News Dan O'Brien

Monday 26 September 2016

The case for mortgage rate cuts at profitable banks is rock-solid

Published 24/04/2015 | 02:30

AIB's outgoing CEO David Duffy with Chairman Richard Pym and Chief financial officer Mark Bourke at the announcement of AIB's full-year results (Picture: Mark Condren)
AIB's outgoing CEO David Duffy with Chairman Richard Pym and Chief financial officer Mark Bourke at the announcement of AIB's full-year results (Picture: Mark Condren)

There is no such thing as a free lunch. It applies to the discussion of what interest rates banks charge their customers and whether the Government should oblige the banks it owns to cut variable-rate mortgages.

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Because everyone has paid for the folly of the banks via the State's multiple support measures over the years, everyone must gain from the payback. Payback will come when the State sells its (considerable) stakes in the banking system. Maximizing that payback must be the top priority.

Forcing the banks to cut mortgage rates would eat into the profits of those institutions which are back in the black. It would make those still in the red even more unprofitable. Any business that is making meagre profits is worth less than one making healthy profits. A loss-making business is worth even less. This means that cutting rates would benefit those with mortgages, but the cost would be borne by the wider taxpayer (because the value of their stake in the banking system would be reduced).

For this reason some have suggested that the government should not tell the management of the AIB and Permanent TSB, which it owns on behalf of taxpayers, to reduce variable-rate mortgages. Instead it should allow the banks' managers fatten profits by as much as possible so that the publicly-owned stakes can be sold for the maximum possible price.

In the case of Permanent TSB, the logic is sound. That institution is still losing money. It failed a stress test last year. It now needs more capital. The State/taxpayer doesn't want to put another red cent into any bank's capital base. As such, the money is being raised from private investors. That is happening right now. If the bank moved to cut variable rates it would become even more unprofitable. That would make it harder to raise the capital it needs and end up diluting the State's stake even more.

This will not be music to the ears of those on variable-rate mortgages with that institution.

AIB, by contrast, is different. And it must have been music to the ears of its variable-rates customers when on Wednesday the bank's boss flagged a rate cut in the months to come. AIB differs from PTSB in a number of respects. It passed its stress test, needs no more capital and made more than €1 billion in profits last year. Because the money it borrows to lend on to customers is now dirt cheap - it pays less than 1pc interest to depositors - it is making very juicy profits.

If AIB cut rates now it would make lower profits. But because there is no urgency whatsoever to offload the bank, a short-term reduction in its profits would have little effect on the ultimate sale value, provided the State's stake is sold off gradually.

There is a very strong case to do just that. Sweden, which nationalized swathes of its banking system in the early 1990s after a massive crisis, only disposed of its last tranches in its banks last year. It took a quarter of a century to secure maximum. The Swedish taxpayer ended up making a profit.

What is stopping the government from simply telling the management of AIB to cut rates today? The short answer is Brussels.

Among the better EU rules are those which curtail governments from subsidising businesses, so that all companies compete on a level playing pitch. But sometimes the rules have to be bent, such as in cases when banks will collapse unless governments take them over. When that happens, strict conditions are set down to ensure that governments don't do foolish things, like pressuring banks to lend to their politically-connected pals. The "relationship framework" that governs the dealings between the Government and the banks it owns curtails the former from telling the latter to do things that would "lead to a prevention, restriction or distortion of competition".

But the variable rates being charged by (profitable) AIB are themselves a result of a lack of competition in the market, as eurozone-wide comparisons of rates prove beyond reasonable doubt. It is hard to see Brussels making a kerfuffle if the government stopped suggesting and starting telling AIB to cut rates. A rate cut would have benefits for the wider economy. Many, if not most, people have yet to see any increase in disposable income. That is the main reason why consumer spending on goods and services in the economy has been among the weakest indicators of recovery.

Putting more cash in people's pockets would add momentum to the domestic economy. That would, among other things, ease pressure for tax cuts and more government spending. Easing the pressure to start splurging again is important because for all the talk there remains a long way to go. Last year, the government borrowed nearly €8,000 million, bringing accumulated debt to over €200bn.

There is no such thing as a free lunch, but lower AIB rates is about as close as one gets.

It should happen sooner rather than later.

Irish Independent

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