Introduction

Following the publication of a new Programme for Government (which contained a number of mixed messages for Irish banks) the new Dáil (Irish Parliament) sat for its first full session on 17 May 2016.

One of the first bills introduced by the main opposition party (Fianna Fáil) was the Central Bank (Variable Rate Mortgages) Bill 2016 (the “Bill”).

The Bill has as its aim the regulation of standard variable rate owner occupier mortgages by empowering the Central Bank to intervene in the event of a “market failure” (i.e. where market conditions are such that standard variable rates on principal dwelling house mortgage loans (“PDH Loans”) are higher than the Central Bank considers to be “reasonably and objectively justified” by reference to a range of factors set out in the Bill).

Essentially the Bill gives the Central Bank the power to cap standard variable interest rates charged by banks on residential mortgages.

Application

The Bill applies to “principal dwelling house mortgage loans” (defined as loans for the primary purpose of purchasing a principal dwelling home for the borrower (and if relevant) the family of the borrower on an owner-occupier basis). This definition excludes buy to let and other forms of mortgage products. The expression “Lender” is also broadly defined as “any regulated service provider within the meaning of the Central Bank Act 1942 or any company, partnership, business or other entity engaged in the provision, management or administration of principal dwelling mortgages”. This expression is designed to extend the scope of the Bill to credit servicing firms regulated by the Consumer Protection (Regulation of Credit Servicing Firms) Act 2015.

Central Bank Assessment

Section 2 of the Bill requires the Central Bank to carry out an assessment of the state of competition in the market for PDH Loans on at least a quarterly basis. Section 3 of the Bill lists eleven factors to which the Central Bank must have regard in carrying out its assessment under Section 2. These factors include:

  1. the variable interest rates being charged by Lenders;
  2. the ease with which borrowers can switch their PDH Loans between Lenders or between different products offered by the same Lender;
  3. the relationship and proportionality between the variable interest rates being charged by each Lender and the cost of funds of that Lender;
  4. Lenders cost of funds and the trend of Lenders’ cost of funds over time;
  5. Lenders reasonable profit expectations in the prevailing market conditions;
  6. such other matters as the Governor of the Central Bank may certify as being of relevance.

The Central Bank must, on completion of its assessment, form a conclusion as to whether the state of competition in the market for PDH Loans is such that a market failure exists.

If the Central Bank forms the view that a market failure exists, it may issue a direction to a specific Lender or Lenders (or Lenders in general) (a “Direction Order”) not to charge a variable interest rate or variable interest rates in respect of PDH Loans in general, or specific PDH Loans (or categories of PDH Loans) which exceed:

  1. a rate specified by the Central Bank;
  2. a margin (or margins) specified by the Central Bank above the Lenders’ cost of funds;
  3. a margin specified by the Central Bank above a rate set by the ECB; or
  4. a proportion, not being more than one third, specified by the Central Bank above the average variable interest charged in the market for comparable PDH Loans as determined by the Central Bank.

A Direction Order may remain in force indefinitely and the Central Bank may apply to the High Court for an order (an “Enforcement Order”) requiring compliance with any Direction Order issued.

Section 7 of the Bill also prohibits discrimination between existing and new borrowers in setting variable interest rates and empowers the Central Bank to apply to the High Court for an order (a “Rectification Order”) requiring a Lender to cease any discriminatory practice prohibited by Section 7.

The Central Bank may also apply to the High Court for orders providing for redress to borrowers if they have been discriminated against and imposing a fine on the relevant Lender.

Analysis

While the introduction of the Bill is undoubtedly well intentioned, the fact remains that it is not the role or function of the Central Bank to intervene in the residential mortgage market to address perceived “market failures” on the basis of factors such as Lenders’ reasonable profit expectations in prevailing market conditions or the relationship and proportionality between variable interest rates being charged by a Lender and that Lender’s cost of funds.

The wider implications for the banking landscape if the Bill becomes law (and if the powers given to the Central Bank were exercised) are potentially negative. The passing of such legislation could negatively impact bank profitability and could deter the entry of new Lenders to the residential mortgage market. The most effective way to address any perceived lack of competition in the residential mortgage market is to encourage new market entrants. The enactment of the Bill could have the opposite effect.

The Governor of the Central Bank has also stated publicly that: “we don’t believe that having legislated mortgage caps is the best way of encouraging competition in the mortgage market”.  The Minister for Finance has also stated his opposition to the Bill on the basis of competition concerns, perceived constitutional issues and the lack of any consultation with the ECB.

Given the voting arithmetic in the Dáil there is a real prospect of the Bill becoming law. If the Bill is enacted it will place unwarranted pressure on the Governor of the Central Bank and could potentially create tensions with the ECB, which will undoubtedly interpret the legislation as a threat to the independence of the Central Bank in its role as the guardian of the stability of the financial system.