Thursday 17 January 2019

Richard Curran: 'Banks are not giving us the full story on mortgage rates'

Homing in: Figures from the Central Bank show homeowners here paid an average interest rate on new mortgages agreed in October of 3.06pc, compared with an EU average of 1.77pc
Homing in: Figures from the Central Bank show homeowners here paid an average interest rate on new mortgages agreed in October of 3.06pc, compared with an EU average of 1.77pc
Richard Curran

Richard Curran

Fianna Fáil is back for a second crack at putting a legislative cap on standard variable mortgage rates, having had its last push in this area run into the sand.

It is a noble endeavour. It is based on the premise that greedy banks, facing limited competition in the marketplace, are filling their boots by charging exorbitant rates.

And when you look at the bald figures on how much we pay compared with borrowers in other eurozone countries, it seems like an open and shut case.

Figures from the Central Bank show homeowners here paid an average interest rate on new mortgages agreed in October of 3.06pc, compared with an EU average of 1.77pc.

But there are two problems here. Firstly, are there more complicated reasons the figures are so different? Secondly, if a major rip-off is taking place, would putting a cap on standard variable rates solve the problem or create a new problem elsewhere?

One would have to assume if this was a clear-cut rip-off, then others would be falling over themselves to get into the market here and grab a slice of those super profits.

There are more competitors coming into the market, such as Finance Ireland. Credit unions want to get into it and An Post is seeking expressions of interest from prospective mortgage partners. Yet, the big two banks, AIB and Bank of Ireland, have more than 60pc of the new mortgage market between them.

Those in the industry will argue the rip-off analysis is all wrong. They say the reasons for higher rates here include higher levels of capital that have to be maintained by the Irish banks. They also blame the extent of legacy bad loans and the fact they cannot move on taking collateral (mainly homes) when things go wrong, as reasons they need to charge more.

Davy Stockbrokers last week did a report looking at this area and compared the rates charged here with other eurozone countries. It produced a table showing the average rates charged per country, combined with the risk-weighting assigned to that market. Ireland's headline rates were highest but so too were the risk-weight densities.

According to Davy, "the analysis strongly justifies higher comparable rates in Ireland and although we expect continued new business competition, an elevated spread is likely to endure". The broker also pointed out how ability to access collateral as part of the work-out of loans is another factor. "In Ireland, this process has largely broken down with elongated work-out times evidenced by the increase in the stock of arrears greater than 720 days - this has the effect of transforming what should be considered a highly-collateralised loan into a quasi-unsecured loan."

It is an interesting argument which implies Irish loan foreclosure processes and courts are so sympathetic to the troubled borrower that it is a lot riskier to lend out mortgages in Ireland. The riskier it is, the greater the price that has to be charged.

Then there is a whole other counter-argument coming from banks. Outgoing AIB chief executive Bernard Byrne gave an interview in October in which he "bristled" slightly at the suggestion Irish banks were charging rip-off mortgage rates compared to other EU countries, arguing it was "factually not true".

He said the difference lay with the front book - or new loans - issued in the market, rather than across the whole book, which includes existing older mortgages.

He argued many lenders across the EU offer "teaser" short-term rates before migrating customers to higher ones. He believed this distorted comparisons for AIB in particular where the focus remains strongly on variable rates rather than fixed-term.

So the counter-arguments say lots of things are to blame: greater risks because of the foreclosure policies; having to set aside more capital; legacy loan issues on balance sheets; not comparing like with like because the EU comparators are offering teasers. The list goes on. And the more the list goes on and on, the more you would be inclined to question it.

So what does the European Central Bank say? After all, it is the eurozone regulator with a huge depth of research and information. It also does not want to see bank instability on the one hand or people being ripped off on the other. When ECB president Mario Draghi was in Dublin recently he said there were a number of factors. But when pressed on it by Fianna Fáil's Michael McGrath at an Oireachtas committee hearing, he said: "The big limit here is the presence of a monopoly. The answer there is (more) competition". Mr Draghi did stress historical and current level of defaults in the Irish system were materially higher than most other eurozone countries, which had also pushed up costs.

But why mention the lack of competition if the whole thing can be explained by way of external factors that justify the current pricing levels and do not leave scope for price-gouging or price cuts? By saying competition was a factor, there is a direct inference that if more players operated in the market, there is scope to reduce these rates further. That implies more flexibility on mortgage rate pricing than the industry is suggesting.

Was the ECB president saying something he knew some people might want to hear or was he directly implying that rates could come down further?

By saying competition was a factor, he wasn't saying he would support any kind of legislative cap being placed to protect consumers - I am sure he would totally oppose that. It could create complications across EU banking, make bank investment less attractive and, in turn, increase the cost of capital for banks still bogged down in the legacy bad loans they carry.

As with many things in business, there are logical reasons why companies do what they do, or charge what they charge. But if you want change, you only have to squeeze. It doesn't mean their reasons were not real in the first place but pressure creates change.

By targeting standard variable rates alone, Fianna Fáil ran the risk of simply ensuring banks charged everybody more for other things. Mortgages come down, but car loans, credit cards, business loans or personal credit goes up.

This is a real danger in any proposed solution. This time round Fianna Fáil is talking to the Central Bank about the parameters within which variable rates could be charged based on the factors influencing price at that particular lender, such as capital and balance sheet.

This is a more subtle and less blunt approach than last time. And it may be enough to cause a few wobbles in the sector. Could it put off future investment and competition? Maybe, maybe not.

Fianna Fáil also wants to see an end to upfront cash-back deals on mortgages which are attractive in the short term but can add significantly to the cost of a mortgage in the long run.

In his interview, Mr Byrne didn't exactly give a ringing endorsement to the benefits of such deals for customers and was non-committal on Fianna Fáil's proposal. "It is not my job to eliminate choice in the marketplace, but it is important people really understand what they're getting into," he said. "Sometimes the allure of these products can be quite strong because it looks good in the short term, but it doesn't necessarily work in the long term."

But, by definition, mortgages are a long-term product. I'll say no more.

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