Capital Adequacy rules will stop any foreign bank cutting mortgage rates in Ireland.

Discussion in 'The Fair Mortgage Rates Campaign' started by RedOnion, 29 Sep 2018.

  1. RedOnion

    RedOnion Frequent Poster

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    2,061
    There's been a lot of excitement over the last week about a new entrant to the Irish mortgage market, and speculation about what rates they might offer. I've seen posters here, and elsewhere, pointing out rates available in Germany and Spain for example, and talk about those rates being made available here.

    However, German mortgage rates will NEVER be available here. Why?

    The 1 key measure that bank investors (and therefore banks) care about is return on equity.

    Apart from bad debt losses, the others big influence on return is Net Interest Margin. That's the number people are focused on - the margins are higher here. Fantastic opportunity for a foreign bank.

    However, the equity part of the equation is overlooked.

    If a foreign bank offered the same rates here as in Germany, their return is lower. Because they must allocate much more capital under capital adequacy rules.

    In Germany the risk weight of mortgages is 15%. In Ireland it's 40 on new business (it's as high as 80 for example on back book in Ulster Bank). A foreign bank moving here would need to use standardised Irish risk weight models, so would be using weights of 35-40% depending on LTV.

    So the risk weighted assets of their balance sheet is higher, requiring more capital.

    Irish banks have the additional impact of counter cyclical buffers requiring more capital against their RWA.

    What's the impact of this?

    The below estimates are from Goodbody in relation to Bankinter:
    " We would note that Spanish mortgage risk weights
    average 15% vs c.40% in Ireland (on new business). Any new entrants here would
    have to work off Irish models or standardised risk weights, so the starting point
    would be RWA densities of 35-40%. We estimate a 2.0% interest rate on 35-40%
    risk weights generate ROEs of 8.5-9.5% vs 22% on a 15% risk weight
    ."
    https://www.goodbody.ie/assets/Goodbody_Morning_Wrap_28_September_2018.pdf

    No bank is going to allocate capital to Ireland to earn less than half the return they can get at home, before factoring in potentially higher losses here, or sharing profits with a partner like An Post.
     
  2. Brendan Burgess

    Brendan Burgess Founder

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    OK, let me get my head around this.

    I want to set up a new mortgage lender and I can choose to lend in Ireland or Spain.

    Say I target €100m of mortgages to keep the numbers easy

    upload_2018-9-30_10-24-52.png

    Assuming that I have the same costs and defaults in each country, this will be reflected in the profitability and Return on Capital as follows:


    upload_2018-9-30_10-30-6.png

    Or look at it another way, with €3m to invest, I could do about double the lending in Spain than I could do in Ireland and so make twice the profits.

    Or look at it yet another way, if I invest my €3m in Ireland, I would need to charge a higher margin to get the same profits.

    Brendan
     
  3. Brendan Burgess

    Brendan Burgess Founder

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    36,336
    And here are the risk weightings across Europe

    upload_2018-9-30_10-36-55.png

    So here are the figures for a bank lending in Sweden vs. a bank lending in Ireland.

    upload_2018-9-30_10-39-5.png
     
  4. Brendan Burgess

    Brendan Burgess Founder

    Posts:
    36,336
    Red

    Who sets the rate at 42.5%?

    Let's say that EBS had decided back in 2003 that it was going to stick rigidly to 80% LTV and 3.5 times income, and, as a result had very, very low mortgage defaults. Would it still have the same capital adequacy requirements as Ulster Bank today?

    If a very conservative lender from Germany set up in Ireland and limited their loans to 50% LTV and 3.5 times income, would they too be caught by the 40% risk weighting.

    This is the point that I don't understand. 90% LTV lending should be more expensive in Ireland than 90% mortgages in Sweden because they are a lot riskier.

    But 50% LTV mortgages in Ireland are no riskier than 50% LTV mortgages in Sweden and show they should have the same risk weighting and the same mortgage rate.

    Brendan
     
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  5. RedOnion

    RedOnion Frequent Poster

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    2,061
    Last edited: 6 Oct 2018
    This isn't what I do, so apologies if I'm light on details.

    Edit: post heavily edited after discussion, as my initial reply was about 6 years out of date!

    The Central Bank decide whether banks can use standardised approach or Internal Ratings. In Ireland, with the exception of EBS, all the banks use internal ratings. I'm not close to the details, so I don't know the exact mechanics of this, other than it relies heavily on past loss / default rates for the bank.

    No, as their loss rates would be lower.

    Yes, for their Irish lending. I think the lowest risk weight is about 35%.
    a new entrant to the market would be forced to use a standardised model, where weights would be set by CBI (I understand based in the loss experience of all the banks - it would take 3 years for a new entrant to build enough data to use their own experience here).

    There used to be a bigger gap, but it's shrunk. Which is why banks stopped differentiating between LTV bands.

    That should be the case, but the calculations factor in past loss experience and default rates. There has been much more default on 50% LTV mortgages here vs Sweden.
    Even without a financial loss in the long run, the EBA rules around capital requirements in default mortgages hits the banks capital requirements you front, so leads to an accounting loss.
     
    Last edited: 6 Oct 2018
  6. Protocol

    Protocol Frequent Poster

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    2,813
    Again, great work by people on AAM.

    A bit technical for much of the media.

    Somebody should explain this in simple English and publish a press release.

    Most politicians won't know this.

    Will our RWA % ever fall? Who determines it?
     
  7. Brendan Burgess

    Brendan Burgess Founder

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    36,336
    Hi Red

    There have been some defaults, but I understand there have been no losses.

    Or put it another way, one lender told me that there were close to zero losses on mortgages which were handed out at 80% LTV and 3.5 times Loan to Income.

    Brendan
     
  8. RedOnion

    RedOnion Frequent Poster

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    Brendan, your first reply above summarises my understanding brilliantly. A table paints a thousand words!

    Possibly the sample size of mortgages that met those criteria post 2003 isn't big enough to be used as an argument with external rating agencies? Or maybe the inability to repossess the collateral weighs heavily?
    If you've a contact in the CB they might be able to help with the specifics.