Rate environment tips market in favour of banks

Jon Ihle

Bank of Ireland is largely funded by deposits

Francesca McDonagh, Bank of Ireland CEO

March 17 2022 02:30 AM

Something unusual is happening to mortgage rates right now that could complicate the delicate competitive balance in the Irish financial sector.

ICS, a non-bank lender run by Dilosk, became the first in the market to raise some of its rates this week, anticipating a probable increase in European Central Bank rates by the end of the year.

Yet ICS’s former owner Bank of Ireland moved in the opposite direction on Tuesday, announcing cuts to its green mortgage product. Qualifying borrowers can now get financing for just 1.9pc.

What accounts for the difference?

ICS and other non-bank mortgage lenders like Finance Ireland raise funding in the bond markets by borrowing against the cash flows from the mortgages they’ve already written.

But the premium investors want for buying those debt securities has risen as markets price in future rate hikes. Indeed, the Federal Reserve and Bank of England have already started their hiking cycles.

Bank of Ireland, by contrast, is largely funded by an abundance of customer deposits, which essentially cost zero. Banks also have access to virtually cost-free ECB funding, too. Hence, the ability to cut prices even into a tightening interest rate environment.

One consequence of this divergence is that non-bank lenders, which have been a growing force in the Irish mortgage market in recent years, may find themselves becoming less competitive than the banks, at least until the ECB moves.

Even then, it could take several interest rate increases before the gap closes and some semblance of competitive balance is restored.

Ironically, that could turn out badly for Bank of Ireland as the Competition and Consumer Protection Commission (CCPC) reviews its proposed acquisition of KBC Bank Ireland’s €9bn in performing mortgage assets.

Last month the CCPC issued a preliminary assessment of the transaction in which it is understood to be seeking market opening measures from Bank of Ireland that could include the bank selling a portfolio of mortgages to a non-bank.

The competition concern is that Bank of Ireland is buying stock but not flow, meaning the capacity for new lending in the market will decline once the deal goes through.

Seeding a non-bank lender with a chunky book of loans could help offset that issue by diversifying the lending market and giving customers – who increasingly are using brokers to source loans – another option.

But if the non-bank lenders can’t match the prices those customers can get from a bank, it’s hard to see how this remedy sets things right for the CCPC, which is most concerned about credit constraint.

We could be left with a situation where Bank of Ireland, AIB and Permanent TSB are able to gobble up more market share, even with more competitors in the market.

If that scenario comes to pass, it would be welcome news in a way for Finance Minister Paschal Donohoe, who wants to dispose of the State holdings in the domestic banks.