Dr. Martha O'Hagan-Luff:

I thank the Chairman and members for the invitation to present to the committee this morning. Specifically, I was asked to consider the potential benefits and risks of selling non-performing loans to private investment funds. As we know, many years after the financial crisis Irish banks continue to have very high ratios of non-performing loans to assets. Although the ratio has fallen from a high of 32% to just above 11%, it is still very high in comparison to the European average of 4.6%, and is one of the highest in Europe. This remains a source of vulnerability facing the domestic banking system. For the banks holding non-performing loans, this reduces their profitability, increases their funding costs and ties up bank capital, which has a negative impact on the supply of new credit and borrowing rates, and ultimately creates a drag on economic growth.

Many measures have been implemented in Ireland to reduce these ratios, one of which is the sale of non-performing loans to investment funds. The volume of distressed loan sales in Europe remains very low compared to the US market, but has begun to increase in recent years. A private investment fund can only raise funds from qualified and accredited investors. It cannot solicit funds from retail investors or from the general public. Such funds' regulatory and legal requirements are much lower than for funds that are accessible to retail investors, and this gives the funds greater freedom in how they handle aspects of their business. They have a very different business model from retail banks. Their time horizon for return on investment is relatively short and they seek higher short-term returns in contrast to the lower long-term returns sought by banks. I have been asked to outline the pros and cons, as I see them, of banks selling non-performing loans to private investors. These loans may be commercial property loans, business loans, buy-to-let or residential mortgages.

I will first outline the potential benefits. Allowing the sale of distressed loans to private investment funds may facilitate debt restructuring to be done more actively and more efficiently. Private funds will have greater flexibility in the resolution of non-performing loans. In the case of a renegotiated loan involving the voluntary surrender of a property, private funds will have more freedom to allow debt forgiveness on the outstanding loan, which is difficult for banks to do. In this scenario, it is possible that customers may be able to negotiate a better deal with a fund than they would be able to do with a bank. Finally, private funds can offer badly needed liquidity to banks for non-performing loans, which is not otherwise available.

However, there are also risks. Loans may be sold too cheaply. This will depend on how much liquidity exists in the market and this will be for banks to negotiate. There are concerns around consumer protection. As the private investment funds are unregulated, they do not fall under the remit of the Central Bank. However, under legislation introduced in 2015, if loans are sold they must be serviced by a credit servicing firm, which must be authorised and regulated by the Central Bank. As such, it will be subject to the same consumer protection legislation as banks. However, even when consumer protection regulations are adhered to, there may still be reputational risk for banks if funds are perceived to be acting aggressively or unreasonably with their former customers.

Finally, there is a potential risk of an increase in forced repossessions, although there has been little evidence to support this to date. Research by the UCC economist, Mr. Seamus Coffey, has shown that the rate of repossessions of family homes and buy-to-lets in Ireland is extremely low compared to our EU counterparts. At the time of his report, Mr. Coffey found that since 2010 repossessions accounted for only 1.4% of mortgages and the rate of repossession by private funds was lower than that by banks.

While it is essential that the most vulnerable in society are protected through schemes such as the mortgage to rent scheme and that high standards of consumer protection are ensured, I will conclude by summarising what I see as the risks of not resolving the issue of high levels of non-performing loans in Irish banks. It delays the resolution of non-performing loans with borrowers. It creates an issue of moral hazard around mortgage repayments, by which I mean that there is less incentive for current and future borrowers to abide by the terms of a contract if the contract is unlikely to be enforced. Secured lending is not secured in reality if repossession continues to be such a lengthy and difficult process and this risks creating a dysfunctional mortgage market. This would lead to a lower supply of new credit and higher interest rates than would otherwise be the case for the market as a whole in the future.