Wednesday 22 November 2017

Hiking rates not as simple as the banks would have us believe

Unlike some of their predecessors, the modern bank executive likes to speak in simple, plain, almost folksy, tones about why certain pricing decisions are being taken. Take the decision over whether to raise interest rates on standard variable mortgages, for instance.

Within weeks Irish Life & Permanent (IL&P) is going to announce a fresh increase in its standard variable rate. This decision has been widely anticipated and even IL&P itself said late last year it was considering additional measures to restore its profit margins, ie, rate rises.

IL&P and other institutions justify the decision by offering up a piece of undeniable logic. The logic is so simple and self-evident that one is taking a risk even trying to theoretically question it. As the bank executives put it themselves, they are paying too much for deposits and taking in too little on mortgages. What could be simpler? End of story. These arguments have been well rehearsed by chief executives in the sector, including Kevin Murphy and others at IL&P.


Proof for this assertion is everywhere, the sector will tell you. Net interest margins -- the difference between interest taken in and paid out -- in Ireland are falling and are far lower than many other markets. For example, IL&P's net interest margin for 2009 is expected to be no better than 85 basis points (0.85pc).

Again, Irish banks are not taking the kind of profit margin out of the mortgage market that their counterparts in the US and UK are. They need to address this or the banks will never return to profitability. What could be simpler? End of story.

But how businesses operate and price their products is not a simple process, as some bank executives would have you believe.

It is in that context that the rate-hiking decisions must be seen and there are certain additional factors borrowers, taxpayers and even disinterested observers should bear in mind when they next hear the banks talking about rate rises.

For example, if mortgage products (and the implicit risk behind them) are not priced correctly, whose fault is that? If banks are forced to aggressively pay over the odds on deposits to balance their books, whose fault is that? Loan-to-deposit ratios in Irish banking have been out of kilter with international norms for years. Again, whose fault is that?

The reason Irish institutions, among them IL&P, are having to be so aggressive on deposits is because they are having to address their runaway loan-to-deposit ratios.

This ratio governs the amount of loans outstanding as a percentage of deposits held, the gap has to be made up via wholesale funding. And boy do the Irish banks have an addiction to wholesale funding.

IL&P's ratio for instance was a whopping 274pc in its 2008 results, and while attempts have been made to bring this down considerably, the issue of loan-to-deposit ratios will dog the Irish banks for some time yet.

Rate rises have to be seen, at least in part, against this background. There is also another reason why Irish banks are having to re-price their variable mortgage products, and this is not something many of them like to dwell on in public.

Thousands of mortgage holders are on trackers, which can only rise when the ECB tightens monetary policy. There is no reliable data on the precise number of these people, but suffice to say there are enough of them out there to cause serious profit erosion for the Irish banks.

The fact that there are so many of them, and they are a drain on the lending operations of the Irish banks, again is a legacy of the Irish banking system itself.

Tracker mortgages

Quite simply, the Irish banks gave out too many tracker mortgages in a short-sighted attempt to grab fickle market share. The drain caused by tracker customers has to be made up, at least in part, by re-pricing on other products. Once more this is not the fault of the borrower, but the fault of the lending officers who extended these mortgages.

Of course it is fantasy to think Irish borrowers can benefit from utopian mortgages rates forever, but the reason the rate-hike cycle is happening now is a little more complicated than the folksy bank executives are letting on.

Irish Independent

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