Mr. Ed Sibley:

I thank the Chairman and committee members for the opportunity to appear here today to discuss the Central Bank (Variable Rate Mortgages) Bill. The Governor of the Central Bank is at the Governing Council of the ECB today. He sends his apologies in advance of his attendance before the committee on 20 December.

As the potential effects of the Bill are relevant from consumer protection, financial stability and prudential supervision perspectives, I am joined today by the Central Bank's director of consumer protection and the head of financial stability.

The Central Bank's mission of safeguarding stability and protecting consumers is at the heart of all that we do. It encapsulates the dual and interdependent priorities for the bank in delivering on its mandate. Effective regulation and supervision driving well-governed and well-managed firms, which support economic growth and employment in Ireland, are outcomes that are in consumers' long-term interests.

Similarly, the fair and equitable treatment of consumers is obviously fundamentally important in its own right but also in supporting the long-term viability of regulated firms and financial stability more generally.

The public debate surrounding Irish mortgage rates is understandable, as are the objectives of the Bill. A cursory comparison shows that some variable interest rates in Ireland remain among the highest in the euro area, despite recent reductions. However, the root causes of this are complex. In my opening remarks, I will discuss some of the main features of the Irish private dwelling home, PDH, mortgage market, outline how some of the associated issues are affecting mortgage pricing in Ireland, and show that there has been significant progress in addressing these issues. I will summarise why the Bill may not achieve its stated aims and may have negative unintended consequences.

Let us consider the Irish mortgage market. As with the wider housing market, it is recovering but it is still suffering the effects of the crisis that beset Ireland and from the mortgage lending that took place in the period leading up to 2008. Since the onset of the financial crisis, many mortgage holders have struggled to keep up with repayments. While the situation is improving, it is still acute, both at system level and also for individual borrowers in distress. The Central Bank has worked to ensure that the appropriate protections are in place for these borrowers who are in difficulty and to ensure that the banks have the financial and operational resources with which to resolve the problems.

At the end of June 2016, there were 740,834 PDH mortgage accounts in Ireland. Of these, 57,500 are in default. In other words, they are more than 90 days in arrears on their payments. Of the 57,500, nearly 35,000 are more than two years in arrears. A little over 120,000 PDH mortgage loans have been restructured, primarily due to repayment difficulties.

The Central Bank has utilised its legislative powers to protect consumers by imposing a number of codes of conduct and requirements on regulated firms, including the consumer protection code, the code of conduct on mortgage arrears, or CCMA, and the minimum competency code. While the Central Bank does not have a statutory function to regulate mortgage rates, we continue to prioritise the protection of mortgage holders.

A central element of the CCMA is that arrangements to solve mortgage arrears must be sustainable and based on a full assessment of the individual circumstances of the borrower, and that repossession should be used only as a last resort. Under the CCMA, a regulated entity may commence legal proceedings for repossession of a PDH only where it has made "every reasonable effort" to agree on an alternative repayment arrangement with the borrower and where other clear requirements are adhered to. The introduction of mortgage arrears resolution targets, MARTs, in 2013 drove a material change in the mix of restructures agreed, with a shift away from interest-only-type arrangements to more sustainable solutions. As a direct consequence of these actions, together with improvements in the Irish economy, mortgage arrears are reducing, while every effort is being made to keep mortgage holders who are struggling to meet their payment obligations in their homes. Mortgage arrears have fallen for 12 successive quarters and by 43% from peak, with more than 120,000 mortgage holders having their loans restructured, although note this is not necessarily a cheaper option for those borrowers.

None the less, mortgage lending is evidently riskier in Ireland than in other eurozone countries. Furthermore, due to the economic and social policy choices that have been made, being able to effect the security that underpins the loan is more challenging in Ireland in the event of a default than in many other eurozone countries. To illustrate this point, between 2009 and June 2016, just over 6,000 PDH properties have been repossessed in Ireland, two thirds of which were either voluntarily surrendered or abandoned by the borrower. Approximately one in five mortgages is or has been in default, and fewer than one in 300 has lost possession of a house through the courts.

Let me move on to interest rates. The stock of mortgages in Ireland can be broadly divided into fixed-rate mortgages and floating-rate mortgages, and the latter category can in turn be divided into standard variable rate mortgages, SVRs, and tracker rates. More and more variable rate mortgages are priced according to loan-to-value considerations. For the moment, I will stick with using SVR as a catch-all for non-tracker variable rate mortgages.

Currently, around 90% of outstanding mortgage loans for primary dwellings are on floating rates. About 50% are SVRs, with the remainder being trackers. Consequently, 90% of PDH mortgage borrowers are exposed to interest rate risk, and are vulnerable to interest rate rises.

Turning to mortgage interest rates themselves, the average interest rate across mortgage products in Ireland has fallen over recent years, and currently stands at 2.64%. This is quite close to that of the weighted average in eurozone countries at 2.55 % and is an exceptionally low level in historical terms for Irish borrowers, albeit that the average interest rate excluding tracker mortgages is 3.78%, despite having declined in recent years.

In the same way as it is an oversimplification to refer only to one average interest rate for Irish mortgages, there are perils in oversimplifying our comparison with other eurozone mortgage rates given the different characteristics of housing and mortgage markets in different member states, including home ownership, the history of default and the balance between fixed and variable rate mortgages.

I will now move on to the factors affecting mortgage rates. In May 2015, the Central Bank published a paper on influences on standard variable mortgage pricing in Ireland. This paper set out the range of factors which affect the margin that banks charge on variable rate mortgages, including the cost of funds, the credit risk associated with the lending, operational costs of running a bank, the cost of capital and the market structure and the competitive environment faced by each bank.

With regard to credit risk, despite considerable recent progress European Banking Authority, EBA, stress test data show that Ireland's mortgage default rate is more than ten times higher than that in many other eurozone and European Union countries. In other words, as I touched on earlier, mortgages are higher risk in Ireland than in the majority of those countries with which mortgage rates are compared. The EBA stress test data also show banks operating in Ireland need to hold significantly more capital for Irish mortgages on average per euro of mortgage lending than other European banks, with associated higher costs, and hence mortgage rates. The low level of repossessions I referred to creates uncertainty on the recoverability of collateral. Cross-country comparative research shows that increased recovery time is associated with lower availability of credit and higher interest rates.

A further determinant of bank lending margins, and hence pricing, is the degree of competition in the market. The crisis resulted in considerable structural changes to the Irish banking sector, including increased concentration. We have seen some nascent signs of restoration in competition, with the reductions in variable rates, some increasing product differentiation and potentially some small new entrants, but this is not of a significant scale at this stage.

The ability and willingness of consumers to switch mortgage products is vital to ensure a well-functioning market. The level of switching of mortgages in Ireland is low, and much lower than before the crisis. In this context, the additional transparency measures announced by the Central Bank in July, and which will come into effect from 1 February 2017, are aimed at increasing transparency and facilitating consumer choice. This has become more important as we have started to see greater differentiation in product offerings and mortgage pricing.

The vast majority of SVR borrowers in positive and negative equity could benefit from either switching to another provider or to another product with the same provider. Switching offers the dual benefits of potentially reducing monthly costs or the length of the mortgage, or both, with potential savings of tens of thousands of euros. The more people who start to switch, the less ability the banks will have to differentiate between new borrowers and existing ones.

The Central Bank is also examining what additional measures it can take to address any impediments to switching, notwithstanding that there is a material difference between switching current account or utility provider and entering into an arrangement involving lending a customer sizeable sums on a 20-plus year basis.

Turning to our assessment of the Bill, it is far from certain it will be successful in delivering its understood aims. We are concerned that the Bill focuses on the symptoms of a complex problem and may, therefore, not only be unsuccessful but run the risk of being counter-productive as it may have damaging side effects affecting the functioning of the market.

From both financial stability and consumer protection perspectives, it is essential that banks have sustainable business models that take into account the risks that are inherent in their lending practices. There is a risk that capping interest rates will result in an under-pricing of credit risk, as was experienced in Ireland and internationally to such dangerous effect in the past. Alternatively, were this legislation to be introduced, lenders may adapt their credit standards and offer variable mortgage loans only to new customers with a low risk profile, ultimately reducing credit availability. Lenders could also raise interest rates on other loans, and increase fees and commissions, in order to maintain or achieve sustainable capital generation.

It is important that banks have the ability to generate capital to transition towards full implementation of new regulatory capital requirements. Adequate capitalisation is essential for a properly functioning banking system and to ensure sufficient availability of credit for businesses and households, in addition to strengthening the resilience of banks to future shocks. Additionally, the proposed legislation may have the unintended effect of stifling competition and innovation and dissuade entry of new participants to the Irish market. International evidence indicates that competitive financing markets are important for the choice, quality and pricing of financial products, which are all in the interest of the consumer. Furthermore, with regard to the interest rates charged on existing SVR mortgage loans, they are subject to existing contracts and contract law, which only a judge could override, not a public body such as the Central Bank.

We are also concerned about the extension of the bank's statutory functions to encompass the regulation of competition, which is a function already carried out by the Competition and Consumer Protection Commission, CPCC. We also note the European Central Bank's concerns raised in its opinion on the Bill, to which I referred, and the European Commission's view, as articulated in the summary of the post-programme surveillance statement issued last week.

I appreciate that the positions I have outlined today are arguments against what might be perceived as a quick action to reduce SVR mortgage rates, which are low by historical standards, albeit higher than in countries with much lower default histories.

Material improvements have been recorded in many of the factors underlying mortgage rates in recent years, most notably lower household indebtedness, lower numbers in negative equity, lower numbers in arrears or default, improved resilience of the banking sector, and ultimately a gradual progression from impaired functioning of our banking system so that it can support economic growth, employment, and incomes. These improvements have coincided with some reductions in SVR rates. Further progress is expected in the coming years as the impact of the measures taken continue to feed through to the mortgage market and financial system, and as the economic recovery continues.

The issues in the mortgage market are complex and rooted in the crisis. Clear economic and social policy choices have been made in managing the crisis and navigating a path out of it. Short-term fixes may have long-term negative consequences for consumers. Decisions to intervene legislatively in the mortgage market, as with any market, should be taken with due cognisance of the market, the factors that lead to the perception of market failure, the underlying causes, and the risks associated with the action and the likely outcomes. Notwithstanding these concerns, as the Governor has previously stated, if these powers are conferred upon the Bank, we will do as we always do and strive to deliver to the best of our abilities the duties and mandate that are given to us. The Central Bank remains focused on delivery of its full mandate. It is committed to working with all stakeholders to support the continued normalisation of the Irish mortgage market.