Professor Patrick Honohan:

I thank the committee for its invitation to speak on the complicated issue of mortgage arrears. I also welcome the opportunity to explain the Central Bank's policy on other matters that the committee may wish to raise.

My opening remarks will be a bit longer than usual, but the committee deserves and is entitled to that. I have previously discussed with the committee the extremely slow progress that was being made by the banks in arresting the growth in mortgage arrears, processing the cases that had fallen into arrears and implementing sustainable solutions. Things are still not moving as quickly as the Central Bank would prefer; the indications are that the process is working, momentum is building, but there is some way to go.

What is the Central Bank's goal in addressing the problem of mortgage arrears? Its approach has been driven by both of its main regulatory objectives, prudential supervision and consumer protection. The consumer protection goal of fair and reasonable treatment has been targeted through, for example, the CCMA, the code of conduct on mortgage arrears, to which I will refer to later. The mortgage arrears targets have been crafted using the prudential powers, though there will also be a side benefit to the consumer. We have manoeuvred our powers to achieve the results that are needed for the nation. Figuring out exactly how to achieve these important policy goals while working within constitutional, legal and practical realities has presented novel challenges to the Central Bank. Although progress is still too slow, I am satisfied that the approach is correct and is progressively yielding results.

It is almost two years since the Central Bank launched the mortgage arrears resolution strategy which has steadily ramped up requirements on banks to improve their policies, processes and staffing around this issue in order to accelerate results on the ground. In March, as part of this process, and with a view to enhancing measurability of progress, the Central Bank introduced a regime of quantitative targets for ensuring that sustainable solutions are found more quickly for distressed mortgages.

The banks having reported compliance with the first quarterly set of targets and the Central Bank has started the process of auditing a sample of the cases to see whether the solutions proposed by the banks can truly be regarded as sustainable. The internal guidelines under which this audit will be carried out have been finalised and posted on the Central Bank’s website. They have been on the website in draft form for the past three months, but despite our nudging and pointing people towards them there has not been much, if any, public commentary on them. They have been finalised and we are starting to work with consultants on the audits.

The question of what is sustainable is key. In a nutshell, a sustainable arrangement is one which is affordable for the borrower in both the short and the long term, and provides sufficient clarity on what happens to the collateral at maturity. The guidelines seek to put sufficient flesh on this basic concept to allow the criterion to be audited, while not being so restrictive as to prevent innovation in solution design. There is much concern about the initiation of legal proceedings and it is a big part of this exercise. The March 2013 targets document set out three modes of generating a sustainable solution. The first, preferred, type of solution is an arrangement where payments are re-established on the original schedule, if it can be afforded, or an agreed revised schedule. This is a re-arrangement or restructuring. The second mode is where the borrower opts for a personal insolvency arrangement. This was not available to borrowers at the end of June so there are none of these in the first wave. The third mode, available to the bank only where an arrangement could not be reached or is not appropriate, involves voluntary surrender or repossession of the property.

Although each of the banks has reported compliance with the targets for the end of June 2013, it is notable, though perhaps not surprising, that more than 60% of this initial wave has followed the third mode. I have provided committee members with a table showing the aggregate figure and the mix between restructures and voluntary surrender or repossession of principal dwelling homes and buy-to-let properties.

With regard to why the banks have relied so heavily on initiating legal proceedings in the first wave of actions under the mortgage arrears resolution targets scheme, subject to verification in the audit process, it is possible most of these cases involve protracted periods of arrears with limited co-operation from the borrower, notably in providing the information needed by the lender to arrive at a better solution. We have only reports from the banks and are interacting with them to obtain more particulars; we do not have the result of the audit. Up-to-date borrower information provided to the lender is essential if the lender is to design a better sustainable solution potentially not involving repossession. Neither the lenders nor the Central Bank expect repossession will be the preferred solution in the end for most of these cases. In most cases, engagement by the borrower will make the legal course unnecessary. If so, as always the best course of action for the borrower is to start to engage by providing the necessary information to the bank to find out what better course is available.

The Central Bank’s code of conduct on mortgage arrears provides a strong protection framework for borrowers who engage with their lenders. Under the code of conduct on mortgage arrears, lenders are required to engage proactively with their customers to help them address the situation; they must carry out a full assessment of the borrower’s situation based on the standard financial statement and each case must be examined on its individual merits. Lenders are required to explore all their options and where they do not offer an alternative repayment arrangement they must inform the borrower of the reasons for this and what alternatives are available. The code of conduct on mortgage arrears provides that lenders may only commence legal proceedings for repossession only where they have already made every reasonable effort to agree an alternative arrangement. The banks are not simply complying with our targets for sustainable solutions, by law they must comply with the code of conduct on mortgage arrears.

I must stress the Central Bank has no mandate to prevent lenders proceeding to repossession if the borrowers refuse to engage, provided the lender has followed the procedures mandated in the code of conduct on mortgage arrears. Any bank proceeding lightly to legal recourse with co-operating borrowers without satisfying the procedures of the code of conduct on mortgage arrears, or where alternative sustainable arrangements are available, is evidently not acting in a manner consistent with the targets regime. This should be detected through the audit and corrective action would be required.

Let us stand back and ask how household debt has become such a big problem. That household mortgage debt would represent the biggest potential source of loan losses after developer loans was evident from an early stage in the crisis. It was also clear the problem would not emerge all at once, but would grow as distressed borrowers ran through their savings and, to the extent that unemployment was the problem, found it more difficult than they expected to secure a new job. The ultimate scale of the problem has been hard to predict and we did not expect the banks to be so persistently ineffective in getting their arms around this problem and delivering sustainable solutions. The best available sustainable solutions can take several forms. Some merely involve identifying where the defaults are not justifiable given household resources, and such borrowers need to be brought back on track. Others, especially buy-to-lets, may involve a surrender of the property to the bank or its assisted sale, with some sustainable treatment of the shortfall. In other cases, the lender cannot be confident of recovering all of the loan, but can be protected against the risk of forgiving more than is needed by the device of a split mortgage. Other schemes are possible. None of these arrangements is ideal. They generally imply a great disappointment for the borrower and a loss for the lender relative to what was originally envisaged, and I am sure such language is an understatement.

The Central Bank is not empowered, nor could it be, to insist on debt forgiveness for any particular borrower. Relief for an insolvent borrower from indebtedness is determined ultimately through the insolvency procedures for which legislation has so recently been reformed and in a direction which is rightly much more favourable to the insolvent debtor than previous legislation. The Central Bank helped to advise on the drafting of this legislation and has been supportive of its aims. Use of the legislation will be an important means of ensuring over-indebtedness problems, especially those involving multiple debtors, can be resolved. The point of the targets is that it should be possible for lenders to avoid imposing the costs and delays of a personal insolvency arrangement or bankruptcy on many insolvent debtors by coming to sustainable negotiated solutions which are better for both borrower and lender.

There has been much talk about split mortgages. With regard to whether this is the Central Bank’s preferred outcome, various types of solution are possible to deal with a situation where the initial repayment promise looks unsustainable. If appropriately designed, and the criteria have been set out in the sustainability guidelines, a split mortgage can be a sustainable solution depending on the borrower’s circumstances. It can allow the lender to take explicit account of future improvements in the borrower’s circumstances, while providing the borrower sufficient assurance of affordability now and in the future. However, it provides only one of several possible approaches. Banks have begun to experiment with other models which can give them and the borrowers the assurance the repayment will be back on a firm basis. The Central Bank does not advocate any particular solution but it must be sustainable.

The committee mentioned an approach outlined by Ulster Bank, and without going into detail the high-level response is that on the face of it this approach seems to have most of the ingredients needed to be considered sustainable. While the Central Bank has set out its sustainability guidelines, nobody, least of all borrowers, would be served by the Central Bank attempting to place a narrow straitjacket preventing innovation around possible solutions within the guidelines, and the Ulster Bank approach may be an example of this. Banks are beginning to learn from experience the elements which differentiate an ineffective engagement with arrears customers from the kind of engagement leading to an arrangement which is not only sustainable, but is in fact sustained because it matches the borrower’s abilities and motivation. Some banks have gone further than others down this road.

With regard to whether the banks should be doing more to achieve sustainability, despite all of our efforts, and despite real progress in policies, processes and staffing, far too many arrears cases have remained untreated, whether sustainably or not. For example, of 98,000 personal dwelling home accounts more than 90 days in arrears at the end of June, 74,000, or three out of every four, were not yet in an arrangement.

Why have the banks been so slow in acting? It may be, as many have suggested, that the delay in correcting the legislative defect identified by the Dunne judgment represented a delay, although it should not have deterred non-repossession actions. The moratorium, which was enforced by the Central Bank, and the code of conduct on mortgage arrears, CCMA, restrictions, which are designed to prevent harassment by debt collectors, have likely contributed to some delay, but they have also been used by lenders as excuses. In any event, the moratorium and other CCMA rules have been streamlined in such a way as to retain sufficient protections for distressed borrowers - a legitimate and important objective - while generating little or no obstacle to efficiently organised collection procedures. The legislative defect identified in the Dunne judgment has also eventually been corrected, as we had recommended. More important has been the fact that the task required a much more focused and effective organisational effort at scale than the banks at first realised, a deficiency that they have been progressively overcoming - with pressure from us, of course - since we started to audit and critique their procedures more intensively in 2011. This is ongoing in parallel with the targets.

There is also a gap between the analysis of the Central Bank and that of some of the banks with regard to the need for clarity and predictability about the solutions being proposed. The Central Bank wants to be sure that there is sufficient clarity about the arrangement, for example, in regard to the treatment of the borrower's liability for the shortfall in a loan following an assisted sale or repossession or for the warehoused part of a split mortgage. Some of the banks have expressed the opinion that a degree of uncertainty about how these elements will be treated could help ensure that they recover as much as possible. The Central Bank believes the contrary. With such a widespread systemic problem of debtor distress, greater clarity on what is residually owed in these circumstances is safer for the lender - it is also better for the borrower, of course - in guarding against any erosion of the debt servicing culture, as well as helping a broader restoration of household confidence, which will help the wider economic recovery and, through that, boost loan recoverability, which is the banks' concern. In particular, the Central Bank regards as unwise the creation of a situation where, because of such uncertainty, the lender and borrower hold inconsistent expectations about what will be enforced and recovered on a particular loan.

There has been a degree of wishful thinking among some of the banks, a belief that many cases will cure themselves even without energetic action by the lenders. Leaving well enough alone is not, however, an adequate approach. Delay worsens the prospects for both lender and borrower. This truism is now being acted upon more expeditiously. The Central Bank does not have executive or management control of the banks' operations. That must remain the responsibility of the boards of directors of the banks if we are to get this working properly. However, the Central Bank is using its powers to the utmost extent to overcome the delays. The process is working. It is still too slow, but momentum is building.

I look forward to members' questions.