Richard Curran: 'More non-bank lenders needed to spoil the bankers' party'
So you have just landed a mortgage for your first home. You are probably so delighted to get one, that you haven't really thought about whether you are actually being charged a much higher interest rate than you should be.
The average standard variable rate in the State stands at 3.04pc, compared to the eurozone mean of 1.79pc. It is a hefty premium for young couples to pay.
Also bear in mind that interest rates are at historically low levels and a few years down the road, they are likely to increase.
Yet, compared to the past, this seems like a very low rate to pay. It is only when it is compared with other eurozone markets that you begin to smell something a bit off.
The question is why? A report published by the Department of Finance during the week sought to explain why these rates are so high in Ireland. It covers a lot of technical stuff like Risk Weighted Assets (RWA) and capital ratios, but it is produced in a surprisingly accessible way.
It said there are a number of reasons for the gap between Ireland and other eurozone countries which share the same base ECB interest rates. These include the amount of capital banks in Ireland have to hold against a mortgage, the cross subsidisation of trackers and the risks associated with the mortgage.
There are systems in place for measuring RWA and there are strict rules about how much capital must be held. For example, the risk deemed to be attached to an Irish mortgage is typically double or triple what it is for a similar bank elsewhere in the eurozone.
The report's authors estimate the amount of equity needed to support a mortgage today is probably five times what it was in pre-crisis times, so nearer to €5 rather than €1 on a loan of €100.
How come, given that the economy is growing, we are approaching full employment and house prices are rising?
It is because of the long reach of the crash in the past and the difficulties, time and cost of recovering the security on the loan (ie the house) in Ireland if things go wrong.
There is a rigid system for determining the risk associated with mortgage lending. The fact that there are still high levels of non-performing loans and the crash itself having been so enormous and that long ago, are all factors. So when examining the probability of default in the Irish market, the legacy and stench of the crash still hangs in the air when it comes to quantitative methods for determining the risk weightings for the banks.
Take AIB, for example. It had a performing risk weighting of 15pc in 2008 - clearly too low given what happened. In 2013 it was 33pc and in 2017 it was 27pc.
The report traces the impact of risk weighting on what a bank charges for a mortgage and how much profit it makes from it.
Bank A and Bank B both give out a €250,000 loan. The RWA percentage for Bank A is 38pc and for Bank B it is just 15pc. Bank A needs to set aside €12,350 in capital for that loan while Bank B needs to set aside just €4,875.
This means for Bank A to make a return on equity (ROE) of 12pc it will charge 2.5pc interest on the mortgage, but Bank B can make a return of 12pc by charging just 2.1pc. If Bank B charged the same 2.5pc as Bank A it would make a return of 31pc.
The problem is that all of the banks operating in the Irish market were bunched by the crash and those which remain are restricted by the RWA and capital rules. Some have a slightly better RWA percentage than others, which gives them a little more pricing flexibility.
So how and when does this change or are we doomed to pay excessive interest rates forever more as a punishment for the mistakes of the past?
According to the report, the bad news is that it isn't likely to change any time soon.
The further the banks put the crash behind them the lower their RWA will become as they free up their balance sheets of bad loans and put a sustained period of solid low-default lending behind them. So it should get better, but not any time soon.
The report sheds a lot of light on the factors that influence why new mortgages are so expensive in Ireland. But it doesn't give us the full picture. For example, it refers to the cross-subsidisation of older trackers mortgages as contributing.
Finance Minister Paschal Donohoe picked up on this very small element of the report when he referred to it as contributing to high mortgage rates.
However, the banks don't seem to be losing money on their trackers anymore. Around 40pc of the market is trackers, but banks are no longer losing money on them. PTSB has said it is making around 1.1pc on its trackers.
The main thrust of the report's explanation is around the risks associated with the Irish market and how they are quantified into formulas that determine the amount of capital that has to be set aside.
The biggest problem is squaring the findings of the report, which appears to provide an explanation which justifies the high charges, with the comments of the head of the European Central Bank, Mario Draghi when he was in Dublin last November.
He said the Irish banks were operating a "quasi-monopoly". What does that mean? It clearly suggests that due to the lack of competition in the market here, banks are charging more than they would if there was more competition.
The Department of Finance report points out that in 2007 there were nine banks providing mortgages in the Irish market and now there are only six.
I interviewed Central Bank Governor Philip Lane at an event in Letterkenny during the week and suggested there was a contradiction in the Department of Finance attributing higher interest rates to entirely justifiable factors, while the head of the ECB says it is a "quasi-monopoly".
Mr Lane said he didn't see it as a contradiction but suggested that one flows from the other. In his view the various historical and regulatory reasons behind the higher rates deter new entrants, which then lead to the "quasi-monopoly".
But there is only one question behind all of this. Are the banks ripping people off by charging over and above what is a reasonable rate of return? If they are charging above the rate that is justified by the various risk factors etc, then we are all losing out.
The department's report does not provide us with the element of the pricing that is over and above the regulatory and historical factors underpinning it. In other words, what is the "quasi-monopoly" extra bit?
It does suggest that return on equity among Irish banks is high but by no means the highest.
So, we should be ripe for a new retail bank entrant to the market. The report finds any new bank entrant that might want to enter the Irish market, would still have to hold capital that is determined by its RWA which can be calculated by its own internal rate or by applying standardised risk weight measures.
The report's authors predict that a new entrant will have to wait at least five years before it receives the necessary approvals to work off its own internal (IRB) models. They say that a key driver for this is the historic credit performance of Irish mortgages.
Either way, new retail bank entrants to the market would be tied into high risk weightings for at least five years.
Non-bank mortgage providers escape these restrictions. That is why we are seeing the likes of Finance Ireland, credit unions and An Post getting into mortgages.
It seems they have a very important role to play.