Banks blame regulator - for wrong reason Sunday, November 15, 2009 By Kathleen Barrington Pat Farrell , chief executive of the Irish Banking Federation, was right to apologise ‘unreservedly’ on behalf of the banks last week for letting down their customers, shareholders and the wider community.
But he is wrong when he says it was the emphasis on consumer protection rather than on prudential supervision that is the cause of the regulatory failure that led to the collapse of our banking system.
Farrell told an Oireachtas committee last week that the regulatory regime got the balance wrong between the consumer and prudential mandates. His message was that the consumer mandate was prioritised over prudent concerns.
The view that Farrell articulated when he appeared before the Economic and Regulatory Affairs Committee is now orthodoxy in Irish banking circles.
Talk to any senior banker about the causes of the banking crisis and chances are he will pretty soon be telling you that the Financial Regulator was so busy publishing consumer information leaflets and policing overcharging issues, that it took its eye off the ball on the prudential side of the house.
The argument has also gained traction with the government, which is proposing to reform the regulatory regime to give greater priority to prudential matters, possibly at the expense of consumer protection.
There is certainly truth in the observation that the Financial Regulator took its eye off the prudential ball. It appears to have paid inadequate attention to the riskiness of the banks’ funding models, particularly their over-reliance on wholesale funding, the high volume of lending relative to deposits, and the huge commercial property concentration risks.
But that is to ignore the elephant in the living room:
namely, that the property developers continued to borrow huge sums from banks to buy development sites and build apartments because they believed that consumers could continue to shoulder ever higher property prices.
The main reason consumers were able to pay more each year for houses was because the Financial Regulator failed to stop banks from selling them unsuitable products.
Property developers came to believe that consumers had endlessly deep pockets because bankers continued to refill the consumers’ pockets with buckets of borrowed money.
When the consumer could no longer afford a property by borrowing the traditional, prudent two-and-a-half times his income, the bankers gradually relaxed the criteria to the point where it was considered normal at the peak of the boom for a borrower to take a mortgage of five or six times his income.
When the consumer could no longer afford the mortgage repayments spread over the traditional, prudent 20 years, the bankers devised new products to allow the borrowers spread the payments over first 25 years, then 30 years, then 35 years and, in some cases, 40 years.
When the consumer couldn’t afford to save the traditional, prudent deposit, the bankers came along and offered 100 per cent mortgages.
When the consumer still couldn’t afford the mortgage repayments, the bankers increasingly offered reckless ‘buy now, pay later’ products with low introductory rates leaving the consumer to face higher interest repayments when the introductory offer expired.
The bankers even launched interest-only mortgages under which the borrower paid only interest and no capital for an initial period and in some cases for a full 20 years.
As revealed in The Sunday Business Post last weekend, as many as 53,000 borrowers, many of them buy-to-let investors, took out such interest only mortgages in the last five years of the boom.
It would appear the only way many of those borrowers could ever have repaid those loans was by selling the property, an option which is no longer open to many of them as house prices have fallen to the point where a sale would lock in a massive capital loss, assuming a buyer could be found in the current market.
Finally, in 2006 and 2007, Irish bankers began to copy what was happening in the US and began selling subprime mortgages to consumers who would previously have been considered too risky under traditional bank lending criteria.
The only thing that prevented the sub-prime mortgage problem becoming a bigger problem in Ireland was not the intervention of the Financial Regulator, but the arrival of the international credit crunch which prevented our bankers from raising the funds that they would otherwise have recklessly lent to borrowers.
When consumers on average incomes still couldn’t afford houses, when interest rates rose after all those risky products had been unleashed, when even the banks recognised that the limits of what they could lend to consumers had been reached - or more accurately breached - the developers in early 2007 began to see the writing on the wall as consumers balked at the prices for homes and began to walk away from the property market even before the credit crunch hit hard.
The developers then leaned on the government to fund so-called affordable housing schemes using taxpayers’ money to help prop up prices. But the amount of taxpayers’ money made available was not enough to prevent the dike from bursting and pretty soon the banks found out that the developers couldn’t afford to repay their loans because they couldn’t find buyers for their developments.
The Irish Banking Federation’s suggestion that the Financial Regulator failed because it was too busy protecting consumers ignores one of the main causes of the domestic banking crisis:
namely them is-selling of unsuitable mortgage products to consumers which, in turn, gave comfort to developers that consumers could continue to shoulder some of the most expensive residential property prices in the world.
It is worth noting that the global credit crunch is also rooted in the mis-selling of unsuitable sub-prime mortgages to American consumers on an even more reckless scale.
It is true that better prudential regulation and better monitoring of the manner in which those sub-prime risks were being transmitted through the global financial system in opaque ways might have helped detect the systemic banking problem sooner.
But there wouldn’t have been a systemic problem if the dodgy mortgages hadn’t been funnelled into the US banking system in the first place.
Equally, there wouldn’t have been a property crash of such gargantuan proportions in Ireland if there had been better protection for consumers at the point of sale of mortgages.
Whether it was the proverbial unemployed man in the string vest sitting on the porch in Alabama buying a Ninja mortgage (no income, no job, no asset) from an unscrupulous sub-prime salesman, or a Dinky (double income, no kids yet) Irish couple buying a 40-year mortgage at ten times average income from an Irish broker or banker, the cause of this crisis is fundamentally the same.
The reality is that the banking system in Ireland and elsewhere collapsed, not because we had too much consumer protection, but because we had far too little.
The fact that the prudential supervision was also inadequate merely compounded the problem.
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