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‘The future of Finance’

Speech | 13-05-2009 | American Chamber of Commerce, Amsterdam, Minister

Speech held by minister Bos in Amsterdam.

Ladies and gentlemen,

There are strong ties that bind the Netherlands with the United States. Not only historical ties, like the discovery of New Netherland, now new York, by Henry Hudson, but also financial ones.
Did you know that in the 18th century it was fashionable for Dutch businessmen to invest in land in the fledgling United States?
Or that it was the Dutch who financed the Louisiana Purchase?
For our Dutch guests here: that was the acquisition by the United States of America of 828,000 square miles (2,140,000 km2) of the French territory of Louisiana in 1803.
This piece of land comprises 23 per cent of current US territory and is more than 50 times larger than the country that put up the money!

And that is what the Dutch are famous for.
That is the foundation of our modern economy: being adventurous and competitive, inquisitive and innovative.
It is also what made us an important financial centre.
From the first stock exchange in the world, and the first to trade in securities, to NYSE Euronext.

But our strong financial sector and the globalisation of financial markets are also the reasons that a once-remote financial crisis has become our financial crisis.
And of course, the crisis has now spilled over into the real economy. Entrepreneurs are losing their businesses, workers are losing their jobs and people are losing their homes.

The question on all our minds, whether politicians, bankers or businessmen, is: how can we regain international financial stability and make sure this can never happen again?
In other words: how can we safeguard the future of finance?

There is no single answer to that question.
You only need to read the opinion pieces in the newspapers, the debates going on within and between governments and parliaments and the discussions that dominated recent Ecofin and G20 meetings.

But virtually every answer, including my own, consists of two parts.
We need to ensure strong international cooperation – because an international crisis requires international solutions – and we need to come up with a new design for the financial sector.

Last week there was another G20 meeting.
These international meetings highlight an important difference between this crisis and the Great Depression of the 1930s.
This time around, countries are showing responsibility and are aware of the need to work together.
And on several issues, significant progress has already been made.

One of the things we have to focus on to improve international financial stability is the improvement of financial supervision.
Right now, the US and a number of European countries are rethinking their models of financial oversight.
The Dutch model of Twin Peaks has attracted attention.
This Twin Peaks has nothing to do with dead teenagers, special agents and cherry pies, but involves two kinds of supervisory bodies that work together along functional lines: a prudential supervisor and a code-of-conduct supervisor.
This model is more resilient than one based on different sub-sectors (banks, insurers etc.).
Why?
Because it is becoming increasingly difficult to separate the different financial markets and because the interdependencies between sectors are becoming increasingly important.
In addition, a prudential supervisor is better suited to monitor the market and look at financial stability as a whole.
I believe that this polder model for financial supervision is ready for international export.
A good, solid Dutch product.
As sturdy as wooden clogs, as ingenious as our waterworks and as hot as Victor and Rolf.
And best of all: it’s free!

As I’ve said, cooperating internationally is not our only task right now.
We also need to think about a new, future-proof design for our financial sector.
What do we need to do differently?
What do we need to do better?

First and foremost, we need to look at the roles of the various stakeholders.
Take shareholders for example.
I believe that shareholders need to steer their companies differently if we want to achieve stability in our markets and businesses.
Shareholders must understand that short-term gains are not the same thing as sustainable profits.
It is not up to shareholders to push and drive the management team.
On the contrary, they should be part of a company’s checks and balances.
Non-executive boards, too, need to help keep the company and its management team on the right path moving forward.
This is about taking responsibility, collectively and individually.

What is more, we need to look at the way the market is organised. Institutions have been allowed to grow without constraint.
Some have grown so enormous that their balance sheets far outsize those of their governments.
Thanks to the wide range of cross-sectoral products available, institutions have also become much more interconnected.
This has turned market risks into systemic risks.
In order to make the financial sector reliable and stable again – and in order to keep it that way – fundamental reforms are needed.
A redesign that ensures that the sector’s public and economic interests are adequately safeguarded again, without bringing it, or even a part of it, into the government’s domain.
And without saddling the tax-payer with enormous risks.

This reform – this fundamental redesign – begins, in my view, with six questions.

The first is: should we introduce a system of ‘savings banks’ and ‘venture banks’?
Is this the ideal model? Or are there other, perhaps more far-reaching options that can help bring the interests of bankers, savers and lenders more in line?
The question merits further study.
The key issue is whether in the future we will be equipped to control the risks of the entire financial system, or whether it might be better to make a small part risk-free while leaving the rest free to take chances, but with greater accountability if things go wrong.

After all, we also need to keep savers’ interests in mind.
Which brings us to the second question: how can we protect savers?

Within the European Union we have a structural provision – the deposit guarantee system – which protects savers’ money against the failure of the bank or institution with which they have entrusted their savings. We’re currently looking at European level at how this is organised.
The problem, of course, is that it wasn’t designed for a system-wide crisis, but for incidental bank failures.

My third question is: are there limits to growth?
Is there a trade-off between growth and financial stability?

Since the 1990s, a large number of financial institutions, some Dutch ones among them, have become so large and so complex, that when problems emerge, they have to be saved because their failure would jeopardise the stability of the entire financial market.
They are too big to fail.
Yet some have grown so enormous that you can’t actually do much to help them anymore.
They are too big to save.

Increasingly, the pursuit of growth in order to compete is clashing with the need to limit growth in the interests of stability.
So how do we deal with this problem?
Should we try to prevent institutions from growing so large that they pose a serious threat to stability?
By discouraging the combination of too many different types of financial services, for example.
Or by applying progressive capitalisation requirements.
There are plenty of options.
Maybe we can work together to find the right one.

The institutions that the Dutch government has saved in recent months are definitely too big to be allowed to fail.
In working through the process, we have used of all sorts of instruments, old and new, proven and untested.
So the fourth question is: do governments have sufficient instruments to avert a systemic crisis?

Injecting capital, offering guarantees, actively tackling illiquidity.
These are all useful and necessary in a severe crisis.
But are they always effective enough?
This is something we all need to think about.
And talk about.
What we clearly need, in any event, is good information.
From the financial institutions themselves and from the supervisory authorities.
Governments need information in order to offer rapid tailored solutions when problems arise.

There is a saying that ‘prevention is better than cure’, and this is particularly true of crisis management.
So it makes sense to look closely at governance and management, at owners and managers, and at how financial institutions are organised and run.

That brings me to my fifth question: how should we tackle the conflict between shareholders’ interests and financial stability?

When it comes to those financial institutions that are quoted on the stock exchange, clear tensions have arisen between bailout operations and shareholder interests.
I’ve said it before: shareholders need to look to the future and think about the long-term outlook.

But not only the shareholders.
Bankers, managers and the directors of financial institutions need to shoulder their responsibilities too.

So my sixth question is: how can we encourage financial institutions to recognise their own responsibilities?
How can we ensure that governance serves to improve management?
To start with, these institutions need to pay more attention to good governance.
That means building a stable internal governance structure with independent and competent non-executives, with a sharp focus on managing risk.
There also needs to be a stronger focus on financial institutions’ public roles and responsibilities.
And finally, remuneration policy needs to change, with greater balance and greater emphasis on the long-term.

Remuneration policy, and bonus policies in particular, have become a hot topic.
Not only because the culture of absurdly inflated incentives is seen as one of the causes of the present crisis, but also because bonus policies have inspired such outrage and recrimination, so much shame and guilt in the Netherlands, Europe and the United States.
Emotions have run especially high where recipients of government bailouts are concerned, institutions like AIG and ING.
All over the world, these policies have been met with incomprehension. Understandably so.
And all over the world governments have announced that these kinds of incentive schemes must be brought to an end.

In some ways, the US and the Netherlands share the same objectives. We need to tackle excesses and safeguard the taxpayer’s interests.
But the scale of the problem and our approaches to tackling it are different.
The US seems to be taking primarily fiscal measures.
I understand, for example, that the Senate will soon be considering a proposal to tax bonuses paid out by government-supported institutions.

In the Netherlands, we also began by taking this approach to discourage remuneration excesses. But while I don’t rule out further fiscal measures, we are currently trying to tackle the problem in other ways.

First, we attached conditions to government support. But that wasn’t enough.
It has proved very hard to change ingrained practices.
As a result, a couple of weeks ago I entered into a gentlemen’s agreement with the entire financial sector: banks, insurance companies and sector-wide organisations.
Under this agreement, the board members of the government-supported institutions have pledged not only to forego their bonuses in 2009, but also to work on changing the culture in the sector and building a new, sustainable remuneration policy.

In addition, in April, the sector itself proposed a number of far-reaching recommendations.
Banning stock options as part of variable pay, for example, a maximum shareholding and a fifty-fifty split between variable and fixed income.
The recommendations take the form of a ‘comply or explain’ system, and we are currently looking at the best ways of ensuring that such agreements will be fulfilled.

But that is not all.
In future, financial supervisory authorities will pay closer attention to remuneration policy.
Last week they presented the principles, based on the international principles as adopted by the Financial Stability Forum and the European Commission.

And that brings us full circle: even this aspect of supervision has an international dimension.
Not simply a European dimension, let me stress.
To achieve a level playing field internationally, legislation and rules should be aligned as closely as possible, not just between countries, but between the US and Europe, too.
And without diluting the responsibilities shouldered by politicians and executives.

We need solid international agreements.
We need a level playing field at international level.
Not only in the interests of stability in our financial markets, but also the strength of the global economy.
You know all about that, of course.
You live and work, you trade and deal, as Americans in the Netherlands, working with the Netherlands.
And not because the Netherlands is a tax haven, but most likely, I hope, because you see our country as a land of possibility and opportunity.
Or, because you love our country and our customs.
Like Russell Shorto, who wrote an article in The New York Times last week about ‘Going Dutch’.
If all expats are this happy to be here, we won’t have to worry about promoting our investment climate!