viability Plan from the Ministry of Finance to the European Committee. November 19, 2009. Letter of DNB which says that real estate is the most important risk. November 30, 2009. Early loan repayment of SNS Reaal to the Dutch State of 185 million euros. 2010 January 28, 2010. The European Committee approves Viability Plan SNS Reaal. May 26, 2010. The Ministry of Finance and SNS Reaal discuss quarterly figures and exit strategy. May and September, 2010. DNB visits real estate projects of SNS Reaal in Spain and the United States.

Bachelor thesis by Agnes van Oudenaren (6045855): Supervision of banks prior to their nationalization: case study on Fortis/ABN AMRO and SNS Reaal

July 1, 2010. DNB requests delivery of exit actions for the international real estate portfolio of SNS Reaal. December 7, 2010. DNB demands lowering risk profile or strengthen capital position and reduction of Property Finance International. 2011 February 17, 2011. SNS Reaal reports a net loss of 225 million euros (SNS Property Finance). March 24, 2011. First Monitoring Report was send to the European Committee about the capital injection by the Dutch government. April 29, 2011. DNB requests plan of action regarding vulnerabilities of the holding. June 1, 2011. DNB requests SNS Reaal to deliver exit plans for the non-core real estate portfolio. August 17, 2011. DNB declines the action plan made by SNS Reaal. DNB requests additional plan with possibilities to deleverage (a reduction of the debt percentage on the balance sheet). DNB also requests an analysis regarding the alignment between SNS bank and SNS insurance. December, 2011. DNB concludes that SNS Reaal is not capable to bring its own financial position to healthy standards by itself. December 6, 2011. DNB and the Ministry of Finance start a group to analyze different scenarios for SNS Reaal. December 8, 2011. Results of European Banking Authority’s capital adequacy test: SNS needs 159 million euros in order to obtain the aimed ratio of 9% Core Tier 1. 2012. On a regular base deliberation on developments at SNS Reaal and exploring solutions; first six months focus on sale of the insurer. In 2012, only public private solutions with large banks were explored. March, 2012. The Ministry of Finance asks Morgan Stanley for financial advice regarding SNS Reaal. May 8, 2012. DNB confirms that no core capital of SNS Reaal can leave the SNS Group and there is need for more capital. May 23, 2012. Letter of DNB to the Ministry of Finance about the possibility of infection to the financial system when implementing different types of solutions. June, 2012. DNB hires Royal Bank of Scotland to come up with a public private solution for SNS Reaal. The first meetings with large banks were planned. June 13, 2012. Implementation of Intervention law, which is an addition to the Law on financial supervision. July, 2012. SNS Reaal sounds after request of DNB and the Ministry of Finance potential buyers for the whole insurance company. DNB starts meetings with three large banks regarding a solution for SNS Reaal.

Bachelor thesis by Agnes van Oudenaren (6045855): Supervision of banks prior to their nationalization: case study on Fortis/ABN AMRO and SNS Reaal

July 31, 2012. Letter of the Ministry of Finance was published about the position of DNB in the situation of SNS Reaal, the effects of failure of SNS Reaal and the possibilities. August, 2012. CVC Capital Partners reports itself as a possible buyer. September 6, 2012. Ministry of Finance and DNB set up meetings with the European Committee’s case team on the situation and solutions for SNS Reaal. September 13, 2012. The Ministry of Finance sends a monitoring report 2012 to the European Committee. September 30, 2012. Halfway report of Ernst & Young on worth of real estate portfolio SNS Property Finance. October 3, 2012. Final results European Banking Authority capital adequacy test. SNS Reaal meets the required ratio Core tier 1 of 9% with +0.3%. November 1, 2012. Management SNS Reaal sends the proposal of CVC regarding the sale of SNS Reaal to the Ministry of Finance. November 6, 2012. Press release figures Q3 SNS Reaal. Core tier 1 ratio diminishes to 8.8% and does not meet the European Banking Authority’s required ratio. November 29, 2012. External accountant KPMG doubts the continuity of SNS Reaal and communicates this to SNS Reaal’s management. End of November, 2012. The Ministry of Finance takes over charges from DNB regarding conversations with large banks. 2013 January 13, 2013. Letter of SNS Reaal to the Minister of Finance with the proposal to clear things up about the possibility of selling SNS Reaal. January 16, 2013. Publication that the European Committee does not approve involvement of ING and ABN Amro regarding the public private solution to offer a capital injection. January 25, 2013. Confidential meeting between the Minister of Finance and financial spokesmen of parties in the Dutch Congres. January 27, 2013. DNB detects a capital shortage of 1.84 billion euros. January 29, 2913. The Ministry of Finance sends concept of selling SNS Reaal to the Prime Minister because they need approval. January 29, 2013. The Prime Minister approves. February 1, 2013. Letter of DNB to SNS Bank and SNS Reaal that DNB does not think it is responsible that SNS Bank still exists as a bank. DNB advices the Minister of Finance to use his powers of the Intervention Law. The decision of selling SNS Reaal’s shares and subordinated debts SNS Reaal and SNS Bank. The Ministry of Finance informs the Authority Financial Markets about the decision of selling SNS Reaal. DNB approves. The Minister of Finance announces the nationalization.