Oireachtas Joint and Select Committees

Thursday, 28 May 2015

Joint Oireachtas Committee on Finance, Public Expenditure and Reform

Overview of the Banking Sector: Central Bank of Ireland

2:00 pm

Photo of Aideen HaydenAideen Hayden (Labour)
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Apologies have been received from Senator Marc MacSharry. I welcome Professor Patrick Honohan, the Governor of the Central Bank of Ireland. Professor Honohan has appeared before the joint committee many times and we are pleased to welcome him again, perhaps for his final appearance. The format will be that Professor Honohan will make some opening remarks, after which we will have a question and answer session.

I remind members, witnesses and those in the Visitors Gallery that mobile telephones must be switched off. I advise witnesses that by virtue of 17(2)(l) of the Defamation Act 2009, witnesses are protected by absolute privilege in respect of their evidence to the committee. If they are directed by the committee to cease giving evidence on a particular matter and they continue to do so, they are entitled thereafter only to a qualified privilege in respect of their evidence. Witnesses are directed that only evidence connected with the subject matter of these proceedings is to be given and are asked to respect the parliamentary practice to the effect that, where possible, they should not criticise or make charges against a person, persons or entity by name or in such a way as to make him, her or it identifiable. Members are reminded of the long-standing parliamentary practice to the effect that they should not comment on, criticise or make charges against a person outside the House or an official by name or in such a way as to make him or her identifiable.

I invite Professor Honohan to make his opening remarks.

Professor Patrick Honohan:

It is just six months since I last had an opportunity to engage with the joint committee. On that occasion, my introductory remarks focused on three main areas, namely, the macro-prudential measures on which the Central Bank of Ireland had just published a consultation paper; the transfer of ultimate responsibility for the micro-prudential supervision of the main banks to the single supervisory mechanism of the European Central Bank, which had just taken effect; and the level of mortgage interest rates, which was already attracting increasing attention from the Central Bank given its consumer protection mission.

In the intervening period, as members will be aware, the Central Bank concluded its macro-prudential consultation and introduced the calibrated loan-to-value and loan-to-income restrictions for mortgage lending. We will continue to monitor the impact and effectiveness of these and we are not dissatisfied with subsequent developments in that market.

The European Central Bank's new micro-prudential regime for banks is settling in well. The transition has been smooth, as has been exemplified by the results of the ECB's comprehensive assessment of the banks at entry, which confirmed the merits of the asset quality review previously conducted by the Central Bank of Ireland. The modest additional capital requirement for Permanent TSB, which was triggered by the higher capital standard set in the European Central Bank's comprehensive assessment, has since been raised in the private market.

The concerns I expressed around the standard variable mortgage rate in November last foreshadowed a wider public focus on this issue, reflecting the widening spread between Irish mortgage rates and those in many other parts of the euro area. The Central Bank has conducted a good deal of research on the topic, some of which it had previously published, and a summary of it was included in the document which was prepared at the request of the Minister for Finance and published last week.

Since the crisis, banks' standard variable rates have moved higher than previously, relative to their cost of funds and, arguably, higher than a fair-minded customer might have reasonably expected. While this development was manifest in a number of eurozone countries, the divergence has become particularly large in Ireland. Is this compliant with the contract that the customers signed? Is it consistent with good business practice on the part of the banks for the long-term relationship? Is it good for the overall recovery of the economy on which the banks depend for their long-term success?

Admittedly, it is essential for the survival of banks that they achieve a sufficient return on the investment of funds, including equity, much of which, in our case, is owned by the Government. If not, they will not be able to achieve and maintain the growing requirement for capital adequacy in the years ahead. The profitability goal has to take account of long-term considerations, including the risks involved in lending, especially the actual and prospective losses on non-performing mortgage loans. Nonetheless, I would welcome a reduction in bank standard variable rates in current circumstances as a benefit to the economy at large. If it were not for the firm conviction that the introduction of administrative control on interest rates would be bad for the country as a whole in the medium term, there could be a case for some Government intervention. Why would intervention be bad for the country as a whole in the medium term? The two notable reasons are that it would have a stultifying effect on bank efficiency and a chilling effect on the entry of other banks.

Let me say something about the standard variable rate type of contract, which was the mainstay of Irish mortgage lending for decades. This type of contract had the advantage of being adjustable in response to changing conditions and, as such, insulated the lender from sharp rises in the cost of funding. For example, it avoided the devastating squeeze on profitability that occurred in the United States, resulting in the insolvency of a large part of that country's savings and loans industry in the 1980s. However, the wording of most standard variable rate contracts means that borrowers are vulnerable not only to changing funding costs, as they will recognise when they take out the mortgage, but to many other types of influence which the lender judges to warrant a change in rates.

The standard variable rate was increasingly replaced for new lending by the tracker mortgage, especially in the boom. This much more tightly defined interest rate contract protected the borrower against any interest rate changes other than those occurring to the European Central Bank policy rate. This is a rate at which the ECB lends a small amount of the funds required by euro area banks and which is adjusted to help ensure the ECB meets its monetary policy objectives, principally with regard to inflation in the euro area. Whereas in the pre-crisis period the Irish banks were easily able to secure deposit and bond funding at close to the ECB policy rate, their ability to do so since the crisis has been constrained, to say the least, although it has been improving recently.

Arising from this constraint and inability to fund at close to the ECB policy rate and because the spreads they set above the ECB rate were too low to cover the loan losses that were to come, the tracker contract has been extremely costly for the State and the other shareholders of the banks. For this reason, the banks stopped offering tracker mortgages. Looking to the future, a different or new contractual arrangement that linked the floating rate on new mortgages to actual funding costs of the banks could be designed in such a way as to achieve the original aims of the tracker without retaining the vulnerability of the ECB policy-rate linked tracker. Of course, the spread would have to cover the costs and risks of lending, which includes prospective losses, but such contracts are not currently offered.

Given the wording of the standard variable rate, SVR, contract, I assume that borrowers agreed to those terms largely because they trusted the banks to behave in a fair manner with regard to interest rate adjustments. For decades, it seems that this trust was, by and large, not misplaced. Is this still the case? There is clearly justification for some of the increase that has occurred in the spread, which was too low in the past. Relevant factors include the persistent drag on their viability from the combination of a large tracker book and the fact that funding costs are much higher than the ECB policy rate; the dramatic increase in non-performing mortgage loans and the need there has been to make large provisions against loan losses; and the sharply increased capital requirements on banks. All of these have threatened the viability of mortgage lending for the banks. In a general way, defenders of the banks can point to these factors as providing some justification for higher spreads on standard variable rates. Still, such arguments are rather open-ended and, in the absence of a transparent, clear and quantified policy on the part of the banks, can be seen as excuses for charging whatever the market will bear rather than being a fair application of the contract consistent with a borrower’s reasonable expectation. Under these circumstances, the standard variable rate borrower’s main protection is competition: the fact that, by setting its standard variable rate too high, any bank stands to lose business, whether new business or switchers, to competitors. Whereas this protection was effective before the crisis, the level of competition currently is too low. Ensuring that official policy does not inadvertently deter competition and entry of banks to the market is thus vital for the long-term health not only of banks, but of the economy.

The Central Bank wrote to each of the banks in February to ask for a clear statement of each bank’s pricing behaviour around standard variable rates. In their responses, none of the banks has so far provided what I would regard as a clear and quantified statement of their policy with respect to adjustments of the standard variable interest rate. In my opinion, good business practice of the banks would demand that they make upward adjustments to standard variable rates only following clear and objective changes in prevailing business conditions and not only funding costs. Good practice would also call on them to lower standard variable rates when the same conditions move in the opposite direction. That is the implicit element of the contract. To regain the trust of their customers, the banks should move to publishing a clear and quantified statement of their standard variable interest rate policy. Since they do not seem to have such a policy, they will need to develop one. If necessary, drawing on its legislative powers for consumer protection, the Central Bank will codify such a requirement formally but this should not be necessary. I have spent some time on that contractual issue as it is a dimension that has not been sufficiently discussed.

Insisting on transparency may seem to be an insufficient official response to the manner in which the spread of standard variable rates has drifted up but I would insist on my words of caution against the enacting of legislation that would provide for officially administered lending rates. Nothing could be more likely to curtail and discourage entry of new competitors into Irish banking, and without the possibility of such entry, I cannot see that banking can recover the operational efficiency and competitive pricing that is essential for Ireland in the long run. For the sake of modestly lower SVRs for a few quarters, a much larger and quasi-permanent, albeit somewhat invisible loss, would be incurred by the customers of the banking system in Ireland. Well-capitalised banks operating more competitively will, in the end, offer lower rates and better service. Besides this, close administrative control of interest rates would not be easily compatible with the principle of an open market economy with free competition, which has underpinned the considerable increase in national prosperity over the past half century in Ireland, and which, of course, is enshrined in the European Union treaty. This is not a matter to be taken lightly or opportunistically for what would clearly be at best a transitory advantage.

The health and ability of the banks to contribute to the needed services to the economy certainly requires them to operate on a profitable basis, and only then can they build and hold sufficient capital to be compliant with international regulations, to be fully financially autonomous and not dependent on an implicit backstop of the State, to have the resilience to deal with future shocks and to serve customers properly. Their recent return to profitability is modest and significantly dependent on provision write-backs rather than normal business profitability. I do not want to overstate that, and that should be seen and compared with the provisions that were there before.

The crisis continues to have serious legacy issues that cannot be resolved easily or painlessly. To mention just one example, ensuring that borrowers whose loans have been sold to unregulated firms continue to obtain the consumer protections that they previously had is a concern which the Central Bank has been to the fore in advocating action. I am very glad to see this being reflected in legislation, on which the bank has actively advised, currently being enacted by the Oireachtas. Without detracting from the importance of what I have mostly been addressing today, the appropriate pricing on the SVR loans, I should not conclude without emphasising that delays and uncertainties surrounding the resolution of non-performing loans remain a much more acute problem. The latter problem is one which we have discussed in this committee repeatedly and on which progress remains damagingly slow.

Photo of Seán FlemingSeán Fleming (Laois-Offaly, Fianna Fail)
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I will pose a few observations as questions. I will not get all of them done in ten minutes so I may have to come back a second time, depending on how many people wish to contribute. Professor Honohan is saying we need competition as the main protection for the economy. The idea is it is the best way to bring down rates and ensure we have a proper and satisfactory banking system to service the economy. He is essentially saying that the banks we have in Ireland will not be adequate for a growing domestic economy. Several times, he spoke about the need to get new competition and new banks into the system. Implicit in that kind of remark, which he made on several occasions, must be his belief that the current banks will not be adequate. Will Professor Honohan comment on that?

Part of what led to the financial crisis in Ireland was the very type of competition that Professor Honohan is now espousing. Bank of Scotland came here to open as the Ryanair of banking, and other banks followed; the herd chased those banks. If that is what Professor Honohan is espousing here as a solution - foreign banks coming in to bring more competition in the market - has he learned nothing? I am surprised at the tone of some of his comments. We have learned but I do not think others have learned. I am concerned about that.

Professor Honohan spoke about several issues but I will try to keep on the same topic at the beginning. He mentioned how profitability in the banks is modest and profitability in future will depend on the provision of write-backs. Representatives of the banks mentioned this when they were here in the past few weeks. They have all stated how bad were the loan books.

In fact, much of the profit the banks reported in the past year has comprised a write-back of money previously provided.

What Professor Honohan is actually saying is extraordinary. He is saying a key component of the profitability of banks in the future will be an acknowledgement that they overstated how bad circumstances were in the past and over-provided. By definition, by over-providing they had a bigger hole in their balance sheets which the taxpayer had to fill. If Professor Honohan is now saying that the banks sold the taxpayer a pup in some regard and circumstances were not as bad as the banks informed him and this committee, why did he not challenge the banks on what he is now saying involves write-backs of over-provisions? Professor Honohan presided over the over-provision. I know he will say that this was a prudent approach at the time, but he is now acknowledging the write-backs that he probably insisted upon in general across the banking sector were too severe. He is now saying a key element of profitability in the future will be writing back his over-provision. I am just concerned about this area and the point to which Professor Honohan referred.

I have a question for the Governor on the new legislation he mentioned. We dealt with it on Committee Stage last night. Does the Governor agree that, when mortgages are sold off, the new owner should be regulated by the Central Bank? There will be an intermediary or the service debt agreement, or whatever, and the intermediary will serve as the local agent interfacing with the customer and taking him to court, but the owner of the mortgage is the one with which I am concerned. As the Governor knows, the legislation does not require the owner to be regulated by the Central Bank. Does he believe it is satisfactory at this stage that the banks can still sell off bundles of mortgages, or thousands of mortgages, to institutions that do not have to be regulated, while the Central Bank just regulates the gormless, harmless agent that the institutions operate through in Ireland? What are Professor Honohan's views on that?

Professor Honohan is very strongly against legislation to deal with rates because he believes the god of competition who caused the problem the last time will solve it for him. He is saying the real answer to reducing rates in the longer term is to have more competition in Ireland. We acknowledge competition brings an inherent risk, but Professor Honohan has not addressed this inherent risk in anything he has said. He outlined in his statement that administrative controls of interest rates would not be readily compatible with the principle of having an open-market economy with free competition. We do not have an open-market economy in the banks; we nationalised them all. How could Professor Honohan even talk about our having open-market free competition in the banking sector? He said somewhere else in his script that we own most of the banks. We still own AIB and Permanent TSB and have a share in Bank of Ireland. The list goes on. Professor Honohan would throw out competition in every other sentence as a panacea, but he is not acknowledging it is not relevant in the market we are in. The two main banks are controlling the market we are in. Perhaps because of the level of control, there is a stronger case. I agree that when we have five or six banks acting responsibly in the Irish mortgage market, there might be a case for some of what Professor Honohan says.

The last point on which I want the Governor to comment, and on which he might have commented the last day, is the issue of quantitative easing. What led to the crisis here was over-lending and over-borrowing. That is the essence of what quantitative easing is. It concerns the banks that were making and lost all the money, and who want to get back to the old way of lending money right, left and centre. How much money will quantitative easing provide in terms of additional borrowing on the backs of businesses and households? Given that our economy is picking up and growing well, as everybody tells us and as every official report states, do we need a massive influx of extra lending in the system, with businesses and households taking on a massive amount of extra debt?

Professor Patrick Honohan:

I thank Deputy Fleming for those great questions. I like the way they are framing the situation. The Deputy is absolutely correct that the system is very far from what one would imagine to be an open, competitive banking system. We have a system that is not entirely Government-controlled because there are a number of other players. The Government has only a small stake in Bank of Ireland but it would still be there in the background if all the provisions did not prove to be adequate. I do not believe that is where we want to be because it is not healthy. Even in electricity production, there are certain entities that are natural monopolies. They just get so big because of the technology that there cannot be more than one of them.

Photo of Seán FlemingSeán Fleming (Laois-Offaly, Fianna Fail)
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We have moved on.

Professor Patrick Honohan:

In the electricity sector, we created more competition. In some circumstances, technology is such that there are only one or two players, and therefore there has to be regulation on pricing. That is understood. If we were satisfied with the current circumstances and said it would be satisfactory to have two banks, two and a half banks or three banks here, all largely State-controlled, into the indefinite future, we could start to design a system around that. I do not believe that will work well, and I do not know of other countries where it has worked well. I want us to return to circumstances where there are five or six players - the Deputy will probably not like the word "players" because of what it suggests - that are competing but not over-competing.

We all know finance is not like selling groceries; it actually involves making commitments for a period of time and taking decisions whose consequences will evolve only over time. That is why there can be too much competition as well as too little. I fully acknowledge that, and that it is part of the story. At least some of the bankers of the past say, "Oh, well, somebody was eating my breakfast so I had to do something else". It is only part of the story, and to some extent that is why one needs to have boards of directors and scrutiny of rating agencies, auditors and regulators. We need to have a lot more competition than there is now, but that competition will be tempered by checking the prudence of what is being done. By reducing the thinking to the slogan that competition is bad, one must ask what is good. Monopoly is obviously not, so it is a question of having much more competition than we have now and of having that competition tempered by prudence.

We have a number of banks here, not just two. Permanent TSB is not really a full-service bank. We have foreign-owned banks here but some of them are more competitive than others. There is not much competition; nobody is going to deny that. I am not saying it is particular banks that are insufficient but that we need to be open to entry. When we are open to entry, perhaps a new bank will not come in. Perhaps it will shake up local banks against the threat of entry. Owing to European and international weaknesses in the banking system, there has not been much consolidation of banking worldwide. Not many European or international banks are wondering where they will open next and considering Ireland in this regard. This has not been happening. One reason, which is pretty important for this committee to bear in mind and which members would hear on talking to any of the bankers here or abroad, concerns the mortgage arrears rate, the very high number of non-performing loans. Bankers will say they are not sure they want to get involved in a banking market in which it seems very difficult to recover on a "delinquent loan", as they would call it. This is one significant reason we are not getting as much competition as we would have got had we had managed to sort out the arrears. We need to keep paying attention to this. There are all sorts of reasons to have the mortgage arrears problem fixed.

Photo of Seán FlemingSeán Fleming (Laois-Offaly, Fianna Fail)
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Professor Honohan personally opposed targets of mortgage arrears that the Minister was talking about here a couple of years ago. I was sitting in front of him when he stated he did not agree with the statistics and targets of 5% and 10%, or whatever.

Professor Patrick Honohan:

I remember the occasion.

Photo of Seán FlemingSeán Fleming (Laois-Offaly, Fianna Fail)
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Those are Professor Honohan's words.

Professor Patrick Honohan:

I remember the occasion and saying we would introduce them but that I did not believe they would be as effective as many people thought. I still hold to that view. It was more a question of giving the matter a high profile. As the Deputy knows, we had been working for 18 months before that but we actually had been working for 18 months before that - it should arguably have been 24 months - to get the banks to a position in which they could credibly do some stuff. They have addressed some issues. We have talked, and may talk later, about how the system is getting us down the road and doing a lot of good but not delivering the full goods at the speed we would like.

Photo of Aideen HaydenAideen Hayden (Labour)
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I must alert Professor Honohan about the time.

Professor Patrick Honohan:

I could go on all day. That is the danger, which I recognise.

Photo of Aideen HaydenAideen Hayden (Labour)
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Deputy Fleming will have an opportunity to come in.

Professor Patrick Honohan:

Deputy Fleming asked about the new legislation and the question of this covering only the intermediaries. I would say that I regard that as a good first step. I am sure that if it is proven that controlling the intermediaries is insufficient, we can have a second bite at this. The intermediaries are the front end so I am very glad to see that done anyway.

Will I say something about quantitative easing or will I come back to it?

Photo of Seán FlemingSeán Fleming (Laois-Offaly, Fianna Fail)
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Come back to it later. Give the others a chance.

Photo of Pat RabbittePat Rabbitte (Dublin South West, Labour)
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If this is Professor Honohan's last meeting, I think we should record our appreciation. He has done the State some considerable service since his appointment and it would be appropriate for this committee to acknowledge that. Professor Honohan made reference to the tracker contract being uniquely expensive to bank shareholders. That is obviously the case. Why has it been so costly to the State?

Professor Patrick Honohan:

I was referring to the fact that not only were the shareholders wiped out, but the State had to come in and become a shareholder and this relates to profitability going forward.

Photo of Pat RabbittePat Rabbitte (Dublin South West, Labour)
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Professor Honohan also said that if legislation had to be contemplated, it would in all probability have only a modest effect on standard variable rates. He mentioned a timeframe of a few quarters. Does this mean that the Governor of the Central Bank envisages that after a few quarters, interest rates will go in a certain direction?

Professor Patrick Honohan:

Does the Deputy mean spreads? It is my typical vagueness on such a matter. I do not want to be pinned down on a timeframe. At the beginning of May, AIB lowered the rate relative to when all this conversation was ongoing. There is some competitive pressure, and in the coming quarters we could see that kind of behaviour. One of the great inhibitors for the banks in lowering the standard variable rate is the fact that they look around and see inertia on the part of the borrowers who could switch. The Central Bank did a calculation and will probably publish something on it later on. We looked to see who could benefit from switching, given that there is a spread of rates. There is lots of information. Are there people who could benefit from moving to a lower-cost provider, bearing in mind that switching involves some costs, such as legal costs? Our people found that as many as 15,000 people could benefit a lot from the current rate. I am not saying that the current rates are even the lowest wherever they are for different circumstances and different loan-to-value situations. They are not particularly low, but even with the spreads that are there, there might be 15,000 people who, if they had the time to do the sums, could save a four-figure sum in a year.

I am not blaming anybody. We all know that we all suffer from inertia and are not sure what is going to happen. It is the same with gas and electricity. If people were more savvy, banks would be more on their toes and we might see the rates go down, so I would encourage that. I am not in the blame game. I am encouraging more competition - competition from borrowers as well as competition between lenders. The lenders do not want to lower the SVR rate if they do not see that they will get much new business from it, since they will have to bring down the rate on all of their back book; because it is, after all, the standard variable rate. They have this huge back book, and they say: "Will we lower the SVR rate? We will get more borrowers. Yes, that will be good. But on the other hand we will lose on the existing stock of loans." From a profitability perspective, the calculation is not as favourable as it would be in other circumstances.

Photo of Pat RabbittePat Rabbitte (Dublin South West, Labour)
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In terms of some of the statements made after the meeting with the Minister about the prospect of a modest reduction or an alternative offer, what merits does Professor Honohan see?

Professor Patrick Honohan:

I want to make clear that I was not part of the discussions between the Minister and the banks. The Central Bank provided background information but we were not involved in the discussions. Some of the banks are offering a fixed rate for a few years. I do not think any of them offer a fixed rate for a 30-year mortgage, so it must be borne in mind that those rates would revert to whatever the standard variable rate is, probably at the end of the contract. One must look at each individual case. Sometimes, this would be an advantageous move for a borrower. For the banks to offer a contract like that, which is not a standard variable rate contract, one can see that they are not burdened by the back book in that case. They can decide that perhaps they could offer a reasonably good deal on a fixed-rate mortgage because they are not damaging their back book. That is why I am quite concerned about the transparency of the pricing on the SVRs. There might be some good deals out there for moving to a new type of contract, but I want to make sure and we will make sure that this is not done in such a way as to disadvantage SVR borrowers who may have very high loan-to-value ratios and are not in a position to switch their contract. We will see what they offer. I do not know what they are going to offer. I am not privy to their business plans in this area in detail.

Photo of Pat RabbittePat Rabbitte (Dublin South West, Labour)
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I have a few questions that do not relate to mortgages, and we might come back to them. What in the name of God is the reason for the delay in fixing the rotten tooth on the quays? I saw it on television last night when we were showing off Dublin to its best. Here we saw-----

Professor Patrick Honohan:

It was gleaming. The way I put it is that up until very recently, my opinion of the social merits of the property developer was nil or negative. Now I see a tiny element of skill in the matter of turning a hole in the ground into a building. We have gone through all the planning and procurement step by step. I am sure the other people do so as well. We had some delays early on in getting those issues right. We have had no hiccups, hitches or decision-making delays. I am as amazed as the Deputy that it takes so long. The main contract is signed and the builders are there with their boots and shovels. If they need cranes, which I suppose they do, they will be there. It is still expected that we will be moving in before the end of 2016, so that is still the schedule. I cannot say anything more than that.

I must admit that it does amaze me. It is probably for another committee to scrutinise. People talk about the new regulations and the way each step of the building process must be checked and signed off on by some inspector before we move to another stage. I am never sure to what extent this is just special pleading by particular professionals or whether there is substance in this kind of the explanation for the delay, because it is not my area.

Photo of Pat RabbittePat Rabbitte (Dublin South West, Labour)
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There are people adjacent to the building down there who say the same thing about bank regulation. They say that in typical Irish style, we have gone 180 degrees from light touch regulation.

Professor Patrick Honohan:

This is why I say that we must be very careful about listening to special pleading because I do not think we have gone 180 degrees. If we have gone a little bit too far in our practise and behaviour in one or two cases, we have been very careful to ensure that this was necessary.

Photo of Richard Boyd BarrettRichard Boyd Barrett (Dún Laoghaire, People Before Profit Alliance)
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First of all, I welcome Deputy Sean Fleming to the ranks of the socialist left on banking policy. He has arguably swapped places with Deputy Rabbitte. I wish to follow up on the question because, frankly, I am perplexed at Professor Honohan's belief in and commitment to competition as the way to sort out some of the issues that confront us. He has not really made the case for it. For example, he rails against administrative control of interest rates, that is, the State setting interest rates - even though he seems to suggest that they should be reduced and that there is an element of profiteering going on. However, he says we should not really have administrative control because that would impact on competition and the reason we must not impact on competition is just that we need competition, but without any real argument to sustain that. It was precisely the dynamic of competition that led to the bubble, uncontrolled lending and the crash that followed, so I really am quite perplexed.

It is not just in the area of interest rates that the argument does not stack up. Professor Honohan finished his contribution by saying that the banks have been damagingly slow in resolving the mortgage arrears crisis. That is a good case for administrative control, as are variable interest rates and what is happening in the whole property area. I would also like to hear Professor Honohan's comments on that. It is extremely worrying that property prices are going out of control, as that was such a big contributory factor to the crash. We had property prices going out of control, and people with low incomes were borrowing money they really could not afford, while chasing property whose prices were going through the roof. That also led to the crash. I do not see, therefore, how Professor Honohan can support his argument that, faced with these serious challenges and problems and the experience that we have just been through, the answer we have to get back to is competition.

Professor Patrick Honohan:

A number of things arise from that. Deputy Boyd Barrett might have a different perspective about ways of organising the economy in general, so we can obviously agree to differ on that. I am subject to the treaty, so I am thinking in terms of an economy in which one has multiple service providers that operate in a competitive manner and price control is limited to cases in which there are clear reasons for market failure. There are clear reasons for market failure in banking. We do control a lot of stuff in banking. For example, on the Deputy's particular point about property prices, the way things were going and bubbles, our interventions on loan-to-value and loan-to-income ratios - unpopular though they were, in some quarters anyway - are a good example of working in an environment in which the banks did not like what we were doing. All of the banks wrote in to say they did not like it, that they hated it and that it was unnecessary, etc., etc. However, they sort of knew that this was par for the course and that they could and would be constrained in what they could lend, having shown that they had in the past loaned too much to people who could not afford to service their debts.

The control of retail interest rates in the banking system is a kind of Rubicon, though. There were times, perhaps in the 1960s, when that was very prevalent. To come out now as a country in the middle of this and say, "We're going to be the country that controls interest rates", has a signalling value far in excess of what one might think in terms of causing a retreat of service providers. That is my perception of it.

Photo of Richard Boyd BarrettRichard Boyd Barrett (Dún Laoghaire, People Before Profit Alliance)
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It is precisely that. It is a completely circular argument that Professor Honohan is giving, which is that it will have a chilling effect in terms of providers.

Professor Patrick Honohan:

Yes, because I do not want a monopoly banking system. If we decided as a nation that we wanted to work with just two or three banks that would be specialised and would jump on the instruction of some Government Departments, that is an entirely different way. Such systems have shown themselves to be very dysfunctional around the world, so I am certainly not going to encourage somebody to go in that direction.

The worst of all would be a halfway house in which we pretend that we are in one system and not in the other. One might say: "It cannot do much harm. You get reasonable people in the Central Bank. They can set a reasonable rate and that will be all right." First of all, however, that is not the way it will be perceived. Second, in committees such as this or in the political system in general, where will the advocacy for higher interest rates come from? It will not be there, so once one starts down this road it will be very difficult to convince anybody that they will ever be allowed to make a reasonable return on their investment.

Photo of Richard Boyd BarrettRichard Boyd Barrett (Dún Laoghaire, People Before Profit Alliance)
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With time against us, I will agree to disagree with Professor Honohan. To be honest, however, everything he is saying points in the direction of greater administrative control and planning in the economy as a whole, rather than letting the market rip. It all points in that direction. I am not really quite sure how Professor Honohan can act or intervene. In some ways, he is saying that we are pretty powerless here.

Professor Patrick Honohan:

We actually intervene a lot. We require them to hold more capital, we have the macro-prudential loan-to-value ratios, and all sorts of restrictions on the way they behave to consumers, which they regard as very burdensome. I want to get away from the idea that the Central Bank is trying to protect the banks rather than the consumer. It is the other way around. We want to protect consumers in the long run against a mistaken attempt to help them by damaging a mechanism which is not working well but could work better.

Photo of Richard Boyd BarrettRichard Boyd Barrett (Dún Laoghaire, People Before Profit Alliance)
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For the record, no matter what provisions Professor Honohan makes against it, if hundreds of thousands of people lose their jobs again, they still will not be able to pay their mortgages. All the provisioning in the world will not help. Similarly, we have a major problem with access to affordable housing.

I have a question about the mandates of central banks, given that Professor Honohan is coming to the end of his term. Does he not think that we should be looking, at a European level, at banks having a mandate? The European Central Bank does not have a mandate that extends to such things as access to affordable housing, as against, for example, the US Federal Reserve. What does Professor Honohan think of that? The issue of property was at the centre of the previous crisis and it is coming into view again.

As time is running out, I have a final question about the issue of non-tax revenue coming in to the Government, which was in the statement that Professor Honohan put out in the last few days.

Professor Patrick Honohan:

Yes.

Photo of Richard Boyd BarrettRichard Boyd Barrett (Dún Laoghaire, People Before Profit Alliance)
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The Government is getting a lot of unexpected money from non-tax revenue, largely to do with the previous bailout of the banks, which is being paid back. Can Professor Honohan quantify how much that is? It would be useful for people to know how much has been coming to the Government in that form. What will happen now? Will we see a big drop in that revenue as the banks move back into private ownership and we come to the end of the bailout?

Professor Patrick Honohan:

They are very interesting questions. I will start with the money one which the Deputy raised at the end. The Central Bank made a profit of €2.1 billion last year and it transferred 80% of that to the Government. It holds the rest in reserves. That €1.7 billion goes across to the Government. Some of it is treated as a capital gain, which is a new statistical approach from the CSO, so it goes towards reducing the Government's debt, not its deficit. It is of real benefit to the Irish people. A part of the profits is coming from the income on the portfolio of assets that the Central Bank is allowed to hold because it is part of the euro system and matches the currency issue.

Correspondingly, the Central Bank has investments, mainly in Government securities, mainly foreign but also some Irish. It receives interest on that and because the Central Bank is charged internally at the ECB's policy rate, the profit component of that is now very large.

That is part of our profit. Another very large part of it, however, comes from the fallout of the IBRC or Anglo Irish Bank liquidation. The Central Bank ended up holding Government promissory notes which in a complicated transaction were transformed into Government bonds with very long maturity. This ensured a stream of very large profits for a number of years at the Central Bank which can be accelerated and advanced, especially as interest rates are lower and the conditions for selling the bonds into the market are more favourable. This actually increases and accelerates the profits. Last year's profits were at record levels and this will continue to be the case for some time I expect. This is a significant claw-back indirectly through very complicated accounting arrangements of the Central Bank.

Photo of Richard Boyd BarrettRichard Boyd Barrett (Dún Laoghaire, People Before Profit Alliance)
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I asked about the mandate of central banks.

Professor Patrick Honohan:

Many say the ECB's mandate is solely price stability and, of course, that has been emphasised to the extreme, but it is not its sole mandate. Subject to achieving that mandate, the ECB - I will not get the wording right - is mandated to support the economic policies of the European Union. This can cover a great deal of the ground mentioned by the Deputy. Of course, the Americans have an explicit dual mandate on unemployment and price stability. However, it is not price stability and access to cheap housing; it is unemployment and inflation, whereas price stability has priority in Europe in supporting the economic policies of the Union. As such, supporting its economic policies is part of the ECB's mandate.

One must think carefully about the issue. These days central banks are extremely powerful because of the crisis. They needed to move away from normal operations and have taken control of additional matters. We at the Central Bank of Ireland already had banking supervision to some extent, but now it is at European level. One needs to be careful about giving too much power to an entity that must balance issues which should be balanced politically, not by appointed persons. I often laugh to myself when I hear people say the Central Bank is not doing this or that. I am thinking, "We are already really doing a lot of things". While these things are very much supported by the political system, for example, trying to have the issue of mortgage arrears fixed, whatever one says about how we have done it, we are doing a number of things that would be considered to be very much on the outskirts and the extreme edge of our mandate.

Photo of Arthur SpringArthur Spring (Kerry North-West Limerick, Labour)
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I wish the Governor the very best on his new horizons and thank him for the service he has done the State.

I start with a question on property prices and the activity in which the banks are involved. We recently extracted from some of the banks the fact that their working capital provisions were down to approximately 10% of what they had been at the height of the boom. One could derive from that statistic that there is not a great deal of construction going on or site finance. If one was to be cynical about it, is there an attempt to control the market for property - supply and demand - and, ultimately, repair their balance sheets? Is there anything the Central Bank can do to ensure a typical bank licensed by the State through the Central Bank will make provision for the marketplace to ensure supply comes on stream?

Professor Patrick Honohan:

In the past the volume of additional lending by the banks was seen as something which drove up prices. It did. While I do not dispute the fact that one might imagine a squeeze to drive up property prices temporarily and that the banks might state that while people want property, they will not let builders gain access to credit, this is unlikely to have a long-term effect of the type to which the Deputy referred. I am not sure, therefore, that I buy the story. There may not be that much competition, but there is no collusion either in their reluctance to provide finance for builders.

Photo of Arthur SpringArthur Spring (Kerry North-West Limerick, Labour)
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Does the Governor consider that a figure of 10% reflects the reality of where the market is relative to where it was at the height of the boom?

Professor Patrick Honohan:

What one finds is that developers and builders will be sourcing the equity component of their financing, a bigger equity component than in the past, as the banks will not lend them that much-----

Photo of Arthur SpringArthur Spring (Kerry North-West Limerick, Labour)
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I acknowledge that. It is very expensive and rare.

Professor Patrick Honohan:

It is expensive, but the mechanisms to get builders to discover and talk to the providers of equity finance for property are being developed. It is not being done by the Central Bank but public agencies are involved. That is definitely the way to go. While builders will not enjoy surrendering the equity and they will not like its cost, that is the safe way. Bank finance should not be providing the equity component.

Photo of Arthur SpringArthur Spring (Kerry North-West Limerick, Labour)
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The model shown to us was that 40% would have to be from equity at a minimum for site finance and the banks might then consider providing 60%. Does it matter what way one looks at it? One is still down to a figure of 10% going towards working capital for site finance and the building of houses. How will supply keep up with demand if that provision is not increased?

Professor Patrick Honohan:

They are planning on the basis of what they expect demand to be. They have lashings of capital and liquidity to make these loans, but this is about the risk decision on whether a builder can do the job and has the equity finance to allow the bank to make the loan. These are the constraints.

Photo of Arthur SpringArthur Spring (Kerry North-West Limerick, Labour)
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To rewind, the Governor says they have plenty of money and that it is up to them to decide how much they want to release into the marketplace. The next step is to find the people they can trust to do this. Is there a shortage of qualified builders or developers?

Professor Patrick Honohan:

The builders also need to have the equity capital to have the rest of the component. That has been the constraint up to now.

Photo of Arthur SpringArthur Spring (Kerry North-West Limerick, Labour)
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The level of equity is now far greater. It is, however, still a constraint and goes back to the net question as to why the banks are at a figure of 10% and whether there is a role for the Central Bank to play. I remember the Central Bank reports we had to produce on the percentage of business in agriculture, the percentage in industry, etc., when I was working in the banking sector. The Central Bank has all of that data. The amount of new money available for site finance and building houses has been compressed enormously.

Professor Patrick Honohan:

It has not been compressed by policy. We do not influence that aspect.

Photo of Arthur SpringArthur Spring (Kerry North-West Limerick, Labour)
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I am not saying that; what I am trying to get at is whether the Central Bank can influence it.

Professor Patrick Honohan:

The Government set new lending targets for the banks when the guarantee was in place. It used that control and additional lending took place. I do not want to be in the space of telling the banks not to bother about risk or the chance of default as I want them to shovel a particular amount of money into the construction sector. That is not the way it works. The Central Bank is not there to decide and steer the banks into particular areas. It is there to restrain them when they are going into areas that are dangerous or damaging or unfair to customers.

Photo of Arthur SpringArthur Spring (Kerry North-West Limerick, Labour)
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That is exactly where we are at; it is unfair to customers. The biggest financial commitment the average person will make in his or her life is for a house. Currently, supply is not keeping up with demand. Rents are going out of control and lack of availability, particularly of family houses, is making it very difficult for my generation to find sustainable housing. If the Central Bank's job is to protect the consumer and if the banks are not providing enough funding for housing supply to meet the demand by developers to buy sites and build houses, should it not act?

Professor Patrick Honohan:

It is way outside our remit. If we were to do that, one would not need any bank management. Bank management must take these decisions.

Photo of Arthur SpringArthur Spring (Kerry North-West Limerick, Labour)
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Why is bank management down at a figure of 10%? Is it because the banks cannot find people they trust?

Professor Patrick Honohan:

The Deputy will have to ask them. I know that he has asked them. I have the view - we have seen it in other countries - that banks are often too risk averse as they come out of a crisis. However, while I say this, I am conscious of the fact that they could have gone the other way.

In some respects, I do not think they were risk averse. I think they went back very readily to 90% and 95% mortgages.

Photo of Arthur SpringArthur Spring (Kerry North-West Limerick, Labour)
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If I were to look at a bank's balance sheet and consider the amount of persons in negative equity, that would obviously impact on the cost of funds for that bank and the perceived liabilities on the balance sheet. These liabilities can be repaired by increasing the values of homes which it is quite possible for them to do. Supply and demand are the kernel of the problem.

Professor Patrick Honohan:

I will not go there. I do not want to see the banks in some way pump up the price of housing in order to be able to get away scot free, as they imagine, by repossessing houses for the value of the properties.

Photo of Arthur SpringArthur Spring (Kerry North-West Limerick, Labour)
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It is not repossessing them. Having persons out of negative equity allows a house to be an asset rather than a liability on the bank's balance sheet.

Professor Patrick Honohan:

I know. The banks' hope is that if they hang in long enough, prices will go up and they will be okay.

Photo of Arthur SpringArthur Spring (Kerry North-West Limerick, Labour)
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Am I not right in saying that it is in their interests to have reduced supply?

Professor Patrick Honohan:

I do not really think so. The Deputy has the idea that somehow the banks will try to corner the housing market and prevent new additions in order that the price will go up. It is a conspiracy theory that does not have substance. I do not see that behaviour.

Photo of Arthur SpringArthur Spring (Kerry North-West Limerick, Labour)
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The Governor has still not explained to me in any meaningful way why they are at a figure of 10%.

Professor Patrick Honohan:

I have no responsibility in that regard. What I am seeing is that they are fairly cautious on volume; they do not want to lend. If the Deputy were a bank loan officer, he would be thinking, "I could make this loan, but it might go wrong". In the current environment his judgment will be skewed towards caution. Current lending is a reflection of the banks' caution, not any policy on the part of the-----

Photo of Arthur SpringArthur Spring (Kerry North-West Limerick, Labour)
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We have probably gone as far as we can on the issue.

Professor Patrick Honohan:

It is an intriguing idea, but I do not think-----

Photo of Arthur SpringArthur Spring (Kerry North-West Limerick, Labour)
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May I ask one last question?

Photo of Arthur SpringArthur Spring (Kerry North-West Limerick, Labour)
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Perhaps the Governor might be able to tell us more when he is no longer in the position he holds. When does he envisage us being back at the European average cost of funds and standard variable rates?

Professor Patrick Honohan:

Given the actual loan losses, the prospective loan losses and the perceived difficulty in recovering loans in Ireland, we will see spreads to cover higher loan risks in Ireland for a good while to come. That is the reality. It will be one of the long-lasting legacies. Anybody coming into the Irish market will be making that choice by comparison with going into the Netherlands or somewhere where it is easier and quicker to recover on a loan if it is not performing so that loan losses will be small. In going into Ireland, they will need to make a larger allowance for future loan losses. That is one element.

I will mention another element. When we make cross-country comparisons, as we have done in our paper, they are never perfect. In some countries in Europe most loans have a compulsory insurance element at a cost of perhaps 1 percentage point on top of the interest rate. We do not see this in the chart. Therefore, the comparisons are a little misleading. However, when one sees the movement that has happened recently, one sees that it is not sustainable. It will not last and the banks will-----

Photo of Arthur SpringArthur Spring (Kerry North-West Limerick, Labour)
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If the repossession and bankruptcy laws were changed, would the standard variable rate ultimately be reduced?

Professor Patrick Honohan:

It is not necessarily to do with the laws. I know that there is talk about changing the laws which I am not against. However, it also has to do with implementation. We are finding the process very drawn out, as are the legal processes. We have the idea that for people who are afraid to deal with their bank or did not know what to do, eventually it will get to the point where they will be into the legal process and they will accept that they have to do something. Then the negotiation will really happen and a deal will be done. However, the legal process is so drawn out that that dialogue is still not happening in many cases. I would not like us to get into a situation where there is both the reality which is damaging in itself and the perception that it takes a long time to sort out a loan. It has already taken a long time to do so.

Photo of Paul MurphyPaul Murphy (Dublin South West, Socialist Party)
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I refer to some of the comments the Governor made to Deputy Richard Boyd Barrett on the power of the ECB. It is my considered opinion that in the time he has been on the governing council - I do not make a causal link - the power of the ECB has increased significantly in real terms. In terms of the role it has played in the crisis, this unelected institution has dictated policies to a range of countries, including Ireland. Coming to the current situation where it is at its sharpest, does the Governor agree that in reality the ECB has played a political role in its decisions on the situation in Greece, in particular the withdrawal of the waiver that allowed Greek Government bonds to be used as collateral against ECB loans? Was that a political decision driven by the fact that Greece had elected a government led by Syriza that was committed to breaking with the policies of austerity?

Professor Patrick Honohan:

I want to be very careful in my language obviously because I am only one of 25 people who make these decisions on the governing council of the ECB. While there are different perceptions in different places, irrespective of the perception, the views of all those whose views I understand, given what has happened in the past few years is to try to ensure our decisions are removed from the political process. The Deputy might say, "That is ridiculous. How could you say that because there are certain consequences?" However, if it is considered in a more granular way, with various decisions being taken at various deadlines, then it becomes evident that the ECB is following the rules; above all, the ECB is governed by law. The Deputy says it has a lot of power, but it is also governed by law, as well as by a mandate. The law constrains it in what it can do. It cannot lend without sufficient collateral. It is in a situation where it deemed Greek Government bonds to be eligible collateral, only on the grounds that the Greek Government was committed to a programme that would get it safely, financially, out of the situation in which it found itself. That was the decision taken back - I cannot remember the date - in 2010. When this assurance was no longer present earlier this year, the ECB was then in a tight legal situation; what was it to do? Without going into the details because I cannot remember the ins and outs of it, the decision taken was that the safest decision politically, in other words non-politically, was to cut it at that point rather than become tangled in a negotiation that involved saying, "Maybe the ECB will pull it if you don't behave yourselves tomorrow. Just say 'No'". The decision of the governing council has been clear, as set out in a number of statements.

Photo of Paul MurphyPaul Murphy (Dublin South West, Socialist Party)
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That means that once a government was elected which insisted it would not go along with the troika agreement, the waiver was going to be withdrawn, although it took a certain amount of time.

Professor Patrick Honohan:

It was not damaging. It was not something that meant that people could not go into their bank and get money out.

Photo of Paul MurphyPaul Murphy (Dublin South West, Socialist Party)
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No, but it pushed the Greek banks into sole reliance on emergency liquidity assistance.

Professor Patrick Honohan:

Yes, but they are getting emergency liquidity-----

Photo of Paul MurphyPaul Murphy (Dublin South West, Socialist Party)
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While I accept that they are, are they not being kept on a very short leash? The extensions given are minimal, with an upper limit of €200 million agreed to.

Professor Patrick Honohan:

They do not need it. They did not need anything last week.

Photo of Paul MurphyPaul Murphy (Dublin South West, Socialist Party)
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The ECB is the point man for the European authorities in terms of the threats to-----

Professor Patrick Honohan:

When one gets into this situation, obviously the bank will be the entity that will stop and possibly refuse to give loans. It tends to be pushed onto the front line in these situations. However, it does not want to be in a political space. It is not possible not to be in a political space, but it tries to minimise the possibility as much as possible.

Photo of Paul MurphyPaul Murphy (Dublin South West, Socialist Party)
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It is in a political space and the people who make up the governing council have a set of political and economic views. They may not all be exactly in line, but, broadly, there are dominant and less dominant members.

Professor Patrick Honohan:

The Deputy would be surprised by the range of views held.

Photo of Paul MurphyPaul Murphy (Dublin South West, Socialist Party)
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I hope I would be surprised. It is not seen in terms of policy. If Greece is forced out of the euro, the most likely impetus will be the withdrawal of emergency liquidity assistance from the Greek banks, the collapse of the Greek banking system and the forcing of the Greek Government into a decision to print money, nationalise the banks, etc. It will, therefore, be the ECB's decision that will force Greece out.

Professor Patrick Honohan:

I do not want to even consider that possibility.

The ECB has not made any threats or anything like that. This is scenario painting and I will not get into it.

Photo of Paul MurphyPaul Murphy (Dublin South West, Socialist Party)
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There have been implicit threats from the ECB to the Greek Government since the election.

With regard to the standard variable rate, there was quite an acknowledgement in Professor Honohan's presentation that, in layman's terms, there is a rip-off of consumers going on to make up for other difficulties the banks have. Is this a fair summation in layman's terms?

Professor Patrick Honohan:

That is an interesting point. The other word used by Deputy Boyd Barrett was "profiteering". It is quite interesting. It is true that in a competitive market new entrants unburdened by the past compete with each other and offer lower interest rates. I am sure they could do it. Are the banks "profiteering"? It is hard to say this when one sees that the level of profits is very modest. Up to now it was almost non-existent and previously it was negative. If it is profiteering, who is getting the profit? If one stops to think about this, there are all sorts of winners and losers in this terrible crisis we are still coming out of and it is not obvious that there are profiteers. Where are the profits coming? They are hardly profits at all. The banks are rebuilding capital. To the extent that profits are being made, they are not paying dividends on their equity. All in all, if one starts doing a fairness analysis of what has happened in this massively unfair situation, it is not exactly clear. Who are the shareholders of the banks? Are they profiteering? No; they own nothing of the banks now. Their shareholding was written down by 99%.

Photo of Paul MurphyPaul Murphy (Dublin South West, Socialist Party)
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It is part of the process of preparing the banks for privatisation and future profitability by fattening up capital.

Professor Patrick Honohan:

Future profitability on a competitive basis - in other words, no more profits than are needed to attract the capital.

Photo of Paul MurphyPaul Murphy (Dublin South West, Socialist Party)
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The part-privatisation of PTSB received relatively little publicity compared to Aer Lingus, although it is right that Aer Lingus is getting the publicity it is. One of the arguments with regard to PTSB was increased capitalisation, but is the bank any more capitalised when a form of State-owned capital is replaced by privately owned capital? The actual form in terms of contingency notes has changed, but is it actually any more capitalised?

Professor Patrick Honohan:

It actually got cash. It got additional cash from the new shareholders. They provided more cash. PTSB has an additional liability on its book, which is equity, and it has more cash. If one looks at its assets compared to its liabilities other than equity, it has a bigger cushion. There is no smoke and mirrors. It is a real increase in its capital. It was not something chosen by PTSB; it was something mandated for it by the ECB. The ECB is demanding higher capital standards for all of its banks, and the other banks already had enough of a cushion so they did not need it. It is a real addition of capital.

Photo of Aideen HaydenAideen Hayden (Labour)
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I have several questions, but before I ask them, will Professor Honohan respond to Deputy Fleming's questions on quantitative easing?

Professor Patrick Honohan:

The thing about this whole central banking area is a question of balancing. The Central Bank looks for a rate of inflation below but close to 2%. Prices falling are not good and neither are prices rising. We want to get somewhere in the middle. The reason quantitative easing has been adopted is that the way things were going, including oil price rises and the weak demand in the euro area, prospective inflation was getting lower and lower and expectations of future inflation were getting lower and lower. People were beginning to not believe that even on a medium-term horizon the ECB could get back to 2% but that, instead, it would be bouncing around 0% or negative. Step-by-step additional actions were taken, and quantitative easing, which involves the purchase of large quantities of Government bonds from throughout Europe, is a tool which has been reasonably effective in the US, Britain and Japan, so why would we not use it? Not using it would make it seem as though the ECB did not really care, so we definitely had to use this tool. Does it risk pushing things in the other direction? If one has been pushing and pushing and not getting there and then one uses a very strong tool, I suppose there could be some risk of this type, but this would emerge not so much as an overshoot of price inflation, but as a risk that people might take excessive gambles with money that is almost free.

What is the benefit to Ireland and when we have seen the problems caused by money that is almost free? Fortunately - we have spoken about this - money is not free for standard variable rate mortgage holders, so they should not worry about it. That is just to be facetious. In Ireland, where this is really having an effect is not in the availability of borrowing for builders or home owners but in the low cost of refinancing the Government's debt. The NTMA has already refinanced loans from the IMF, which were yielding more than 5%, to a very low interest rate. It has an effect on the channelling of the profits of the Central Bank, which is a very large sum of money, and will continue over a number of years. This really strong benefit to the public finances has been a boon to Ireland, where over-indebtedness of public finances is a burden.

In addition, tracker mortgage holders have seen this come through immediately. Many people in Ireland are paying approximately 1%, and sometimes even lower than 1%, on their tracker mortgages. These include people who borrowed at the height of the boom, and probably borrowed more than they ever should have, and it is certainly easing their budget. They will not go out and buy another house. They will find it possible to do things they were not able to do because they were scrimping and saving to pay. The ECB did not do it for an over-indebted economy. It did it to generate additional demand and make sure prices came back to the 2% target, but it has been an unmitigated plus for the Irish economy.

Photo of Aideen HaydenAideen Hayden (Labour)
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Several other Deputies would like to speak again, but prior to that I will put several quick points. Professor Honohan spoke about the banks' cost of funds. All of the banks have come before the committee and we have gone through the shenanigans of listening to them justify why the variable rate is higher than the European norm. All of the answers we have received are to do with the cost of funds and historic debt. It is quite refreshing that Professor Honohan has been reasonably honest in saying it is higher than a fair-minded customer might reasonably expect. The interesting point was that Professor Honohan stated that ultimately the answer to this difficulty may lie with the Central Bank, in terms of openness, transparency and consumer protection, and that it might codify a requirement that banks be more open and transparent as to how they set their variable interest rates. How quickly could the Central Bank act in putting in such a requirement? Four banks have come before the committee, and the discussions certainly were not open and transparent to the people sitting in the committee.

My other observations relate to mortgage arrears, on which I echo the comments made by others. I am saddened that we will not have our regular six-monthly meeting with Professor Honohan. Much has happened in the time the committee has been sitting at an historic point for our country. Perhaps the issue which has most dominated all of our discussions has been mortgage arrears. The most recent country-specific recommendations highlight how difficult the situation in Irish banking remains, with the historically high levels of debt and rates of mortgage arrears. What in Professor Honohan's opinion is the fundamental problem that remains in resolving this very difficult issue?

It is troubling to see that at the moment, with most of the banks that have come before this committee, legal action is the option taken in about 40% of the cases where arrears are greater than 90 days, and certainly where they are greater than 720 days. There is a real issue in terms of the whole thing escalating into the legal system. That is one observation we made from our engagement. That has changed significantly over the past 18 months. My last question to Professor Honohan is this: from his point of view, with his stewardship of the Central Bank, how would he rate the Central Bank's performance on the issue of mortgage arrears?

Professor Patrick Honohan:

On the first question regarding transparent terms, if we start to codify this it will take months and months. It is fairly new territory. We cannot say we will simply do the same as they do in England. I am hoping - I have not seen it yet - that the banks will come up to the line on this. It is better if they design something that makes business sense but is transparent. If we try to design it from a distance, we may start with something that is clunky and needs to be revised. I am not saying I have this in the back pocket and am going to do it next week. It will take months, because any of these codes of conduct must go through consultation processes, legal considerations and so on, so it is complicated. We wrote to the banks in February. I expected more from them, but when has that not been the case?

Photo of Aideen HaydenAideen Hayden (Labour)
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There is a book in that statement.

Professor Patrick Honohan:

Why is the process regarding mortgage arrears moving so slowly? This is a multifaceted issue. I do not think anybody in Ireland wanted to see mass evictions and repossessions resulting from this crisis. That would have been the quick way to do it and that is how they did it in America. They had many repossessions. We started with moratoriums on that in 2009 and so forth. We warned about doing anything rashly. Then we moved to engagement and so forth. I am glad we have not had that huge wave of repossessions and that there has been time for the economy to make this recovery, for property prices to bounce back from their nadir and for people to start getting jobs again. There is a definite plus there relative to a quick resolution, which would have been a harsh resolution. That would have been socially damaging.

The banks remained over-optimistic all along and are still over-optimistic regarding what they can recover. That speaks to what Deputy Fleming has been asking regarding write-back provisions. I am not an enthusiast of the banks' writing back provisions. I am no longer in charge of this, because the ECB will be looking at that, but our staff were very much involved in it. There will be a temptation for banks to write-back provisions on the basis of optimism that everything is going to be all right. That optimism has caused them to be slow to do anything because, for example, establishing a split mortgage would be a hassle and although the split would allow them to recover if things improved, they would not see the need to do that and would just leave the person on interest-only for a few months.

In addition, some of the work we did to provide massive amounts of very cheap liquidity to the banks took the pressure off. That is part of what the ECB was doing when it came to us in 2010 and 2011 telling us our banks needed to downsize and to deal with these loans. We said we would still provide them with liquidity, even though it would remove the incentive for them to deal with this quickly. It is quite easy for the banks to decide to just spin this along. The customer may not be paying any interest, but then the bank is not paying much interest either. That is another reason this has been slow: there has not been a tight budget constraint on the banks because we in the Central Bank have arranged that. However, that should not have removed their responsibility to deal with the situation.

There is a legal system. Some 50% or 60% of the cases are going into legal proceedings, which can be extremely drawn out. Deputy Rabbitte talked about construction being extremely drawn out. Our legal procedures are also very slow. That gives time for compromises, but it may give so much time that people do not bother making a deal in the hope that something will crop up.

The efficiency of the banks can always be improved, but it is much better than it was when we first looked at it, in 2011, thinking that they could not do this. We had a deeper crisis than most of the others, which is why we are still dealing with it. A certain amount of Irish society is reflected in how we have handled this. It does not leave us with a healthy banking system, but it has allowed us to avoid doing some damage at the expense of not fixing situations and leaving people with a huge debt burden. They do not know where it is going to go. How have we done on it? The committee is used to my coming here and saying we are not doing well enough. Superficially, our number of non-performing loans appears high, but people who know what we are doing and have scrutinised it are saying we have some good procedures in place now. It is not for me to say, but we look worse on the headline numbers than on our processes. It is an Irish solution to an Irish problem. Is that not what A. J. Chopra said when he did not realise what he was saying?

Photo of Aideen HaydenAideen Hayden (Labour)
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That is a very interesting answer. I take it Professor Honohan is giving the Central Bank an A+.

Professor Patrick Honohan:

More like a B+?

Photo of Seán FlemingSeán Fleming (Laois-Offaly, Fianna Fail)
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I have two questions. One relates to the issue of quantitative easing. Professor Honohan is saying this is an ECB-wide issue.

Professor Patrick Honohan:

Yes.

Photo of Seán FlemingSeán Fleming (Laois-Offaly, Fianna Fail)
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He has confirmed to us, in a way, that the one-size-fits-all approach to quantitative easing does not suit the different economies in the EU, depending on what stage they are at. He has said that because we had such a high national debt the benefit of quantitative easing in Ireland has gone to the Government and the NTMA, dealing substantially with the national debt.

Professor Patrick Honohan:

And the people on tracker mortgages.

Photo of Seán FlemingSeán Fleming (Laois-Offaly, Fianna Fail)
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Exactly. That is because of the debt. He is saying that because of our national debt, aside from the tracker people, it was the Government that benefited from quantitative easing, rather than the real economy, the people, the citizens and the businesses, whereas in other countries where the debt-to-GDP ratio was 60% to 70% lower than ours, that same benefit did not have to be commandeered at Government level and at the equivalent to NTMA level, and it worked its way straight into the economy. Professor Honohan has implied that because of our debt, the Government grabbed the benefit of the quantitative easing and less of it has trickled into the real economy than would otherwise have been the case. I know the tracker people benefited, but it was almost by accident because of the level of debt. Why was some of the benefit of quantitative easing not directed to what Professor Honohan said was the biggest problem, namely, the non-performing loans? He should have been able to focus some of it there. It seems we have not benefited fully from that.

I do not agree with the ECB rationale that 2% inflation is a good thing. I know Professor Honohan said we did not want negative inflation, but we do not want it to run away either. Can he explain to us why we should not have it at 1%? The biggest single problem with the EU is that there is a closed-shop mentality.

We even see it in people trying to cross the Mediterranean. They do it in every walk of life when it comes to financial matters. They look at themselves as a closed shop, but they forget that they are in a global economy. If an annual cumulative interest rate of 2% is being promoted over a ten year period, after ten years the cost base of operating in the European Union will be 25% higher than the cost base of operating in other economies that do not have policies involving such levels of inflation. If we continue to make Europe a less attractive place for global investment, investors will head to economies that do not have a policy of incrementally increasing costs each year. I do not understand why Professor Honohan thinks 2% is the right rate. That is my question on quantitative easing.

Professor Honohan mentioned that the IBRC promissory note went to being Government bonds. He has said the Central Bank will make fabulous profits out of the new arrangement because it will be able to sell the Government bonds earlier and thereby reduce the debt. He might tell us what his actual projections are. If he does not have his figures with him - I do not see him with a big folder - he can send them to the committee at a later stage by way of correspondence. What are his projections for the benefit to the Central Bank from the system as designed, over the period in which the change resulted, compared to how he now sees it unfolding in the next few years? He might send us a note on the improvement that will be made in the profit of the Central Bank.

I would like to conclude by asking a question about the benefit of the note. Is it required under EUROSTAT rules to go against the national debt, or can any of it work its way into the Government's current account? Professor Honohan can come back to us in writing, if necessary.

Photo of Pat RabbittePat Rabbitte (Dublin South West, Labour)
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I would like to ask a question about the same matter, if the Vice Chairman will permit me to do so. I apologise for intervening, but I have to attend another meeting.

Photo of Aideen HaydenAideen Hayden (Labour)
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If the Deputy wants to come in very quickly, we will put both questions together.

Photo of Pat RabbittePat Rabbitte (Dublin South West, Labour)
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We can get rid of it now.

Photo of Aideen HaydenAideen Hayden (Labour)
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That is what we will do.

Photo of Pat RabbittePat Rabbitte (Dublin South West, Labour)
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I ask Professor Honohan about Deputy Sean Fleming's point and the point raised by Deputy Richard Boyd Barrett about the profit redounding to the Exchequer through the Central Bank. Did I understand correctly that Professor John FitzGerald was saying in the article he had written, which I intended to read more carefully, that some €9 billion was likely to be saved by the Exchequer in the relevant period? Off the top of my head, I cannot think of anybody other than his late father who would have forensically examined Note 15 to the 2014 report of the Central Bank. The man on the barstool has divided the €64 billion fiasco into roughly two halves. He understands that as we prepare for the privatisation of our shares, there is now the prospect to recover the money put in on the recapitalisation side. He believes the money put into Anglo Irish Bank is gone, dead; that it is finished, over and kaputt. Is it the same as saying the €9 billion saving is actually €9 billion that will not go up in smoke?

Photo of Aideen HaydenAideen Hayden (Labour)
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If there are other questions, they may be asked now. We are going to take the remaining questions in one group.

Photo of Richard Boyd BarrettRichard Boyd Barrett (Dún Laoghaire, People Before Profit Alliance)
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I am interested in the answer to Deputy Pat Rabbitte's question. We will obviously hear what Professor Honohan has to say, but it strikes me that we are being told the money will be given back, but only after A, B, C, D and E have been done. It is similar to the Greek situation. It seems that a great deal of pain will have to be inflicted on many people in order to ensure this money is given back. That is just a comment.

I would like to ask a question about the Consumer Protection (Regulation of Credit Servicing Firms) Bill 2015, with which we dealt yesterday. Can Professor Honohan see any purpose, value or positive contribution vulture funds have in a well functioning financial sector in this or any other economy? I cannot see that there is. We are now seeking to regulate them to some extent, but there are question marks over whether we are doing it well enough. I wonder whether we should be regulating them out of business completely. I do not see what value they add to anything. We can set aside ideological differences we might have about whether banking should be public or private and so on. That is one debate. These vulture funds do not have a long-term commitment to a market, customers or anything else. Given that Professor Honohan has said his objective is to have a well functioning financial sector - that should be the objective of any central bank - does he agree that we should be regulating vulture funds completely out of business?

Photo of Arthur SpringArthur Spring (Kerry North-West Limerick, Labour)
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I have a very simple question, but it may have a very difficult answer. Why did quantitative easing not happen four or five years ago, when it would have made this mess much easier to deal with? Is it the case that some countries did not want it to happen?

Photo of Aideen HaydenAideen Hayden (Labour)
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Does Deputy Paul Murphy have a final question?

Photo of Paul MurphyPaul Murphy (Dublin South West, Socialist Party)
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What is preventing all of the benefit of quantitative easing from going to those who own finance capital? That is what has happened around the world. The vast benefit has not trickled down. Why will the same not happen in the European Union?

Photo of Aideen HaydenAideen Hayden (Labour)
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That is quite a range of questions for Professor Honohan.

Professor Patrick Honohan:

I will begin by responding to the questions asked about quantitative easing and inflation. I should not be talking about this at all, given that we are in the quiet period before the monetary policy meeting that will take place next Tuesday and Wednesday. While I will make an exception, I will not talk about current monetary policy decisions, rather I will talk about quantitative easing in general terms. I hope that will be acceptable.

There is a clear answer to the question asked by Deputy Sean Fleming about the 2% rate. The measurement of inflation is not very good at taking account of quality improvements and new goods. There have been studies of this in the past 20 or 30 years, particularly in the United States where there is quite a body of evidence and the data are super. The US authorities asked how much of a difference it would make if they could take proper account of new goods and quality improvements. They came up with the conclusion that it was the driver of the figure of 2%. I do not remember exactly what it was, but they more or less said that if one year was taken over the next, the rate was probably 2%. The real rate of inflation is 0% when the rate is 2%, if members know what I mean, when quality improvements are taken into account. We do not need to worry about competitors because the Americans, the British and the Japanese are aiming for a figure of approximately 2%, while some other countries are aiming for much higher rates. All of this will be sorted with exchange rates.

An interesting question was asked about the distributional impact of quantitative easing. We discuss it frequently. It is simplistic to suggest the people who sell the bonds to the Central Bank will surely make the profit. That is an overly simplistic approach. As the effects of quantitative easing pass through the economy, they generate greater activity, profits in some areas, new jobs for people who do not have jobs and higher wages. They pass through the economy and the issue is being studied. I know from the recent INET conference I attended in Paris that some left-thinking people have been discussing whether there are better ways of engaging in quantitative easing. Consideration is being given to approaches that could result in a better distributional effect. There is a broad distributional impact, but perhaps it could be done better.

As Deputy Arthur Spring said, we did not come to this until a certain point in time. Other countries had done it at an earlier stage. Yes, there are different interests. Some governors and members of the governing council perceive some issues as having greater prominence than others. Countries in which the saving constituency is very dominant are not clear that they like quantitative easing at all, with zero interest rates on their savings. Many considerations, including legal issues and the question of compliance with the treaty, were widely discussed. We tried all sorts of other tools. It was easier in a single country jurisdiction for the Americans to buy Federal Government guaranteed securities, for the Bank of England to buy many British Government securities or for the Bank of Japan to buy many Japanese Government bonds.

People were looking at the monetary financing of Governments and wondering if they could really do this. There were a lot of legal considerations and concerns. We got there, and that is important.

Photo of Pat RabbittePat Rabbitte (Dublin South West, Labour)
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The impact on payment of debt is helpful.

Professor Patrick Honohan:

Yes, undoubtedly.

Photo of Pat RabbittePat Rabbitte (Dublin South West, Labour)
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That may not be distributional in the normal meaning of things, but it is helpful.

Professor Patrick Honohan:

It is helpful. Also, Deputy Fleming said the Government had grabbed all this. The Government grabs, but it gives back. It gives back in the services which otherwise have to be more squeezed and the benefits it pays. The Government organises how it does it, but it obviously goes back into the economy in one way or another.

On the profits of the Central Bank, first of all, from a quantitative perspective, we show in the annual report the value of the unrealised capital gains at that moment of the remaining assets in its portfolio. That was more than €9 billion. We had already made more than €1 billion on this IBRC portfolio since the liquidation. The sum of €1 billion and then some plus €9 billion is €10 billion and then some. However, the €9 billion is not in the bag. If interest rates were to go up again, the capital gain would be smaller. Gradually, we will recover some of it. I did the calculations the day before we published our annual report in preparation for this meeting. At that moment, when the interest rates were at their very lowest, the unrealised capital gain was €13 billion. One might say, "Wow", but that alerts one to the fact that it can move around a lot. We should not think the €9 billion is in the bag, but, still, things are going well on that front.

Is it really some clawback of part of the cost of IBRC? The answer is "Yes" and "No". There is a better way to think about it. When the Government put that promissory note into the IBRC, it was at the highest interest rate. It was a really high, bad interest rate time to do it. It was not quite the highest, but it was a bad interest rate time to do it. That is what happens. When in trouble, a high interest rate will have to be paid. What we have managed to achieve is, basically, to refinance - sorry, I should rephrase that because the Central Bank does other things. What the Government has managed to achieve is a refinancing of that cost at these extremely low interest rates. The capitalised value of that refinancing is the €9 billion or €10 billion sum. That is why it is so difficult, given that we are talking about many years and different financing schemes. Did IBRC still cost us €35 billion adding all the things together? Yes, but now it has been refinanced in such a way that, actually, the Government will only have to borrow maybe, in the end, €10 billion less, because the bond is there and the bond is now worth more.

Photo of Pat RabbittePat Rabbitte (Dublin South West, Labour)
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It is not over-----

Professor Patrick Honohan:

The Central Bank is holding the bond and the Central Bank's profits go back to the Government.

Photo of Pat RabbittePat Rabbitte (Dublin South West, Labour)
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That calculation is not over the period of 40 years. It would be over a decade because-----

Professor Patrick Honohan:

We have to sell it as quickly as possible, subject to financial stability conditions. If we sold it tomorrow at the current price, which would not be a very financially stable thing to do, but if we could do that, we would have the €9 billion, but that is not going to happen. We will do it in an orderly way.

Photo of Richard Boyd BarrettRichard Boyd Barrett (Dún Laoghaire, People Before Profit Alliance)
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The vulture funds?

Professor Patrick Honohan:

Deputy Boyd Barrett is referring to investment funds, private equity funds, hedge funds and so on. There is a lot of things to complain about in respect of some of the behaviour of certain funds, but they have become an ingredient of the financial system which is increasingly important. That is for various reasons, but one of the reasons is the considerable regulation of banks. Squeeze that part of the balloon and something else emerges. Many of the funds are serious intermediaries which are providing facilities to pension funds. Where are we going to invest our pension money? Let us go to this investment fund, because it knows about how to do these things. These types of funds are doing it on a scale of billions. They can economise. They are buying Government securities and equities in reputable companies and so on and so forth. A vast bulk of that business is reputable, well run and, if one looked under the bonnet and kicked around it, one would think it is actually all right. There are then some more aggressive funds with which one might not wish to do business. Some of them are regulated. Some entities are not regulated. We would want to be very dubious about those ones.

Photo of Pat RabbittePat Rabbitte (Dublin South West, Labour)
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Has the Governor commented on the Penrose Bill?

Photo of Aideen HaydenAideen Hayden (Labour)
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The Bill reducing the bankruptcy term to one year.

Photo of Pat RabbittePat Rabbitte (Dublin South West, Labour)
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From three years to one.

Professor Patrick Honohan:

I am not briefed fully on that matter and there are a number of issues regarding bankruptcy. I am disappointed with the failure of the banks to seize the opportunities created by the Personal Insolvency Act. I told them that if they did not, there would be consequences and I think there are going to be consequences.

Photo of Aideen HaydenAideen Hayden (Labour)
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On behalf of the joint committee, I thank Professor Honohan for his engagement with the committee today and in the past. On my behalf, I commend him on his work at the Central Bank over the past number of very difficult years. On behalf of the committee, I wish Professor Honohan every success in the next stage of his life.

Professor Patrick Honohan:

I thank the Vice Chairman.

Photo of Aideen HaydenAideen Hayden (Labour)
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I propose that we go into private session for a few minutes. Is that agreed? Agreed.

The joint committee went into private session at 3.56 p.m. and adjourned at 4.05 p.m. until 2 p.m. on Wednesday, 10 June 2015.