Matthew Elderfield: Banks, we're watching you on debt relief offers
It's a tightrope balancing act trying to safeguard taxpayers and help insolvent borrowers.
Fixing the mortgage arrears problem in a fair and balanced way is one of the biggest challenges facing Ireland.
Discussions about the problem of mortgage arrears tend to be polarised.
Most people see the problem through the experience of friends or relations. Some focus on those who are really unable to service their debts and are on the brink of insolvency. Others have the view that there is a growing number of borrowers who won't pay and who are adopting a wait-and-see attitude. Meanwhile, the vast majority of Irish borrowers do continue to service their loans.
What does a fair and balanced approach look like? The starting point is that Ireland cannot afford to let off those who could pay but are reluctant to do so. Most people resist cutting back on discretionary spending. Some may not want to pay simply because their investment in a buy-to-let has worked out badly. The sums are too big for these to be sufficient reasons to be let off. The taxpayer has already borne a huge burden from bank failure, and cannot lightly take more.
Long-term debt modification involving permanent debt relief is only relevant for cases of over-indebtedness involving or bordering on insolvency.
As one of the world's leading debt relief experts puts it, "Debtors should fulfil their obligations if at all possible, and freedom from legitimately incurred obligations is a privilege, potentially subject to abuse, that should therefore be a carefully guarded last resort."
The new personal insolvency legislation is designed to provide a balanced approach to debt relief for those borrowers who actually are insolvent because they are unable to pay their debts in full as they fall due.
The new framework is not designed to deal with negative equity: this is not in itself a viable rationale for providing debt relief under the law – or indeed directly by the banks. But for insolvent home owners, this new legislative framework has shifted the balance in favour of borrowers, which is welcome and needed. This needs to be factored in to bank decision-making – and also the thinking of other lenders like credit unions.
So, not everyone is eligible for the new personal insolvency framework – just those that are insolvent. And the Central Bank thinks that not everyone who is eligible should need to resort to the new procedures: Banks should put arrangements in place with their customers before it gets to that point. That's why the Central Bank has recently set specific targets for the banks to deal with their customers in arrears. This is designed to break the impasse of short-term solutions, forcing the pace of action from banks and requiring any solutions to be sustainable.
The Central Bank will be looking closely to make sure that the solutions offered are indeed sustainable. The Central Bank's policy has sought, and will continue, to navigate a balanced course, recognising both the need to be careful in the use of the capital that has been provided to the banks at such crippling cost to the taxpayer, and the need for households who are truly unable to support their debts to be dealt with in a fair and realistic manner.
There will be a number of different types of sustainable solution depending on circumstances. In some cases, repossession or voluntary surrender of the home will unfortunately be inevitable as a last resort. But a fair and balanced solution can even be found for many of the toughest cases, avoiding repossession, with imaginative and innovative design from the banks.
In current Irish conditions, especially given how far property prices have fallen, a well-designed debt modification that enables the distressed, over-indebted borrower to keep their home if they want will often be the best attainable solution for borrower, lender and society.
A split mortgage concept with debt servicing conditional on income increases could provide a sustainable solution for a significant number of stressed borrowing relationships, by both (a) removing the threat of imminent bankruptcy, and (b) retaining the potential for economic recovery to reduce prospective loan losses of the banks (and their impact on the taxpayer).
The Governor of the Central Bank, Patrick Honohan, earlier this week set out some of the design criteria we expect to see in split mortgages to ensure they are fair and balanced, providing sustainable relief to borrowers while also avoiding unnecessary costs to the taxpayer.
What is going to happen next on all this? The banks are under deadlines to start offering – and then concluding – sustainable solutions with borrowers. Homeowners in mortgage arrears need to engage with their bank: non-co-operative borrowers lose the important protections of the Central Bank's Code of Conduct on Mortgage Arrears. This means being open about their financial position and, also, being prepared to make some tough changes to discretionary spending. There are no easy solutions, but a fair and balanced approach is possible.