Why do Banks lose Money on Trackers?

[QED]

Might be a stupid question but :-

If a bank paid out €500k in 2006 at +1% Tracker, they have paid all the cash related to this deal and do not need to source this money again?

I assume that the terms the bank received in 2006 allowed them to make money from selling the cash at Tracker +1%.

What has changed in relation to this specific mortgage sale?

 

[Teknon]

Trackers track the ECB base rate currently 2.00%. So in theory the rate you pay to the bank is 3%, however because Irish Banks have been continually downgraded and are considered high risk, nobody will lend to an Irish bank at the ECB rate of 2.00%. They are probably paying around 3% or higher for funds they are lending to you, making no profit and probably a significant loss.

 

[jpd]

In 2006 they borrowed €500k from A (could be a german bank or UK pension fund or French fund) at ECB +0.5% for 3 years to fund a 20 year mortgage. Making a profit of 0.5% on the deal.

However, in 2009 they had to pay back A and when they go to borrow €500k they couldn't find anyone to lend them the money at ECB +0.5% - they had to pay ECB + 1.5% for a 2 year loan. Now losing 0.5%

Roll on to 2011, now they have to find another €500k to pay back 2009 loan - now they have to pay ECB + 5% as no one trusts Irish banks anymore.

Of course, they could sell the mortgage to someone - but no one will buy an Irish mortgage at face value so they are looking a loss either way.

Luckily (for the bank) the government steps in on behalf of the taxpayer and guarantees all loans.

 

[QED]

Thanks - Why did banks not match the term of their borrowing with the term of the loan sold? This would remove a lot of the risk.

 

[tiger]

Part of what banks do is maturity transformation; in this case transform peoples short term savings into long term loans.
http://en.wikipedia.org/wiki/Banking#Economic_functions

 

[jpd]

Not many individuals or indeed businesses would want to tie up their deposit for 20 years, so it would be difficult, if not impossible, to get a long term loan without a bank to transform short term loans to long term loans.

 

[ajapale]

A slight aside:

Trackers per se should not be a problem but rather
A) cheap trackers (absurdly low margins) and
B) tracking a rate which bears no relationship to the cost of money to the institution.

 

[QED]

B) tracking a rate which bears no relationship to the cost of money to the institution.

This is the point I am trying to get to. Are Tracker Mortgages used in other Countries? Who dreamt them up?

Even without the huge Bust, Tracker Mortgages (with low margins) were a huge risk to Banks. Was this point ever raised by Regulators / Central Bank etc.?

Since the taxpayers are paying for these mistakes, there should be discussion around the mistakes made on a day-to-day level as well as the more headline grabbing Billions and Billions loaned to Tradesmen and Farmers who became 'Developers; overnight.

 

[NorfBank]

This is the point I am trying to get to. Are Tracker Mortgages used in other Countries? Who dreamt them up?

In Europe the trackers that were available used Euribor as their base rate but also had higher margins.

In the UK there were trackers on the Bank of England base rate but sensibly they put floors in place e.g. BOE + 2% but could never be less than 4%.

Here we went the other way with a capped tracker from IIB/KBC, e.g ECB + 2.25% but could never be more than 5%.

[broken link removed]

 

[lazing]

Regling and Watson (2010), in their government commissioned review of the Irish banking crisis, highlighted the massive growth in short term bank borrowing as a cause of Ireland's financial crisis. At the end of 2003, the two largest Irish banks (AIB & BOI) had €11.1 billion in short-term securities of 12 months or less remaining duration. By the end of 2006 this had increased to €41 billion. The banks were reliant on benign wholesale markets in order to roll-over such borrowings.
Wholesale markets began to dry up in August 2007. Northern Rock, the UK bank, failed the following month. The heavily indebted Irish banks, operating with very high loan-to-deposit ratios, began to experience liquidity problems. In 2008 these liquidity difficulties deepened, especially around mid-March, when the investment bank Bear Stearns was rescued by the US authorities. By September 2008, short-term liquidity was in crisis, particularly in the aftermath of the Lehman Brothers bankruptcy (Governor of the Central Bank of Ireland, 2010).

So in a nut-shell the Irish banks have a asset-liability mis-match... effectively using short-term money to fund long term positions (i.e. mortgages). The cost of short-term money has shot-up, so when the banks go back to re-finance (or roll-over the short-term money) they are getting squeezed massively... leading to losses on trackers.

 

[jpd]

So in a nut-shell the Irish banks have a asset-liability mis-match... effectively using short-term money to fund long term positions (i.e. mortgages). The cost of short-term money has shot-up, so when the banks go back to re-finance (or roll-over the short-term money) they are getting squeezed massively... leading to losses on trackers.

To be fair, all banks do this - it's a definition of what a bank is - but Irish banks mismanaged their position very badly.

 

[marksa]

To be fair, all banks do this - it's a definition of what a bank is - but Irish banks mismanaged their position very badly.

Not entirely true, all banks do have mismatches, but it is prudent to have a good mix of short (<1year), medium (1-2year) and long term funding. e.g. a regulator may say that a bank has to have a minimum of 35% >1year deposits/funding. The Irish bailed out banks most likely are almost entirely short/medium at this stage.

 

[marksa]

To be fair, all banks do this - it's a definition of what a bank is - but Irish banks mismanaged their position very badly.

Asset-liability mismatch is not the absolute definition of a bank. A licensed bank is one able to take customer deposits, and the function of a bank is to take on credit risk and to seek a significant enough interest rate to compensate for this risk. The Irish banks assumed that mortgage lending was almost free of credit risk, and priced the risk too low. that combined with the previously mentioned comments about soaring short-term funding costs.