Minister Donohoe notes publication of report highlighting link between mortgage rates and bank capital

11th March, 2019

The Minister for Finance and Public Expenditure and Reform, Paschal Donohoe TD, today notes the publication by his Department of a report that seeks to explain the link between bank capital and mortgage pricing in Ireland.

Irish mortgage rates are higher than the European average for a number of reasons including the fact that more than four in every ten mortgages in this country are still loss making trackers. While this is generally acknowledged, what is not widely discussed is the fact that Irish banks have to hold far more capital on a mortgage than their peers in other countries, which is due in large part to a very high level of historic losses. 

The report explains how these historic losses influence the calculation of bank risk weighted assets (RWAs) and therefore their capital, profitability and mortgage pricing. The focus of the paper is on RWAs which are only one, albeit a crucial component of the equation that determines the amount of equity a bank must hold against its loans.

Minister Donohoe stated:

“As this report shows, the current application of bank capital rules means that the very significant losses from the last crisis still have a considerable influence on how Irish banks price their products. As banks in other Eurozone states do not have a comparable legacy burden, it is important that this is recognised in public debate when we compare mortgage rates.

In light of this, I have asked my officials to consult all interested parties and explore whether there are any innovations we can pursue that would help offset this cost and bring about lower rates for consumers e.g. alternative long term funding models.”

The following are the paper’s main conclusions:

  • A large part of the difference (40-50bps) between Irish and European mortgage rates can be explained by the fact that Irish banks have to hold far more capital on mortgage loans than their peers (2-3x). This is in large part due to very high RWAs which are a function of the high losses incurred in Ireland during the last downturn.
  • An Irish bank has to hold as much as five times as much equity capital on a mortgage written today compared with 2007, despite the fact that these new loans are far less risky due to changed underwriting standards and the new regulatory environment. Therefore mortgage margins today need to be higher than they were pre-crisis for banks to make an acceptable return.
  • RWAs and therefore capital requirements in many European banks are much lower, as these countries did not experience the same housing related losses. In fact as RWA models are backward looking, the longer a country experiences a housing upturn and the further away the last downturn becomes, the lower its bank RWAs will be.
  • As Irish banks reduce their NPLs, average mortgage RWAs will fall improving banks’ ability to compete on price, but the risk weighting (on performing loans) will remain much higher than the European average as the imprint of the last crisis will take years to work out.
  • Any new bank entrant to the Irish mortgage market cannot ignore the poor loss history when calculating capital requirements and deciding how to price the risk. As a result, non-bank lenders may be in a better position to offer lower rates as they are not subject to bank RWA and capital requirements.

Risk Weighted Assets in Ireland – The Link to Mortgage Interest Rates