Michael Noonan (Limerick City, Fine Gael)

I welcome the decision by the majority of lenders to reduce their standard variable rates following the recent announcement by the European Central Bank and I encourage all lenders to follow suit. Such a reduction will be of benefit to home owners struggling with mortgage payments.

The Government wants the lending institutions to pass on the interest rate cut for several reasons. In particular, the interest rate cut will be of assistance to those mortgage holders struggling to pay their mortgages. Following a request from the Taoiseach, Mr. Elderfield, the Deputy Governor of the Central Bank, forwarded a report regarding mortgage interest rates on 11 November 2011. The Deputy Governor acknowledges that the Government is not unjustified to have concerns for some particular banks regarding the widening of the spreads by which their standard variable rate exceeds their cost of funds and how they are still so far above the prevailing rates of their industry peers. However, the Deputy Governor states that the power to exercise close regulatory control over retail interest rates is not sought by the Central Bank at this time. He has indicated that the Central Bank will, within its existing powers and through suasion, use existing processes to engage with specific lenders which appear to have standard variable rates set disproportionate to their cost of funds.

In his report, the Deputy Governor states that, while the standard variable rates of mortgage interest for Irish banks reached historically low levels in early 2009, several forces have contributed to the subsequent increases in such rates. First, the access of the Irish banks to wholesale funding from the market was sharply curtailed, especially from mid-2010 and there was a sharp increase in the interest cost, including the guarantee fee mandated by the EU Commission of what market funding was secured. Second, while the ECB policy rate is only 0.25% higher now than it was in 2009, the total cost to the banks of some of the sizeable drawings they have made on Central Bank funding, inclusive of guarantee fee, is significantly higher than the policy rate. Third, the banks appear to have increased, at different times and to different degrees, the spread by which the single variable rate exceeds their cost of funds.

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The Deputy Governor goes on to say that the third issue is the one on which the current debate is focused. He has indicated in his report that a somewhat wider spread of new loans could be rationalised on the basis of the bank's belated realisation of the credit risk that may be involved in mortgage lending, although this can be limited by prudent loan underwriting practices and risk reduction mechanisms such as low loan-to-value and loan-to-income ratios. A significant widening of mortgage interest rate spreads has been happening in other countries as well. The Deputy Governor comments that it is less clear that retroactively applying a risk-spread to existing loans is fully consistent with fair practice, given that standard variable rates have, in the past, generally moved broadly in line with the cost of funds and given the current situation where most borrowers have limited alternatives such as re-financing or prepaying.

In his report, the Deputy Governor states that the Central Bank has two concerns. The standard variable rate contract has operated for decades during which the reasonable assumption has been established that it would generally track the cost of funds to the lender. The exercise of the currently heightened market power by some banks in increasing rates for existing standard variable rate borrowers would be an abuse contrary to public policy. The Central Bank comments that from the point of view of prudential and consumer legislation, it is possible that the deleterious effect on the mortgage arrears situation arising from large increases in the standard variable rate could result in a net worsening of the banks' prospective profitability, while at the same time adding to the financial difficulty of hard-pressed home owners. The Deputy Governor has indicated that experience of interest rate controls in the past and in other countries does not encourage the Central Bank to believe that such a regime would be advantageous in net terms as the banking system recovers its normal functioning. Binding controls tend to reduce availability of credit and channel it to the most creditworthy customers, starving smaller and less secure customers from credit. The Deputy Governor indicates that this could have a chilling effect on the entry of sound competitors into the market. By absolving banks from their responsibility to price risk accurately, binding interest rate controls would, especially during this recovery phase, impede progress towards the re-establishment of bank management practices that can ensure a healthy and free-standing banking system no longer dependent on the Government for bailouts.

I welcome the report from Mr. Elderfield which will be examined to see what further action, if any, is required. My initial reading of his report is that the Deputy Governor is not seeking emergency legislation. Taking into account the advice of the Central Bank, I do not intend to recommend to Government the introduction of emergency legislation as requested by the Deputy. The Deputy Governor has also commented that competition policy issues may arise in this area. I will bring a copy of his letter to the attention of my colleague, the Minister for Jobs, Enterprise and Innovation for any further requirement in this regard.

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