Squeezing mortgage holders for more profits


If the banks collude in raising mortgage rates, this needs to be investigated by the Competition Authority.


From The Irish Times (05/02/2010) – by Michael Casey


There seems to be an acceptance that Irish Life Permanent plc had no option but to raise their (non-tracker) mortgage interest rates for the second time in a matter of months without any signal from the European Central Bank. This is despite the reassurance given by Gillian Bowler about treating “our customers with the courtesy, respect and understanding they deserve”. It is widely accepted that the other mortgage lenders will follow ILP.


One of the “justifications” for the increase in mortgage rates is that the cost of deposits (and of borrowing by banks) have risen. This may be true but it does not follow that the lending institutions are in negative profitability. Because of inertia, a high proportion of depositors earn very low interest on their money – 0.5 per cent or less.


With inflation falling by 5 per cent a year, why should any bank pay more than 2 per cent for term deposits? It’s not as if deposits are at risk since they’ve all been guaranteed by the taxpayer. How many institutions pay interest on current accounts? What of transaction charges and surcharges and non-fee income?


Financial institutions pay a lot of money to PR companies to influence public opinion. We should not accept this argument about negative profitability unless all the relevant data is provided to make the case. It is to be hoped that the consumer protection wing of the Financial Regulator is assembling this data.


I doubt if the case can be made. It is much more likely an attempt to increase profitability and mollify shareholders. The directors of banks could lose their jobs if shareholders are annoyed; it is much safer to transfer money from customers to shareholders. (Bankers usually refer to their unquestioning customers as “low-hanging fruit”.)


In the current recession most small and medium-sized firms are paring costs, prices and profits to the bone in an attempt to woo customers and stay in business. Why on earth would banks do precisely the opposite? The answer is because they are not afraid of losing business.


If they all increase mortgage rates together then there is no incentive for any borrower to move his or her mortgage to another bank. They are captive customers. If the banks collude in raising mortgage rates this needs to be investigated immediately by the Competition Authority. If the banks really believe that margins are being squeezed, why don’t they reduce the term deposit rates, which are quite generous in a climate of falling prices? Why don’t they halve the salaries of managers and senior executives, cut back on lavish corporate hospitality, sell property and art collections?


One reason why they don’t take painful measures is because for years they were cosseted and in a position to make handsome profits year in and year out without much effort or strain, innovation or improved efficiency. They were so poorly run that they rode the property bubble without any regard to risk and almost destroyed the economy. The taxpayer had to bail them out. Now they want their unfortunate customers to pay more and increase the banks’ profitability.


It is instructive to take a somewhat longer perspective. In the seventies the banks had little interest in mortgage business. It had narrower margins than they were used to and it involved longer-term lending. This kind of business was all right for the building societies but not for the banks. Gradually, the banks began to pay more attention to the mortgage market, which started to grow fairly quickly.


They deliberately decided to enter this market and they cherry-picked the most reliable borrowers. They justified the narrower margins on the grounds of “cross-selling”. In other words, the new customers who took out mortgages with them could be sold other products as well, eg current and deposit accounts. The building societies were far from pleased and often complained that the main banks were able to cherry-pick customers because they had privileged access to the information provided by the system of cheque-clearing.


In addition to cross-selling, the banks also engaged in cross-subsidisation. For example, they often “justified” the very high interest rates on credit cards on the grounds that this had to subsidise overdraft facilities which, they argued, were very costly. Convincing data was never provided on any of this.


The important point is that the institutions often adopted lower-margin business as part of a deliberate business model to maximise overall profitability. They now seem to be arguing that this business model has also failed and they need another bailout – this time by the mortgage owners. It seems as if the banks can make any mistake, eg an ill-chosen business model, and be fully compensated for it. This is not just moral hazard; it is perverse.


Another question arises. If the banks can raise mortgage rates without any signal from the ECB then surely Ireland is driving a coach- and-four through the single monetary policy of the euro zone? If one country can unilaterally change its retail interest rates then there is no single monetary policy. How can the Central Bank or the ECB itself, justify this? If there is some justification, then another even more intriguing question arises.


For many years before the property bubble burst the Central Bank was often asked whether interest rates were too low in Ireland and whether this was pushing up property prices. The answer was invariably, “Yes, but because of EMU, there is nothing we can do”.


Well, if there is no problem about ILP and the other banks pushing up rates now, then why weren’t they encouraged to do so several years ago when such action would have slowed down the rise in property prices and prevented the horrific aftermath?

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