Ali Ugar: 'Banks have to be sustainably profitable to support the Irish economy long term'
Dan O'Brien is right to say mortgage rates are high but we need to understand why this is so
There is no disputing Dan O'Brien's assertion that average mortgage rates in Ireland are among the highest in Europe (Sunday Independent, July 21).
However, we need to understand why this is so in order to see how these rates can in time become more competitive relative to other countries - notwithstanding the competitive forces at play.
The fact is Ireland is also at or near the top of the European table for the amount of capital which mortgage lenders have to hold for each and every new mortgage loan they make. In effect, this means that lenders here have to hold €50 for every €1,000 they lend out in mortgages compared to a European average of just €16. The more capital they have to hold in this way, the more it costs them to make those loans.
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Another fact: Ireland is also at or near the top of the European table for the length of time it can typically take a lender to repossess a property: some 42 months here compared to the UK (18), Denmark (18), Norway (18), Sweden (18), Finland (24), The Netherlands (24), Austria (30) and Germany (30), for example.
Again, lenders here are faced with higher costs than lenders elsewhere in Europe. Furthermore, this creates uncertainty in enforcing collateral for a product which is intended to be based on secured lending.
Another fact: Ireland has one of Europe's highest levels of mortgage arrears. In addition to presenting overindebted borrowers with untold difficulties, the cost to lenders here of addressing this has been and remains considerable relative to their European peers.
These are key factors which impact on mortgage pricing for existing lenders; and, just as important, they impact negatively on the thinking of potential new market entrants. Addressing these factors would facilitate the intensification of competition which would be welcomed by all.
Nor is there any disputing Dan O'Brien's assertion that the profits of Ireland's banks compare well with the eurozone average.
But again, we need to understand how good or otherwise that eurozone average is in order to properly judge the relative performance of our banks.
The supervisory arm of the European Central Bank (ECB) has been highlighting weak bank profitability as a key risk for the euro area's financial stability. Supervisors argue that profitability allows banks to be in a better position to provide adequate and sustainable funding to the real economy as well as build up their capital bases which can act as a first line of defence against unexpected shocks in the future. In addition, low profitability can incentivise banks to take on riskier lending or trading activities in order to generate higher returns.
ECB data shows that, as of the first quarter of 2019, the return on equity for banks in Ireland supervised by the ECB has been 6.18pc compared to the eurozone average of 5.76pc. So, yes, our banks lie above the eurozone average.
At the same time, the ECB estimates the cost of equity for banks - which is a measure of the risk associated with the sector and the return required by investors - to be 8pc to 10pc.
In effect, what the ECB is saying is that banks' return on equity needs as a minimum to be in this 8-10pc range if they are to be sustainably profitable. Banks in Ireland are simply progressing towards the range of where ECB believes Europe's banks need to be in terms of sustainable profitability.
Furthermore, as detailed in the chart, the average return on equity for the 120 largest banks (blue line in chart) in the eurozone conceals differences between the top performing banks (yellow line) and the poorer performing ones (brown line).
A recent Central Bank of Ireland study argues that the profitability of the banking system in Ireland should not merely be a concern for shareholders as bank profitability underlies both financial stability and economic growth. It is particularly important for the sector in Ireland which received taxpayer support to have viable business models delivering sustainable profits so that these banks can pay back the taxpayer fully and the State can make a return on the support it provided during the financial crisis.
A significant portion of profits generated during the past few years within the Irish banking system has been retained. This has helped banks to have strong capital bases, which is on average twice the level of capital held by eurozone banks.
This strong capital base should help banks to continue to provide credit for firms and households.
It is important to recognise that a sustainably profitable banking sector, based on viable business models, is vital in supporting the Irish economy over the long term as well as in attracting new entrants to the market to further increase competition.
Dr Ali Ugur is Chief Economist and Head of Prudential Regulation with Banking & Payments Federation Ireland (BPFI), the representative body for the banking, payments and fintech sectors.