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Dutch banks have caused tens of billions of euros worth of damage to entrepreneurs and semi-government agencies through interest rate derivatives. So says Hester Bais, author of the book Worst Bank Scenario, in conversation with Paul Buitink and Sven Kuipers of Holland Gold. Entrepreneurs were obliged to enter into interest rate swaps to hedge the risk of interest rate fluctuations on their loans, even though this was not in their interest. In fact, they were duped by the bank.
Bais explains that entrepreneurs usually take out loans with a variable interest rate because they can then make accelerated repayments without paying a penalty. That went wrong when banks started bundling these loans with interest rate swaps from 2006 onwards. These are financial instruments that can absorb the risk of a rise in interest rates. But because market interest rates only continued to fall, these interest rate swaps took on a negative value, which meant that entrepreneurs who wanted to repay their loans more quickly were still saddled with extra costs. Costs that quickly ran into tens or hundreds of thousands of euros.
According to Bais, banks have made several mistakes in this case. Many of the bank's customers did not even know exactly how an interest rate swap worked and what the risks were. In addition, the banks acted against the interests of the customer, because they knew that interest rates would fall further. Entrepreneurs should benefit from this interest rate reduction with a variable interest rate, but the interest rate swap did not give them that advantage. On the contrary, the loan was offset by an increasing negative value of the interest rate swap. Finally, banks had a financial incentive to sell interest rate swaps, because they received extra commission on them.
As the value of interest rate swaps became increasingly negative due to falling interest rates, banks began to demand more collateral. At the same time, they increased the interest surcharge that entrepreneurs paid compared to the market interest rate to cover their deductibles. Bais explains that many entrepreneurs have run into problems as a result. They had to provide more and more collateral to the bank to cover the negative value of the interest rate swap. During the credit crisis, the value of the collateral dropped, as a result of which many entrepreneurs were no longer able to roll over their bank loans.
Banks had liquidity problems during the credit crisis. This became clear as early as 2006, when banks started trading more with derivatives. These agreements were not properly documented, which meant that banks did not have a clear view of the liquidity risks of the interest rate derivatives at first. At the same time, the banks' sales channel was encouraged to conclude as many interest rate derivatives as possible.
When interest rates started to fall, banks had to ask for more collateral from their customers, collateral that banks sometimes financed themselves. In this way, banks passed on the risk of the interest rate swaps they had provided themselves to their customers. New regulations made these risks visible. It is striking that in investigations into the credit crisis, much more attention was paid to capital than liquidity. According to Bais, pension funds have solved this liquidity problem by providing liquidity to banks through other vehicles.
According to Bais, our current financial system is very vulnerable, because it is based on loans as collateral for new loans. If the value of the collateral increases, more lending is possible, which in turn increases the value of the collateral. This has a self-reinforcing effect, until a crisis comes and the value of the collateral collapses. Then, suddenly, everyone has a problem. "We now have a system in which we have to be able to borrow everything, but that actually gets some people into trouble. Socially, it brings more adversity than prosperity. The beauty of a gold standard is that it forces moderation."
