Brendan Burgess
Founder
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I have edited out some of the padding to focus on the key bits:
On that occasion, my introductory remarks focused on three main areas, namely …and (iii) the level of mortgage interest rates, which was already attracting increasing attention from the Bank given its consumer protection mission.
The concerns I expressed around the standard variable rate in November foreshadowed a wider public focus on this issue, reflecting the widening spread between Irish mortgage rates and those in many other parts of the euro area. The Bank has conducted a good deal of research on the topic (some of which previously published) and a summary of some of this was included in the document which was prepared at the request of the Minister for Finance and published last week.
Since the crisis, banks’ SVR rates have moved higher than previously relative to the banks’ cost of funds and arguably higher than a fair-minded customer might have reasonably expected. This development was manifest in a number of Eurozone countries but the divergence has become particularly large in Ireland. Is this compliant with the contract that the customers signed? Is it consistent with good business practice for the long-term relationship? Is it good for the overall recovery of the economy on which the banks depend for their long-term success?
Admittedly, it is essential for the survival of banks that they achieve a sufficient return on the investment of funds, including equity (much of it owned by the Government, by the way). If not, they will not be able to achieve and maintain the growing requirement for capital adequacy in the years ahead. The profitability goal has to take account of long-term considerations, and of the risks involved in lending, especially the actual and prospective losses on non-performing mortgage loans.
Nonetheless, personally, I would welcome a reduction in bank SVR rates in current circumstances as a benefit to the economy at large. Were it not for the firm conviction that the introduction of administrative control on interest rates in Ireland would be bad for the country as a whole in the medium term—notably because of its stultifying effect on bank efficiency and its chilling effect on the entry of other banks—there could be a case for some government intervention.
The SVR contract
A different/new contractual arrangement that linked the floating rate on new mortgages to actual funding costs of the banks could be designed in such a way as to achieve the original aims of the tracker without retaining the vulnerability of the ECB policy-rate linked tracker. (Of course the spread would have to cover the costs and risks of lending.) But such contracts are not currently offered.
Given the wording of the SVR contract, I assume that borrowers agreed to SVR terms largely because they trusted the banks to behave in a fair manner with regard to interest rate adjustments. And for decades it seems that this trust was, by and large, not misplaced. Is this still the case? There is clearly justification for some of the increase that has occurred in the spread, which was too low in the past. Relevant factors include: the persistent drag on their viability from the combination of a large tracker book and the fact that funding costs are much higher than the ECB policy rate; the dramatic increase in non-performing mortgage loans and the need there has been to make large provisions against loan losses; and the sharply increased capital requirements on banks have all threatened the viability of mortgage lending for the banks. In a general way, defenders of the banks can point to these factors as providing some justification for higher spreads on SVRs. Still, such arguments are rather open-ended, and, in the absence of a transparent, clear and quantified policy on the part of the banks, can be seen as excuses for charging whatever the market will bear rather than being a fair application of the contract consistent with a borrower’s reasonable expectation.
Under these circumstances, the SVR borrower’s main protection is competition: the fact that, by setting its SVR rate too high, any bank stands to lose business (whether new business or switchers) to competitors. Whereas this protection was effective pre-crisis, the level of competition currently is too low. Ensuring that official policy does not inadvertently deter competition and entry of banks to the market is thus vital for the long-term health of the economy.
The Central Bank wrote to each of the banks in February to ask for a clear statement of each bank’s pricing behaviour around SVRs. In their responses, none of the banks have so far provided what I would regard as a clear and quantified statement of their policy with respect to adjustments of the SVR interest rate .
In my opinion, good business practice of the banks would demand that they make upward adjustments to SVR rates only following clear and objective changes in prevailing business conditions (not only funding costs); good business practice would also call on them to lower SVR rates when the same conditions move in the opposite direction. To regain the trust of their customers, I believe that the banks should move to publishing a clear and quantified statement of their SVR interest rate policy. Since they do not seem to have such a policy, they will need to develop one. If necessary, drawing on its legislative powers for consumer protection, the Central Bank will codify such a requirement formally, but this should not be necessary.
Broader considerations
While insisting on transparency may seem to be an insufficient official response to the manner in which the spread of SVR rates has drifted up, I would insist on my words of caution against the enacting of legislation that would provide for officially-administered lending rates. Nothing could be more likely to curtail and discourage entry of new competitors into Irish banking, and without the possibility of such entry, I cannot see that banking can recover the operational efficiency and competitive pricing that is essential for Ireland in the long run. For the sake of modestly lower SVRs for a few quarters, a much larger and quasi-permanent albeit somewhat invisible loss would be incurred by the customers of the banking system in Ireland. Well-capitalised banks operating more competitively will, in the end, offer lower rates and better service.
Besides, close administrative control of interest rates would not be easily compatible with the principle of an open market economy with free competition which has underpinned the considerable increase in national prosperity over the past half century in Ireland (and which of course is enshrined in the European Union Treaty). This is not a matter to be taken lightly or opportunistically for what would clearly be at best a transitory advantage.
Without detracting from the importance of appropriate pricing on the SVR loans, I should not conclude without emphasising that delays and uncertainties surrounding the resolution of non-performing loans remains a much more acute problem. The latter problem is of course one which we have discussed in this Committee repeatedly and on which progress remains damagingly slow.
I have edited out some of the padding to focus on the key bits:
On that occasion, my introductory remarks focused on three main areas, namely …and (iii) the level of mortgage interest rates, which was already attracting increasing attention from the Bank given its consumer protection mission.
The concerns I expressed around the standard variable rate in November foreshadowed a wider public focus on this issue, reflecting the widening spread between Irish mortgage rates and those in many other parts of the euro area. The Bank has conducted a good deal of research on the topic (some of which previously published) and a summary of some of this was included in the document which was prepared at the request of the Minister for Finance and published last week.
Since the crisis, banks’ SVR rates have moved higher than previously relative to the banks’ cost of funds and arguably higher than a fair-minded customer might have reasonably expected. This development was manifest in a number of Eurozone countries but the divergence has become particularly large in Ireland. Is this compliant with the contract that the customers signed? Is it consistent with good business practice for the long-term relationship? Is it good for the overall recovery of the economy on which the banks depend for their long-term success?
Admittedly, it is essential for the survival of banks that they achieve a sufficient return on the investment of funds, including equity (much of it owned by the Government, by the way). If not, they will not be able to achieve and maintain the growing requirement for capital adequacy in the years ahead. The profitability goal has to take account of long-term considerations, and of the risks involved in lending, especially the actual and prospective losses on non-performing mortgage loans.
Nonetheless, personally, I would welcome a reduction in bank SVR rates in current circumstances as a benefit to the economy at large. Were it not for the firm conviction that the introduction of administrative control on interest rates in Ireland would be bad for the country as a whole in the medium term—notably because of its stultifying effect on bank efficiency and its chilling effect on the entry of other banks—there could be a case for some government intervention.
The SVR contract
A different/new contractual arrangement that linked the floating rate on new mortgages to actual funding costs of the banks could be designed in such a way as to achieve the original aims of the tracker without retaining the vulnerability of the ECB policy-rate linked tracker. (Of course the spread would have to cover the costs and risks of lending.) But such contracts are not currently offered.
Given the wording of the SVR contract, I assume that borrowers agreed to SVR terms largely because they trusted the banks to behave in a fair manner with regard to interest rate adjustments. And for decades it seems that this trust was, by and large, not misplaced. Is this still the case? There is clearly justification for some of the increase that has occurred in the spread, which was too low in the past. Relevant factors include: the persistent drag on their viability from the combination of a large tracker book and the fact that funding costs are much higher than the ECB policy rate; the dramatic increase in non-performing mortgage loans and the need there has been to make large provisions against loan losses; and the sharply increased capital requirements on banks have all threatened the viability of mortgage lending for the banks. In a general way, defenders of the banks can point to these factors as providing some justification for higher spreads on SVRs. Still, such arguments are rather open-ended, and, in the absence of a transparent, clear and quantified policy on the part of the banks, can be seen as excuses for charging whatever the market will bear rather than being a fair application of the contract consistent with a borrower’s reasonable expectation.
Under these circumstances, the SVR borrower’s main protection is competition: the fact that, by setting its SVR rate too high, any bank stands to lose business (whether new business or switchers) to competitors. Whereas this protection was effective pre-crisis, the level of competition currently is too low. Ensuring that official policy does not inadvertently deter competition and entry of banks to the market is thus vital for the long-term health of the economy.
The Central Bank wrote to each of the banks in February to ask for a clear statement of each bank’s pricing behaviour around SVRs. In their responses, none of the banks have so far provided what I would regard as a clear and quantified statement of their policy with respect to adjustments of the SVR interest rate .
In my opinion, good business practice of the banks would demand that they make upward adjustments to SVR rates only following clear and objective changes in prevailing business conditions (not only funding costs); good business practice would also call on them to lower SVR rates when the same conditions move in the opposite direction. To regain the trust of their customers, I believe that the banks should move to publishing a clear and quantified statement of their SVR interest rate policy. Since they do not seem to have such a policy, they will need to develop one. If necessary, drawing on its legislative powers for consumer protection, the Central Bank will codify such a requirement formally, but this should not be necessary.
Broader considerations
While insisting on transparency may seem to be an insufficient official response to the manner in which the spread of SVR rates has drifted up, I would insist on my words of caution against the enacting of legislation that would provide for officially-administered lending rates. Nothing could be more likely to curtail and discourage entry of new competitors into Irish banking, and without the possibility of such entry, I cannot see that banking can recover the operational efficiency and competitive pricing that is essential for Ireland in the long run. For the sake of modestly lower SVRs for a few quarters, a much larger and quasi-permanent albeit somewhat invisible loss would be incurred by the customers of the banking system in Ireland. Well-capitalised banks operating more competitively will, in the end, offer lower rates and better service.
Besides, close administrative control of interest rates would not be easily compatible with the principle of an open market economy with free competition which has underpinned the considerable increase in national prosperity over the past half century in Ireland (and which of course is enshrined in the European Union Treaty). This is not a matter to be taken lightly or opportunistically for what would clearly be at best a transitory advantage.
Without detracting from the importance of appropriate pricing on the SVR loans, I should not conclude without emphasising that delays and uncertainties surrounding the resolution of non-performing loans remains a much more acute problem. The latter problem is of course one which we have discussed in this Committee repeatedly and on which progress remains damagingly slow.
