I welcome Mr. Pat Farrell, chief executive of the Irish Banking Federation, who is accompanied by Ms Eimer O'Rourke, head of retail banking, and Mr. Paul O'Connor, head of wholesale banking.
Financial and Banking Climate: Discussion with IBF.
Mr. Pat Farrell
Thank you, Chairman and members. We are pleased to have the opportunity to discuss the issues raised by the joint committee. To summarise, I will outline the role of the Irish Banking Federation, how the sector has evolved, particularly from the retail point of view, and I will comment on the international sector. I will talk about the global financial turmoil, of which we are conscious and its impact on our economy, and I will refer briefly to regulation, although I am constrained to a degree as the IBF is not the regulator. I will talk about the financial markets and how the market looks for the future.
There are three distinct elements to the Irish Banking Federation. We represent more than 70 member banks, 13 or 14 of which are retail lenders, the remainder are international banks based in the IFSC and across the country. We have a number of professional service firms as well as associates. The Mortgage Council looks after the mortgage lenders, the Federation of International Banks looks after the international banks and the Irish Banking Federation brings together all the entities.
It is not unusual that we would be plugged into the European scene, as members might know 60% to 70% of the legislation that drives financial services emanates in Europe and will be increasingly so into the future. We are represented on the European Banking Federation, which is the voice of commercial banks across Europe and would be the primary lobby body with the Commission and all its entities. We are also a member of the European Mortgage Federation, representing mortgage lenders across Europe.
More recently we joined the European Covered Bond Council. We did so because in the past number of years the traditional model of funding lending from customer deposits has not been able to keep pace with the growth in the economy and increasingly Irish banks, as banks have internationally, have used instruments such as covered bonds and issued mortgage assets to increase the ability to lend to the market. We are a member of the European Covered Bond Council, which is the body which represents people who issue these mortgage bonds across Europe.
I will comment on the role and contribution of the banking sector to the economy. It is no harm to remind ourselves that banking is not just a business that oils the wheels of the economy in terms of providing credit, it is also a very big player itself. In 2006, the sector spent €6.2 billion on wages and services. It also pays more than €1.7 billion in taxes, when account is taken of VAT, PAYE and corporation tax. In fact the sector accounts for 7% of GNP. We also collect a further €120 million on behalf of the State through stamp duties, cheques, cards and other financial transactions.
If one adds the numbers working in professional service firms, in other financial bodies such as brokers and so on, and the people who are employed in support services across the Irish Financial Services Centre in the Docklands, the number of people employed in the banking sector comes to 100,000. More than 6% of private sector workers in Ireland are employed in financial intermediation. That is a very significant figure. We often hear about the numbers employed in the construction sector or in other sectors but it is not often that we hear about the numbers employed in financial services. The banking sector employs approximately 41,000 people, so the lion's share of people employed in the sector are in banking, of which 32,000 are employed by the major retail banking groups. On top of that, a number of Irish banks have operations across the globe which employ an additional 15,000 people.
The next slide is a map of Ireland, courtesy of the IDA, showing the location of the branch network as well as international financial services. International financial services are not just based in Dublin but are increasingly based right across the country. For example, MBNA in Carrick-on-Shannon, which will particularly resonate with the Chairman, is a major credit card provider employing 1,200 people in the upper Shannon region. It is the major employer in that region and underpins economic activity in the area. More recently, Elavon has established a base in Cherrywood. It is a major card acquirer and employs 500 people in a service centre in Arklow with 60 employees in Loughlinstown and Cherrywood, and those numbers are growing.
Right across the country, from the western seaboard to the south, this picture is replicated. In the south a critical mass of funds administration companies is beginning to develop in places like Cork, Waterford and Kildare. In Kildare and Kilkenny more than 2,000 people now work in financial services with companies like State Street, Bank of Ireland and others.
As for employment in international financial services, 17,000 work in the IFSC, the majority in banking and funds and the remainder in insurance. The projections of the expert group on future skill needs, in a report published by PWC, are for employment in the sector to grow to 30,000 by 2012 and that figure relies solely on trend growth in international financial services in recent years. Even as we speak, big global names such as Wachovia and Goldman Sachs are establishing operations in Ireland. Global players such as Citigroup and Merrill Lynch, which initially began with small operations in the IFSC, now employ 2,000 and more than 1,000 people respectively.
In recent months the City of London, which regularly benchmarks global financial centres against itself, ranked Dublin as 13th in its global financial services centre index. That ranking was arrived at by looking at a number of factors such as property costs, regulation, taxation, access to customers, skilled workforce and the responsiveness of Government to business needs. Asset managers right across the globe gave Dublin a ranking of tenth, alongside Edinburgh and Frankfurt, and insurance executives listed Dublin in seventh position. London and New York were the top two overall centres and Dublin came in tenth. When the survey began more than two years ago we were ranked 22nd, since when we moved up to 15th and then 13th.
We recently carried out a survey of CEOs in the IFSC and, despite the fact that the survey was carried out in March, most said they will continue to increase their business activity and employment during 2008. Most companies expect to expand their product range, although they are also focused on operating costs and business processes. Some 87% of CEOs rate Ireland as a good business location for international financial services. The IFSC continues to be a very attractive location for international financial services companies.
I will now focus on retail banking, which is probably the sector with which we have the most interaction on a day-to-day basis. Banking is a very mature market and there has been a huge number of new entrants to the market in recent years. The timeline chart shows the names of the players who have entered the market, acquired Irish banks or created strategic alliances with other players. The most recent was Fortis Bank, which formed a joint venture with An Post in 2006. I remember talking about this on the last occasion I was before the committee and members will also see in the paper that Fortis is developing its product range, announcing the launch of a current account and looking at developing products for the mortgage market.
On the next page of the presentation, members will see the new entrants across all the various areas. We have grown from having eight providers of credit cards to 13, from nine providers of personal loans to 21 and from nine providers of mortgages to 14. However, there are fewer providers of current accounts, with one very small provider no longer providing them. With the advent of the single European payments area in 2010, any citizen of this country will have the ability to operate a current account and set up standing orders and direct debits with any provider across Europe because all the banks in Europe are committed to providing a suite of SEPA-compliant products for those facilities. Effectively, this means a person who wants to send a standing order or direct debit from Dún Laoghaire to Gdansk would be able to do so with the same ease and at the same cost as if he or she did so within the country. The direct debit facility has been in operation since 1 January 2008, when it was launched by Mr. John Hurley, the Governor of the Central Bank.
I will talk a little about distribution because if a poll was carried out it would probably show that people's foremost impression was of a wholesale reduction in bank branches over the years. However, exactly the opposite is the case and in the past five years the number of bank branches has remained stable. There are 956 bank branches across the country and while some have closed in certain areas new branches have opened in others. Not only has the number of branches remained stable but the distribution capacity in terms of bricks and mortar has increased substantially. Members will probably be aware of the arrangement, which has been in place for a long time, whereby An Post offers agency banking services across its network. One can walk into any post office and lodge funds, withdraw money or pay bills across the counter. This has provided a lifeline for many rural post offices across the country.
On top of the developments in the bank branch network there has been almost a tripling of ATMs. One can now find an ATM within a couple of hundred yards, certainly in any urban area. Many machines have been installed in other convenience locations such as supermarkets, petrol forecourts and so on and there are now more than 3,000 ATMs. In addition, more than 40,000 merchants have laser and debit card facilities whereby one can pay bills or get cash back. This is for the convenience of banks, retailers and customers because it reduces the amount of cash held by merchants, retailers and banks.
The next page of the presentation deals with the global financial turmoil. I do not want to recapitulate recent events because more has probably been written about them in the financial pages than about any other issue in a long time, certainly in my memory. We have clearly had a global liquidity squeeze, starting in August 2007, and the events are well understood. They have their genesis in the collapse in the US sub-prime mortgage market, where people were provided with loans who had no ability to repay them. As they came up for repricing, that inability to repay became evident so they became worthless and this spread a contagion across the financial system. The critical issue was a lack of transparency over where risk ultimately lay. This led to a breakdown of trust among banks as the lack of transparency and clarity as to where assets reposed as well as who held them made banks reluctant to lend to each other. The losses had a direct impact on the banks that held the assets in question but an indirect impact on other financial institutions, effectively driving up the cost of funding which has affected all banks and financial institutions globally.
The turmoil has obviously had much broader implications because it has affected confidence generally and has inhibited lending in unsecured interbank money markets. Central banks have made several interventions and there have been a number of market initiatives. The injection by central banks of additional liquidity into the market, particularly on the short-term side, has been helpful. As a result of what we now know, there is wholesale reappraisal and re-pricing of risk. There are still problems at the short end of the interbank market. These have been alleviated specifically because of the interventions of central banks pumping additional liquidity into the system. The ECB system was particularly active and its earlier interventions were well timed and well judged. The spreads remain fairly high on longer-term rates, which has made bank funding more expensive than heretofore. That has had an impact at the retail side with customers because it has created a direct impact on the rates offered by banks on personal lending products and on mortgages.
The next slide best illustrates what has been happening in financial markets. The red line represents the ECB rate. That is the rate we have all come to regard as the benchmark rate and the one on which we price mortgage lending rates and other rates. There was a series of increases and then the rate remained steady at 4% since last July. In the meantime rates rose steadily in the three-month Euribor market, which is the interbank market, from July-August onwards, peaking towards the end of the year. Then there was a reduction because, coming to the end of the financial year, banks were anxious about liquidity and were, effectively, hoarding cash to maintain their levels of liquidity. That then abated somewhat. However, coming towards current times the Euribor rate rose again.
It is obvious that a crisis or turmoil that had its origins internationally, particularly in the United States, has spread across the system because the financial markets are more globalised than any other market. That has increased the funding costs for the banks. Lack of liquidity still persists in most interbank markets and that means the supply of credit has tightened. Irish banks are not as impacted as those in some markets because — and this has been adverted to on several occasions by analysts and by the Central Bank — approximately 50% on average of the funding for banks in Ireland comes from the interbank market. We have a very good savings ratio here. This continues to be the case and banks still source more than 50% of their funding for lending from customer deposits. While mortgage rates have risen, so have rates for savers because banks are obviously keenly competitive in that space and, in the current climate, are keen to attract more customer deposits and retail funding.
The diversification that has allowed banks to keep up with the economic growth in the market has come about through the issuance of covered bonds. This is, effectively, packaging mortgage assets and then selling them on as debt instruments to the market. That allows banks to re-lend into the market. That market has dried up over the period since the turmoil began although, generally speaking, there are some green shoots beginning to emerge and we are beginning to see the signs, although they are very tentative, of the beginnings of activity in these markets again. We also have access to the ECB system. That has meant that banks are able to generally avail of those facilities in order to exchange and for liquidity, and that has been very useful for the banking system here.
The next chart shows the level of housing completions. It is hard to say which is tracking which, but loan activity has decreased almost in tandem with the level of house completion. It shows the correlation between the two. Other more authoritative voices have spoken on this topic and I am aware that the regulator has attended before the Joint Committee on Economic Regulatory Affairs. The survey the Central Bank did last year showed that the exposure of Irish banks to subprime is negligible. Irish banks' investments in residential mortgage backed securities and hedge funds is low. There was a new liquidity regime introduced by the regulator in July 2007 which was prudent at the time because it was driven off the back of requirements in the capital requirements directive, or Basel II as it is sometimes called. This required banks, through the regulator here, to adopt a new liquidity regime. That has now proved to be very useful in terms of the conditions in which banks here find themselves currently and since the turmoil began. Banks are now providing weekly liquidity reports to the Financial Regulator.
The system is stable and sound overall. Again, my sources for these comments are authoritative. Last month the OECD did an economic survey of Ireland and pronounced that Irish banks are well capitalised and profitable. Earlier, in February, the Governor of the Central Bank said that the outlook for the stability of Irish banks is positive. In both the OECD study and Governor's review it is stated that the sector's shock absorption capacity has been largely unaffected by the turbulence in the markets to date, that there has been no significant exposure to US subprime assets and that, furthermore, the stress testing of the banking system indicates that Irish banks are solidly profitable and well capitalised.
The area of regulation of the sector is somewhat outside my competence in that we are not the regulators of the sector. Regulators attend before the committee on a regular basis and the committee has oversight responsibility for the discharge of their functions. The regulator was established as a single authority in 2003. That is a good thing when one considers the situation that has evolved in the UK where there was a tripartite mechanism which seemed to be deficient in terms of its rapidity of response to issues in the UK. We, on the other hand, have a single regulator. We have, effectively, the financial stability role of the Central Bank alongside the banking supervision role of the regulator combined in one unitary authority housed in the one building. That has stood the test of time.
The IMF, which did a review of regulators in late 2007, judged the Irish Financial Regulator number one globally for its independence and accountability. The regulator here does not operate in isolation. It operates within the EU regulatory framework. It therefore operates within the committee of European banking supervisors and, therefore, there is regular dialogue with regulators across the EU within fora where they are able to exchange information and data on what is happening in their own geographical area and on what is happening in banking groups that have operations that transcend national boundaries. They are able to get a holistic view of what is happening across complex pan-European banking groups so, for example, the regulator here regularly engages in a college with regulators from other countries in which banks that are based in Ireland have operations, and vice versa. For example, where there is a subsidiary of a Dutch bank here, the Dutch financial regulator would invite the Irish Financial Regulator to participate in a college that would supervise the activities of that bank.
On financial regulation generally, the current conditions have marked a coming of age because the regulator is just five years old. It began as a unified authority. That was a good and prudent move at the time and it has served us well, particularly in recent times. The regulator and the regulated entities have met the challenges and weathered the storm well to date. The fact that the regulator has adopted a strategic planning approach has been very beneficial and its consultation process has improved and strengthened over the period since it was first established. That is important because it is a principles based regulator and, at the end of the day, it places a primary onus on the banks' board and executive management to ensure they are compliant and that they have good quality governance.
Looking at the financial markets in the future, the essential issue is to try to restore confidence and trust. There are some green shoots there but it would be difficult to call it at this stage in terms of whether we have hit the bottom. Even as late as today there is a report in the newspapers that one large global bank is of the view that the turmoil could last for another 12 months. That is not to say it would last at the intensity experienced since August 2007. There are a number of green shoots, but it is a difficult one to call at this stage.
There are many lessons to be learned for regulators and banks. Given the involvement of investment banks, particularly those in the United States, in packaging subprime assets, more understanding and transparency in respect of the underlying assets will be required. For example, what is their mix and how are they being rated? Investors will seek more transparency because the products were not what they were to believed to be. There will be increased ongoing disclosures to regulatory authorities about these instruments, what they constitute, etc.
This is a global issue — financial markets are the most globalised sector — and requires a global response. In recent months the European Union has set out a clear road map as to how it views the issues being addressed within its environment. The International Organisation of Securities Commissions, IOSCO, the committee of global securities regulators, has also tabled initiatives, while other regulators in the United States and Europe have been in close contact. The huge number of international regulatory bodies' reports — the Financial Stability Forum has published a report — are being used as a road map to drive change.
Locally, the regulatory and market response to the turmoil has been timely and well judged. I referred to some of the decisions made by the Financial Regulator last year on the back of the capital requirements directive. Irish banks remain well capitalised. Members may have read recent reports on banks trying to rebuild the capital on their balance sheets, but Irish banks' capital ratios are well above those mentioned. The priority is to restore confidence in the financial markets. Financial institutions which held the assets in question are continuing to deleverage and, in some cases, find markets in which to sell them at significant discounts. There are the beginnings of activity in the market in the form of investment and hedge funds that are prepared to buy the assets at bargain basement prices. The process has some way to go. Our focus is on maintaining our good position in the market during the period of turmoil.
I thank Mr. Farrell for his comprehensive report.
It is heartening to hear that the Irish banks are in rude good health, although their share values have taken a considerable hit.
Mr. Farrell addressed the lessons learned. One of the lessons learned from a recent trip to the United States led by the Chairman related to the extraordinary way in which commissions were paid. Effectively, they were one-way bets and people were paid to take high risks with their companies' capital, resulting in significant exposure for shareholders. Those riding shotgun on risk management were marked absent, that is, they were paid in such a way that they no longer saw it as their role to ride shotgun on anything and gave the green light to all sorts of activities. The presence of derivative products enhanced the risk in spite of being meant to reduce it. These features appear to be rampant throughout the industry in the United States and Europe. Mr. Farrell did not refer to how the banking system should reform in the light of events. While there has been little evidence of the practice in question in the Irish market, I would be interested to hear Mr. Farrell's response.
The Central Bank's risk analysis or stability report revealed an extraordinary level of exposure on the property front which has driven the stock market down. It is not that we have had a bad experience. Rather, the percentage of loans tied up in properties is high. What is Mr. Farrell's perspective? We have not reached the bottom of the property shake-out. Mr. Farrell does not have insights into the extensive exposure on properties, but he may have an insight into the system's capacity to deal with the level of exposure and whether policy issues must be considered to ensure such exposure does not have an adverse impact. The central banks of some jurisdictions have been remarkably interventionist, whereas traditionally they would have run a mile from such interventions. If there is property exposure, do we have policy instruments to address it?
I will revert to a number of older friends who may have been forgotten in the recent focus on the credit crunch. The consumer director of the Financial Regulator drew the attention of the committee and people in general to the fact that, during the period in which interest rates were decreasing, the banks chose to increase the margins on personal borrowings — credit cards, small business loans, etc. — and lower them in respect of larger business customers, mortgages and so on. What has occurred in respect of the margins in the different sectors of the banks' business during the recent increases in interest rates?
The failure of a particular bank — one suspects others also — to have proper systems of data protection in place has entered the public domain. It did not appear to provide for even basic encryption of personal records kept on laptops that were subsequently stolen. Not only was the data protection provided inadequate, but the way in which the issue was handled was strange. For example, the theft was not notified immediately to the Data Protection Commissioner and a long time passed before the defects were admitted to. This is not a satisfactory way to deal with an important issue of public confidence. Which of the lessons learned are being applied by the federation to its member companies in the light of what was a disastrous outcome? The matter continues to unfold because we have not got to the bottom of it.
I was pleased to see that our financial services' competitiveness ranking increased from 22nd place to 13th at a time when the National Competitiveness Council stated we had dropped 17 places in terms of our competitiveness in general business. What are the key differences and why is the banking sector's experience of improving competitiveness different from that of every other sector? Are there areas of banking in which we have scored high recently? It cannot be a question of cost, as all indicators suggest our costs are not improving. What is Mr. Farrell's insight into what is driving our competitive edge upwards?
I attended an event organised by the Irish Banking Federation at which the message was that regulatory regimes were becoming onerous and burdensome. It was the belief of many of the federation's members that the system was slow, cumbersome and not up to speed, but this belief appears to have changed dramatically. I would be interested in Mr. Farrell's comments in this regard.
Mr. Pat Farrell
In regard to the lessons that can be learned, I spoke in my presentation about the need for greater transparency and understanding of underlying assets so that people can know the composition of the assets they purchase. I also set out the requirement from a regulatory point of view for more disclosure and greater transparency of these products.
The Deputy correctly pointed out that the incentives were wrong in terms of the commissions paid to these people. Nearly all the subprime loans were written by unregulated entities and not by banks. That is one lesson we can learn from the United States. Legislation is currently being considered in the US Congress to close the gaps that appear to exist in the regulatory regime between the Securities and Exchange Commission, the Federal Reserve and the other bodies involved.
Mr. Paul O’Connor
The reason we have structured products is that economies need credit to function. It is the oil that keeps economies moving. Once a credit provider has an asset book, it packages the assets into structured products and sells them on through the secondary market.
Several lessons have been learned on the functioning of the secondary market. The European Commission asked the industry to establish a round table to consider the securitisation space in particular with a view to determining the measures that can be put in place for the future. The Commission is keen that the solution is led by the industry because it does not wish to impose a level of regulation. The round table has agreed three key measures, the first of which is better provision of data so that authorities can identify where risk exists and who owns it at any point in time. In the subprime crisis, where debt was sold on through the functioning of the secondary market, the issuer and original purchaser could be identified but the key problem was tracking the debt as it was sold on. That issue underpins the uncertainty that currently affects the market.
The second measure concerns best practices for investors. In future, issuers will provide more information on underlying assets, thereby putting the investor in a more informed position. These best practices will be implemented by the industry in both Europe and the US.
The third area involves greater disclosure under pillar three, market disclosure, of the Basel II directive on capital requirements. Reporting under the pillar will take place for the first time after this year but the matter is being revisited to ensure greater granularity of reporting on these products, which would put financial regulators in a better position. Reporting discipline is good for banks because it ensures that internal processes are established to produce and analyse data.
Mr. Pat Farrell
The other area to which Deputy Bruton referred was bank lending. I refer the Deputy to the regulatory authorities on this. As late as last month, the governor of the Central Bank indicated that loan books of banks are regularly stress tested and they have been judged to contain good shock absorption capacity to withstand the turbulence currently being experienced in the market. Banks are well capitalised, with strong tier one ratios of 7% to 9%, and every other authoritative analysis of the market has concurred with the Central Bank's view. I refer the Deputy to those reports because reassurance ultimately comes from the people who are charged with regulating the sector. They have access to the data and are in regular contact with banks on these matters.
In regard to the consumer director and interest rates, the most recent quarterly bulletin of the Central Bank examined the movement on interest rates and found that rates on new consumer credit loans broadly reflected trends in money market rates. It also stated: "mortgage rates are somewhat insulated from the financial turbulence due to competition among mortgage providers." It was only in recent weeks that the majority of mortgage providers increased their rates and, even then, they have not been increased by the actual change in spreads based on interbank rates. I am sure some of the committee's members are shareholders in banks and avidly read their annual reports. They will be aware that the recurring theme on interest rates is the continuing compression of net interest margins for all banks. That, taken with the statement from the Central Bank which analyses these movements and rates, reveals margins have not widened as a result of the changes which have taken place. Interest rates on savings and deposits have increased alongside mortgage rate increases and in some cases they have performed quite strongly.
I am glad the Deputy raised the issue of credit cards because there have been several new entrants into that market since we last spoke about the matter. Rates now vary from 8.9% to 17% APR. The Financial Regulator regularly publishes surveys on the different features, benefits and interest rates attaching to credit cards. I firmly take the view that competition would be further enhanced if the €30 Government tax was removed. The tax was reduced modestly in the last budget but its elimination would spur competition. I have one credit card, which costs €30 just to carry in my pocket, and I would spend €90 if I had three cards. Most people would carry several credit cards, switching them on and off according to which provider pleased them in a particular month in regard to features and benefits or interest rates. However, one would not carry more than one card if it cost €30 to carry each card issued. Other actors outside the banking sector have a role to play in stimulating competition in the credit card market.
I am not at liberty to discuss the issues pertaining to the Bank of Ireland, which have been well chronicled, and are matters for the bank and the Data Protection Commissioner to address. However, on the broader issue of data security for customers accessing websites and internet banking, we have invested significant time and effort in establishing a high technology crime forum, chaired by Mr. O'Connor.
Mr. Paul O’Connor
The forum was established to bring together the financial institutions engaged in internet banking or offering interbanking services from Ireland, the Garda Síochána and representative bodies of telecommunications companies and payment organisations in order to reach a common understanding of the threats faced by the Irish banking industry in terms of information security and financial crime over the internet. The forum was established to share information and the general principle is that all institutions, including An Post's Postbank, are committed to ensuring the maximum level of security is available to customers.
Mr. Pat Farrell
In regard to the IFSC and competitiveness, it is well understood that our level of competitiveness has reduced. Competitiveness is an issue for the IFSC as well as for every other sector. In fact, in the survey we did recently costs were cited heavily by senior executives and CEOs as an issue. However, when companies consider, in the round, the advantages of doing business in the IFSC, they obviously outweigh the costs. These advantages are well chronicled but, for the information of members, they include the fiscal regime. The 12.5% rate — previously 10% — of corporation tax was an important incentive in attracting firms to the IFSC.
But they have not been improving. Mr. Farrell is saying the country has actually improved as a location from 22nd to 13th, which would suggest——
Mr. Pat Farrell
I am speaking generally, but if the Deputy wishes to hear about specific improvements, I will mention that the availability of a skilled workforce has been an asset and that there is much work under way with academic institutions in introducing new courses and training modules to improve skills. Part of the response of the IFSC to the country's general loss of competitiveness is to try to drive activity further up the value chain. When the IFSC was first established, a significant majority of its operations were back-office; now there has been a definite shift towards middle and front office activity. This has been the trend for some time but it needs to be accelerated in the next number of years if we are to maintain our relatively favourable position. Other things that have occurred on the fiscal side include the introduction of the holding company regime in last year's Finance Bill. This makes it attractive for a company to establish its base of operations in Ireland as opposed to having a subsidiary or satellite company here because the regime for tax treatment purposes is more attractive. Thus, we are not just talking about any one issue.
The other thing people like about the location is that we have access to a market in Europe which is improving all the time. As the market in Europe has become bigger, firms locating in the IFSC have had access to an ever bigger market. The final important element of the improvement is the completion of the financial services action plan which has been a boon for wholesale banking because it has actually created a single market in wholesale financial services across Europe. Effectively, a wholesale bank or financial services firm in the IFSC is operating to a large degree under a common framework of regulation and can market its products across Europe. Some of the IFSC companies have become European bases for activities which cut right across the European Union.
I do not want to be seen to be speaking out of both sides of my mouth, but with regard to regulations generally, the reality is that we are not involved in a love-in with the Financial Regulator. At the end of the day the regulator must regulate the sector and if it is doing its job properly, we will not always agree with it. This occurs frequently, but we must acknowledge that the decision to establish the regulator on a unified basis proved to be the correct one. I also made reference to the fact that consultation with the regulator had improved. Thus, while some of my comments a few years ago, in the early days of the regulator, were about lack of consultation, things have improved considerably in recent years. The level of consultation is now a lot higher and that means the decisions and outcomes are of better quality because consultation takes place with all stakeholders, not just with the industry. A consumer panel and an industry panel were established a year after the regulator was set up and this has also helped improve the level of consultation from the point of view of both the industry and the consumer.
With Deputy Bruton, I welcome the representatives of the Irish Banking Federation. Following on from this discussion, there are a number of points and questions I would like to raise.
I welcome the comments of Mr. Farrell, particularly about the importance of employment in the banking and financial services sector. It is an appropriate area of enterprise for Ireland, with its mix of people and educational qualifications and the importance of the English language. I also accept Mr. Farrell's comments about the capitalisation of commercial Irish banks, in particular, being strong compared with some of their counterparts in the USA which have run into trouble. My question is in the context of globalised financial markets and the complex derivative financial products traded. It sometimes seems that the only type of person who can understand these products is a 26 year old straight out with an MBA and a computer and some serious mathematical skills, plus long experience of late night poker in order that he or she knows how to play for risk. This is very demanding in the context of the standard high street bank. I took part in the committee's trip to Washington DC and Wall Street, where we met some of these 26 year olds, some of whom were doing well and some not so well.
The issue for Irish banking is that while it is not exposed to a severe degree to the sub-prime crisis and, with regard to the other complex instruments — derivatives, hedge funds and so on — we must take the word of the Central Bank that it is supervising the sector in such a way that it is satisfied our banks are not over-exposed, what is worrying about the balance sheets of Irish banks is the extent to which the banks have inevitably been involved in construction industry financing and the fact that at the height of the construction boom in Ireland, it was not so much that construction costs per se were rising but that the boom was being driven by land values and speculation in land. This in many ways parallels what happened in Ireland in the 1970s and 1980s following our accession to the European Union. If members recall, banks had money to lend to farmers for land of any value because agriculture was entering a boom period, but when interest rates became higher, the same banks turned harshly on many of the farmers concerned. Having lent at the top of the hill at maximum rates and effectively boosted prices, when things became tougher, the banks turned on the people to whom they had lent. This has been paralleled in recent years in the construction industry. While construction inflation is strong, it is nothing like the inflation in land values.
In terms of the balance sheets of the commercial banks, are builders exposed? It seems this issue is not being addressed. Not all builders will be exposed but, inevitably, some speculators and developers will be. The redoubtable Mr. Owen O'Callaghan said the other day about the fall in the market, "There will be blood." I would be interested to hear Mr. Farrell's assessment of the impact of this on his members and whether he believes they are exposed or covering their exposure. I know that some of them are seriously considering acquiring more equity. In addition, as Mr. Farrell said, deposits in Ireland are strong, which strengthens their liquidity base.
That leads me to my second question. In my constituency in north-west Dublin which has seen massive building and expansion all the builders tell me the same story. They are being told by their banks to sell because they need liquidity. There are probably no absolute figures available but it seems builders are being forced to sell at a discount on the previous prices which included inflated land values. Thus, the hit they are taking depends on how long they have held the land. They are being told to sell in order to generate liquidity for the banks. However, in Mr. Farrell's view, are the banks holding a gun to the head of the construction industry by forcing builders to sell? How does Mr. Farrell expect this situation to play out?
On the other hand, developers constructing properties on the periphery of cities and providing houses and apartments targeted at first-time buyers, are discovering that many of the latter are experiencing difficulty in securing finance. It seems the days of the 100% mortgage and the buy-to-let mortgage are gone, except in the case of certain favoured occupations such as barristers, civil servants, gardaí and perhaps Oireachtas Members.
In certain constituencies.
Builders tell me that young people working in the retail sector, for example, and people with their own business are being offered a maximum loan value of 75% to 80% by banks and building societies. For a first-time buyer seeking to purchase a home costing €400,000, which represents a modest property in Dublin, he or she must secure a deposit of up to €100,000. Prices are much cheaper outside Dublin. There was mention on Joe Duffy's radio programme last week of builders in places such as Roscommon offering fine houses for less than €300,000.
Has the Irish Banking Federation had any discussions with the Government as to how younger people who are not used to saving can be assisted in entering the market? I spoke to one reputable and established builder who wondered how sales might be rekindled given that the mortgages offered to people in this category are so tight. The decrease in sale prices means that people who purchased homes in my constituency two to three years ago are now faced with a substantial degree of negative equity at a time when mortgage prices are rising.
Ireland has one of the highest rates of indebtedness, including credit card debt, in the EU. The Central Bank has repeatedly pointed this out in its reports in recent years. With tighter liquidity and with banks in the United States looking at the credit card indebtedness of those customers with a poor track record, what is happening with Irish banks? People are continuing to borrow heavily on their credit cards. Will the Irish Banking Federation offer advice in this regard? Many people with their own businesses are facing into tighter times and banks are taking a much tougher line with them. There are many small and medium businesses in my constituency. Owners have told me that credit lines previously available to them are being subjected to increasing scrutiny by banks.
Over and above what the regulator may be saying to banks, is the IBF looking at the bigger picture, taking stock of areas other than the construction economy and considering the knock-on effects of the tighter liquidity to which Mr. O'Connor referred? How do the delegates expect this to play out? I note that Davy Stockbrokers seems to have reached an agreement with the credit unions in regard to products it sold them which comprised complex long-term bonds. This deal seems eminently sensible, establishing a ten-year timeframe. It seems there was an effort to be fair to the credit unions but also to the sellers by affording them some space to assist their clients. What is the delegates' view of customers purchasing products for pension fund investments?
I apologise for interrupting Deputy Burton. Some members wish to be excused because there is a vote in the Seanad.
At what time does the Chairman expect the meeting to end?
That is a matter for the committee. I consider two hours to be an appropriate length of time.
What is the delegates' view on customers purchasing pension products which are often tied up in complex financial offerings? How much information is available to them about the inherent costs built into those products which are often exceptionally high compared with the United Kingdom, where margins appear on pension products and there is greater regulation? The credit unions, despite the financial advice available to them, have made some inappropriate investments in long-term bonds. How does the Irish Banking Federation see its members offering advice to people who want to invest in pension products but do not want to be fleeced?
In the context of all that is happening in the markets, do the delegates not agree that the salaries and other remunerations for senior banking executives in this State are excessive? Such inflated salaries belong to the height of the boom. If there was some moderation in the financial packages awarded to senior executives, we might assume that the banks were taking some responsibility for the financial difficulties that many people in business and employment now face. It would show some awareness on the part of senior bankers that they acknowledge and share some of the pain they have caused through their reckless stoking of the boom and, in some cases, by their sheer greed. There must be a recognition of the difficulties experienced by those who are struggling in business, those who have lost their jobs and those who purchased a home in the last two or three years and now face negative equity.
We live in an age where the economy moves in cycles. We have seen several such cycles in the last 150 years, with the economy alternately rising and falling. The delegates referred to stress-testing. This strikes me as something of a joke because it seems to have been of little use in the case of ordinary mortgage holders in whose cases in was routinely applied. When I hear of banks paying more for money than they are getting in return, it seems to me that stress-testing has no importance or weight.
I agree there is a liquidity problem that must be faced. That is clear from what has been happening with share prices in the last six months. The market is generally the best barometer of what is happening in the financial world. When the amount paid by the banks for money is greater than the return they will receive from lending it, there is undoubtedly a crisis. I do not want to name the banks in question but people have told me that substantial quantities are being deposited at a higher level of interest than the return on the money. That calls for a serious investigation. We do not want a situation where one of the banks operating in the Irish market, none of which is a large player on the international scene, goes belly up. There is the danger of such an eventuality in the context of the global crisis.
Mr. Farrell is representing the banks in a voluntary capacity. His function is to defend them and to make their case to the Government and other regulatory agencies. The Central Bank could have been more vigilant in the last two years. It seems to have been fast asleep when the economy was riding the crest of a wave. As we have discovered, that wave was built on bricks and mortar. I attended many Fianna Fáil functions and conferences where people spoke about the dangers of our economy being too reliant on the construction industry. No action was taken and no advice was given. I am very critical of the Central Bank in its role in defending the economy, the banking system, and the citizens of the State who invest money.
We can look at Japan, which was in a crisis over the past ten or 15 years. The country even had interest rates of zero while experiencing both deflation and inflation. It has been all over the place and has still not emerged from the crisis. Low interest rates do not solve anything and do not provide the necessary discipline. That is a fact which has emerged from that country.
On e-banking I listened attentively to the points on the ATMs but our biggest problem in Ireland is we are among the biggest users of cash and cheques in Europe and the world, which will have a significant cost factor if we do not move into the e-banking area. I understand it costs our State €1.4 billion. We must get into e-banking if we are to be a force in finance and business in future. Currently we are very inefficient in that regard. When the discipline is there in our economy is the time to emphasise the importance of e-banking and get people away from cash. We can look at countries like Denmark and France. The UK is much like ourselves but still has about 50% of its business done through e-banking. I have four credit cards but my secretary has only one. So I make a contribution. As well as I can with the current crisis, I transfer from one credit card to the other to survive. That is a good way of doing it.
I have made a number of points but there is a role for the Irish Banking Federation in the e-banking area. How will we go about making this more attractive to people and giving people greater encouragement to have a more efficient system of banking, rather than drawing cash from every hole in the wall in the country? There are many of them to be seen now. Cash is not the way forward.
Mr. Pat Farrell
I was asked about 17 questions and I will go through them. Perhaps Mr. O'Connor will comment on complex financial products.
Mr. Paul O’Connor
The other people who generally understand the complex financial products are regulators. The Financial Regulator in Ireland has a very good team on derivatives. It consists of people who have worked in the industry beforehand.
Is it the case in the United States or Europe?
Mr. Paul O’Connor
I am just talking about the Irish Financial Regulator. One of the difficulties with complex financial products is that they are really a product of innovation in the marketplace. It is very hard to put a brake on innovation. What is important is that banks have the necessary risk systems to understand exactly what their teams are doing, and that there is necessary dialogue with the regulator so it can also have some oversight on the direction of the market.
This is something the European Commission has considered in detail as a response to the credit crunch. It has looked at how it can monitor accelerated growth in certain asset classes. I have not seen its recommendations yet but it is certainly on the radar.
It requires vigilance on the part of the banks with their teams and vigilance on the part of regulators. There must be very good dialogue between the two in order to monitor the development of products. It is very hard to slow down innovation so it must be managed in a sensible way.
Mr. Pat Farrell
Returning to the issue of Irish banks, it is not my role to talk about the balance sheet of banks. There is a regulator in place and a Central Bank which regularly stress tests and has access to a significant amount of information on banks. There are weekly reports to the regulator by the banks on liquidity positions. All the published data and references which have been made — by the regulator, Central Bank and OECD — point to the fact that Irish banks are well-capitalised, profitable and well positioned to weather the evident turmoil. They have very minimal if any exposure to the kinds of toxic assets that have been the subject of such focus over some time.
With regard to builders and house prices, we collect data on the mortgage market on a quarterly basis. Nearly 30,000 mortgages have been advanced in the first quarter of the year. It is not like there is a famine in the mortgage sector.
I refer the committee to an article in one of today's daily newspapers by Frank Conway, a representative of the Irish Mortgage Corporation. I use this as a reference because mortgage brokers are the people out there dealing with all the various financial institutions. He makes the point that although the 100% mortgage product has been pretty much withdrawn from the market — it is available in some cases, as Deputy Burton mentioned — applicants can get up to 92% loan to value on mortgages for first-time buyers.
Mortgages are still being written in the market in quite a volume. The number of mortgages written in the market in the first quarter of this year is not much different from the first quarter of 2005. It is down from the heady levels of 2006, when the market peaked in every way in terms of house prices and mortgages written.
The level of credit card debt has been reducing quite sharply in recent months. That has been commented on and reported on, and the Central Bank has referenced it in reports as well. Credit cards account for only 2% of total personal sector credit. Housing mortgages account for the vast majority of people's borrowings.
Deputy Burton raised the broader issue of the protection available to consumers relating to pension and investment products and so on. There is a raft of safeguards, some of which have only come into place or been strengthened in recent years. The consumer protection code now exists, which Ms Mary O'Dea stated in her discussion with the Joint Committee on Economic and Regulatory Affairs was probably, as a benchmark, one of the best in Europe in that it now requires institutions to test people's suitability for a product. It puts institutions through a "know your customer" process, where the need is established and the customer is provided with the right product.
Banks are obliged to go through the process and can be benchmarked against this if the product is judged to have been sold incorrectly. In some cases there are examples of the Ombudsman making awards to people in cases where it was felt, on examination of facts, the product sold was not appropriate.
I cannot comment too much on pensions as there is a pensions regulator, Mr. Paul Kenny, who is charged with looking after the area. The level of legislation and oversight in that area, as I know as somebody who looks in at the market rather than being directly involved, has strengthened considerably in recent years. We also have the market in financial instruments directive, which was transposed into Irish law in November. It replaced the old investment services directive. It provides for much greater disclosure and transparency on investment products to retail and institutional customers.
It is not appropriate to comment on the levels of salaries other than to say that the financial sector pays competitive rates. Many of the salary headline figures we see are related to performance bonuses, which are only earned if people hit certain targets. I would not like to say more than that.
Deputy O'Keeffe mentioned that the Central Bank must be more vigilant. The current financial crisis caught everybody on the back foot, particularly global regulators. Mr. O'Connor, who referred earlier to these complex financial products and regulators in the United States, would acknowledge there are lessons to be learned by the regulatory system and the banks.
Deputy O'Keeffe identified that a major issue exists in respect of e-banking and cash in general. At present, convoys of Defence Forces personnel and gardaí are traversing the country escorting huge quantities of cash in order to stock up the cash registers of retailers. This money must then be removed from those registers at the close of business and transported back to the cash-holding centres of banks. This enterprise adds absolutely no value to Ireland Inc. While those involved provide a valuable public service, they could be deployed to carry out security duties other than those relating to the transport of cash.
In conjunction with the Irish Payments Service Organisation, IPSO, we put forward a plan to bring about a significant reduction in cash transactions. This would be similar to what happened in Denmark and the Netherlands. It is not by accident that those countries which have significantly reduced their reliance on cash and increased their levels of electronic payments are ranked among the top states in the world for competitiveness. These countries have gained serious competitive advantage as a result of having much more electronically-based systems.
Many actors or stakeholders will be required to take action. There is a renewed willingness to examine this area. There is a need to reduce the number of cheques in the system to a significant degree. The Government took some steps in that direction in the most recent budget when it reduced the tax on ATM cards and increased it on cheques. The various actors have unofficially signed up to trying to reduce to almost negligible levels the number of cheques in the system by 2012. That would be a welcome development.
Businesses that are moving towards electronic payments and away from cheques are benefiting from being able to feed information into their general ledger and accounting systems directly by electronic means as opposed to being obliged to transpose it in a manual format, as required when one deals in cash and cheques. Electronic payments lead to greater efficiencies for banks, the Government — which is one of the largest generators of cheques, although it is beginning to make inroads in this regard — and for the country in general. It has been estimated that between €1 billion and €1.5 billion could be saved by Ireland Inc. — there is a need for further discussion with regard to how this would be divided up — if we could reduce the amount of cash and cheques in the system.
Ireland is behind the pace in respect of this matter. With the advent of the single European payments area, we are in danger of being placed on the back foot competitively because other providers will be able to enter our market and offer the kind of electronic banking facilities to business and ordinary customers that they have been able to develop in societies which have moved away from a reliance on cash and cheques. We still have a heavy reliance on the latter.
In the context of the development of the all-Ireland economy, it is doubly important that we reduce our dependence on cash and cheques because the UK is beginning to seriously address the need to reduce the level of cheques and cash in its system. If we in this jurisdiction do not take action, a further differentiation will be created between North and South. This will not be of assistance in respect of the creation of the all-Ireland economy to which the political and administrative systems aspire.
Will Mr. Farrell reply to my question on speculative land purchases and the bidding up of land values?
Mr. Pat Farrell
Is the Deputy referring to developers bidding up land values?
I am referring to banks bidding up land values by lending for speculative land purchases. As Mr. O'Connor said, one could think of a number in that regard. I do not know whether it is about risk management or whatever but what is the position? Does Mr. Farrell have a view on banks bidding up land values in this way?
Mr. Paul O’Connor
I will respond to the Deputy's question. The Financial Regulator moved last year or in the closing months of the previous year to increase banks' costs in respect of speculative lending. The new capital requirements directive makes provision for a national discretion, which allows for a 50% or 100% risk weighting. The Financial Regulator initially applied the more conservative 100% weighting and subsequently increased it to 150%. Effectively, the cost of capital to a bank involved in speculative lending in Ireland is three times higher than is the case in 50% of other European countries. The Financial Regulator has sought to discourage or disincentivise speculative lending for banks. The same is true in respect of lending relating to residential mortgages, in respect of which the LTV is 80% or higher. The cost of capital to banks in this regard has been increased as part of the implementation of the capital requirements directive, which acts as a disincentive and reduces the return to banks in respect of that higher proportion of lending.
All of this is additional to the credit crunch. What I have outlined are prudential measures which were put in place by the Financial Regulator and which took full effect from 1 January.
After the horse had bolted.
Mr. Paul O’Connor
The pace of development in Ireland has been quite significant in recent years.
How do banks deal with the interest arising on those speculative land purchases? Is it rolled over and rolled up until all of the properties in a development are ultimately sold?
Mr. Paul O’Connor
I could not comment on the specific arrangements. Banks have a variety of options available to them. These are dependent on the nature of the proposition. It may, for example, be a commercial development. Banks offer a variety of options to customers who have debt issues and they will work with these individuals to either roll up their debts or suspend payments until they return to employment or whatever. There are many options available and the same applies to the commercial side. However, I do not really have an insight into specific practices.
I will now take questions from Senator MacSharry and Deputy O'Donnell. We will bank their questions and our guests may reply to both.
I welcome the representatives of the Irish Banking Federation and thank them for their presentation. As Mr. Farrell stated, we never truly acknowledge the number of people who are employed in the banking sector. The estimate that between 60,000 to 100,000 people work in the sector is significant. We often hear about the level of employment in the building and farming sectors but not so much about the number of people working in banking. The banking sector makes an immense contribution.
What data is available regarding the cost of regulation compliance to the members of the Irish Banking Federation and to what extent is this cost passed on to consumers? There are obvious benefits in the context of the regulation of the market. Is there a view, however, that it has been over-regulated? I opened a deposit account in an eminent financial institution recently. I have been a customer of the bank in question for over 20 years. I merely wanted to open a simple deposit account but I was asked to produce documentation such as a driving licence, a marriage certificate — it is a joint account — a passport, etc. These documents were already on file with the bank in respect of a number of other accounts, including that relating to our mortgage.
Are we over-regulating in respect of the banking sector and are the costs relating thereto being passed on to consumers? Are we being charged because the banks are doing things which are not really required? What is the position regarding the safe and reasonable regulation of the sector versus value for money for customers?
I accept that this matter does not come directly under the remit of the Irish Banking Federation but what is its view and that of its members on the role of the European Central Bank? The latter seems to focus more on inflation than the economy. Should the European Central Bank begin to comment, at least verbally, on the over-valuation of the euro versus the dollar and sterling? I am not suggesting that the euro should be devalued but there seems to have been a significant impact in this regard in recent times. Should the European Central Bank begin to considers matters differently and make soundings that would support a return to normal conditions in world trade?
It was stated that some green shoots are appearing. When will there be a return to normal trading in the interbank market? When will banks be confident as regards lending beyond 90 days to other banks? If the latter occurs, it will mark the beginning of a return of confidence.
What tangible improvements should the Legislature begin to put in place to maintain competitiveness that is beginning to wane? Evidence of this is apparent in the easing off in respect of internationally traded services.
I thank the Irish Banking Federation for attending today. Many of the points I had intended to raise have already been dealt with. I acknowledge that many people now work in the banking sector. Mr. Farrell said that 50% of funds for loans were raised in the interbank market. Is that an average for the banking sector? Do some banks raise a higher percentage of funding in that way than others? Does the Irish Banking Federation issue guidelines to banks in that regard? Without mentioning specific banks, some have very high gearing in terms of borrowing on the interbank market.
Mr. Farrell referred to the robustness of the banks and, according to the most recent financial reports, he appears to be correct. He also mentioned the Central Bank's financial stability report. Its survey was qualified by a statement to the effect that it could not be certain there were not off-balance sheet items. Is the Irish Banking Federation satisfied further exposure will not be revealed? Mr. O'Connor referred to securitisation which arose in America as investors went for high-yielding, commission-led products in a sector whose borrowers ultimately could not afford their mortgages. Those mortgages were packaged as securitised assets and I have no doubt some ended up with Irish banks, though I do not know to what overall value.
Mr. O'Connor referred to the fact that most mortgages are being restricted to 80% of a property's value. However, some are as high as 92% and 100% mortgages still exist. As far back as 2005 the ESRI and the IMF stated the number of houses being built in Ireland was not sustainable. He said lessons had been learned but, in England in the late 1980s, 100% mortgages were being offered and houses were overpriced. We see liquidity problems in the current rates of interest and the interbank market but surely the banks should have seen that continuing to offer 100% mortgages would lead to negative equity.
Banks, to maintain their margins, now screen customers more heavily. There has been a reduction in credit and people now only qualify for 80% mortgages. As a result, some second-phase houses on estates of 200 properties have been sold at anything between €20,000 and €100,000 less than the earlier phase. That is happening everywhere and it means negative equity. Surely the lessons should have been learned in 2005 and the Irish Banking Federation should have curbed the rate of 100% mortgage lending to vulnerable first-time buyers. Had we learned the lessons in 2005 we might not have experienced the market fall and negative equity we have today.
Mr. Pat Farrell
I acknowledge the comment about employment in the sector. Banking is a very significant employer, not only in the number but in the quality and sustainability of the jobs in question. Senator MacSharry asked whether the sector was over regulated and whether compliance costs were too high. Business in general — not just banks — will always want a light-touch regulatory regime. The banking sector is and has to be regulated because it deals with people's money and prudential supervision is important for the stability of the entire economy, necessitating regulatory oversight.
On the levels and cost of regulation, at the moment the Financial Regulator costs approximately €50 million to run. The sector, by virtue of the financial arrangements made at its inception, contributes 50% of the cost. One of the reasons it does not contribute 100% of the cost is, as the regulator said at a recent meeting of this committee, to prevent the perception of regulatory capture on the part of the Financial Regulator. The solution, for better or worse, is the one that was decided upon. The State picks up the rest of the tab and that is set to continue for the next couple of years.
The Government has committed itself to a better regulation programme as part of an EU-wide endeavour to reduce the burden of administrative and compliance costs by 25%. I have not seen the granularity of the programme but I presume it will look across all sectors and regulatory areas. A review is under way of all regulators here, of which there are quite a number, and that will also address the question. The sector has taken on a huge amount of additional regulation in recent years, particularly in the area of consumer protection, and that has created costs. Ultimately the consumer pays for regulation because those costs have to be passed on in the system.
Senator MacSharry also asked about the ECB. The mandate it has been given is to fight inflation, though regulators in other jurisdictions, such as the Federal Reserve, have a dual mandate and look at stimulating the economy as well as keeping inflation down. It is a political question and one for Heads of Government, should they wish to revisit the situation. The origins of Europe and the political framework in which it exists explain why the ECB has been given the mandate it has and it is sticking rigidly to it. I cannot see how it can go beyond that but the question is worth putting as other regulators have different mandates.
What is Mr. Farrell's view of the mandate?
Mr. Pat Farrell
I do not have a view on the mandate as it is for politicians, at the level of head of Government, to decide. They seem to feel the mandate is the correct one. If they wanted to change it and give the ECB a dual role in that regard they could do so.
Deputy O'Donnell asked about whether the figure of 50% of funds raised on interbank markets was an average figure. It is an average figure but, generally speaking, all lenders in the market are deposit-taking institutions. Without having the figure for each bank to hand, most will not vary significantly from the average in that regard. There are one or two wholesale lenders but they in turn are funded by parent banks with big customer deposit bases.
The Deputy also asked about the robustness of the banks in the context of high-yielding products. Last year when the crisis began I listened to Mervyn King, the governor of the Bank of England. Speaking at the Northern Ireland Chamber of Commerce, he tracked the problems back to a supply of cheap money. There has been a huge build-up of customer savings in India and China, their not yet having become consumer societies and their people not having outlets to spend their money, and that has flooded the world with cheap money. That is not what we needed but they are the facts of life. Because the return on cash deposits was low, and had been consistently so for a long time, investment banks started to develop the yield-chasing products to which the Deputy referred. People availed of those products and that led to the problems we now have. I share the Deputy's analysis in that regard.
The Financial Regulator has looked at the exposure of Irish banks. In addition, all the banks have been through the reporting cycle, have had their books audited and their asset profiles examined.
Does Mr. Farrell agree that 2008 will be a significant year for the banks, particularly given the moneys they have extended to developers? Obviously that is an indirect consequence of the international credit crunch.
Mr. Pat Farrell
It is a consequence of the credit crunch. That brings us to the issue of 100% mortgages. For a short period 100% mortgages were available on the market. As we speak, and I have this from a broker who can look across the market, 92% mortgages are available. In the first part of this year 30,000 mortgages were written. That is not an inconsequential sum. There are mortgages——
That is going back three years. I made the point that I do not agree with 100% mortgages.
Mr. Pat Farrell
The total value of mortgages accounted for by 100% mortgages is approximately 5% of the total mortgage book.
Once again, Mr. Farrell is averaging the figures over many years.
Mr. Pat Farrell
I am not trying to confuse the situation. It is a fact that the total value of mortgages accounted for by 100% mortgages would be approximately 5% of the total value of mortgages. Approximately six months ago we did a survey of first-time buyers who had taken out a mortgage two or three years ago. We asked them questions as to their level of comfort with the affordability of the product they bought and their repayment capability. The responses we got were very positive; 80% to 90% satisfaction in terms of ability to service the mortgage they had.
I do not want to waste time, but my point is a simple one. What happened is that the market developed over five years. Instead of buying a house for life, people buy a house to move on. It is the same model as in the UK. Now, probably for the first time ever, negative equity has come into the Irish market. The IMF and the ESRI pointed out that too many houses were being built and that this was not sustainable, that this would happen. Did the banks not take that on board and pull back in terms of offering money?
Mr. Pat Farrell
The reality is that we operate in a competitive marketplace in which people are seeking funds. We apply the stress test and the credit underwriting standards. If a bank does not respond to the market some other bank will. The other controls relate to the Central Bank or the Financial Regulator, as Mr. Paul O'Connor has outlined, deciding to set aside more capital. Regarding negative equity, it is a phrase that has been coined in recent times. I bought a house in 1981 in Sligo for £39,000 and I sold it six years later for £39,000 which was a period of almost double digit inflation. I suffered negative equity, but nobody had a term for it and I did not go around nursing it afterwards. The reality is that some people have negative equity
However, Mr. Farrell had a great quality of life.
Mr. Pat Farrell
That is right. In the survey of first-time buyers we addressed the issue of the length of time for which people bought their houses. Approximately 90% said they were buying for at least five years. I accept that there was negative equity in the UK. However, the UK population is far more mobile than the Irish population. The Irish population is becoming more mobile as well but it was far more mobile in the UK where people must move around to various centres of employment to stay employed.
I am making a point with which Mr. Farrell clearly does not agree. I believe it is a justifiable point. The point is that 100% mortgages were always going to lead to problems. The only way that would not happen would be if the market continued to grow and grow, but eventually the bubble was going to burst, and it has. Now many first-time buyers are in negative equity. A point was made. It should have been taken on board.
Mr. Paul O’Connor
The Deputy mentioned two issues, mortgage backed securities and Irish banks' exposure to subprime assets.
It was covered in the financial stability report.
Mr. Paul O’Connor
The point should be made that not all mortgage backed securities are bad. In a securitisation unit there may be five or six layers of assets, only one of which might be subprime. The uncertainty has meant that if there is any presence of subprime asset nobody wants to buy any of it. There is a basic value to those assets but the accounting rules state that if nobody wants to buy those assets today their value is zero. It is a bit like asking whether one's house is worth zero if nobody wants to buy it today or does it hold a value. We believe it holds some value and there will be a buyer tomorrow.
That leads on to my final question. What is the Irish Banking Federation's view of banks repossessing houses over the next 12 months?
Mr. Pat Farrell
Mr. O'Connor referred to the fact that we have a code of practice on mortgage arrears. If one looks at the levels of repossession in respect of 2007 as opposed to 2006 there is no change. With banks having gone through the reporting cycle, there is no appreciable change in the level of arrears. Leaving that aside, the banks have all signed up to a code of practice on mortgage arrears. We also have a pilot project with the Money Advice and Budgeting Service on dealing with specific cases of debt. There are safeguards in that. The Financial Regulator referred at a previous committee meeting to the fact that there are also safeguards within the consumer protection code. There are safeguards within the system for people who find themselves in arrears. What a bank wants to do is to reach an accommodation with a customer to get him or her back into the payment cycle. It is not in the interests of the bank to sharply cut off the issue because invariably when the situation is assessed an arrangement can be arrived at that works to the benefit of both parties. The code is there to deal with such situations.
I thank the management of the IBF for attending today's meeting and for their presentation. Is Mr. Farrell concerned about the report in one Irish newspaper this week that multiple Irish financial institutions are still providing 100% mortgages without carrying out any adequate background checks on the home buyers?
Apart from banks reporting more regularly to the Central Bank and to the Financial Regulator, what other measures is the IBF putting in place to restore confidence and trust in Irish financial markets?
Regarding the predictions in the presentation on international financial services employment growth to 32,000 by 2012, is this growth dependent on the low rate of taxation continuing in the IFSC? If the derogation Ireland has from Europe that enables it to have a low tax rate is withdrawn, what effect will that have on the predicted employment in this sector? There are 70 plus members of the Irish Banking Federation. That seems a great number of players in such a small market. Does the chief executive see consolidation in the market in the years to come, particularly as matters get tighter?
Regarding the property market, is there any concern that some banks may be overexposed, with the crash in the Irish property market and the fact that there are many apartment blocks lying vacant, particularly in my constituency of Dublin North-East? Obviously developers must pay the mortgage on those. If they are unable to sell them, that will have an impact in terms of the banks getting their money back. I wonder how that will all pan out.
I thank the Irish Banking Federation for its presentation. Having recently met the Federal Reserve and a number of other bodies including the HSBC Bank, with the Chairman and other members of the committee, I believe the Irish banking system could not be more different to the American system. In the US there appears to be almost no regulation. Mr. Farrell referred to the unregulated entities. To the brokers there it was like pyramid selling. They could not believe their luck when everybody was throwing money at them. However, somebody was going to be left holding the baby and there was nobody in the system to call a halt. Henry Paulson has said he will bring forward legislation but I am sceptical, given the fragmented nature of governance within the financial sector in the United States. Some of the products the financial sector sells are extremely intricate, complicated and cutting edge and I am not sure it is possible to regulate all of them. The banking system will always have to play catch-up in that context.
In Ireland the position is very different and we have a clear regulatory framework. It needs more work but the IMF states we are high in the rankings for independence and accountability. Perhaps I am optimistic but I have huge confidence in the banking sector. There will always be problems but, on balance, Ireland has a very good banking system. We must give credit to banks when they deserve it and they have tightened up in the wake of the credit crunch, which is good. E-banking which has been touched on is also good.
Mr. Pat Farrell
I am not clear which institutions are referred to in the reports on 100% mortgages which Deputy Flanagan mentioned. The regulator introduced rules last year which made it very hard for capital. The emphasis at this committee has been on the suggestion 100% mortgages had disappeared but they are still available, in rare circumstances, for a person who has a guaranteed and progressive income stream such as a Deputy or consultant.
Politics is not a stable career.
Mr. Pat Farrell
I withdraw that statement, as it is definitely a more fragile career than I suggested.
Mr. Farrell should know that better than anyone else.
Mr. Pat Farrell
I take the Deputy's point. Measures to restore confidence in the markets must be taken globally because the issue did not have its origins in this market but in the United States and the contagion has spread worldwide. A lot of work is being done by regulators internationally. Intervening with liquidity provides a short-term fix but beyond this they are working to take the necessary measures to restore confidence to the markets and that will happen over time. Every time something like this happened, as it did with the hedge fund, Long Term Capital Management, lessons were learned and markets subsequently became more robust. Lessons will be learned on this occasion too.
There is a risk trade-off in that innovation in financial markets is huge and has brought huge benefits. It has allowed world trade to expand at an unparalled pace. If the innovations were not introduced, we would not have enjoyed that level of growth in the world economy. Innovation is very good but it can also have a downside effect, as we have seen.
It is good as long as it is properly regulated.
Mr. Pat Farrell
Absolutely. On the growth of the IFSC, there is a variety of things that make Ireland attractive as a centre for international companies to do business. The most important is access to the European market of almost 470 million people. We do not have a derogation but sovereignty over taxation issues. Our corporation tax rate of 12.5% is the one we, as a country, have decided to strike and it has been very successful for us. The Deputy referred to discussions on a common consolidated corporate tax base, CCCTB, in Europe but even these discussions allow for countries to opt in or out.
We are very clear that a common consolidated corporate tax base would be disastrous for Ireland and do not think a harmonised tax base is anything other than the short road to a harmonised tax rate. Some of the formulas brought forward for how such a rate would operate such as calculating liability on the basis of where goods are consumed would be disastrous for Ireland because this is a small exporting economy with a very small domestic market, meaning consumption would be treated as taking place in Germany and France and the tax take would go to those countries. We are totally opposed to the CCCTB concept and do not believe it can work.
Can other states not set their tax rates at 12.5%?
Mr. Pat Farrell
They can. There is some discussion in the United Kingdom about reviewing its tax rate. The authorities there reviewed the tax system, particularly for non-domiciled individuals in the city of London, and it has led to an outflow of some valuable economic activity from London. They did not actually change the system but the fact that they had discussed doing so dented confidence. It is very important we assert and reassert our sovereignty and stick with our tax rate.
The figure of 70 members gives the wrong impression. We have 12 or 13 providers in the retail market but the remainder are not in that market, being providers of international services in the IFSC, export services to other countries in the European Union or services out of Dublin for their parent organisations.
The fall in house prices was referred to. I do not want to call it a cloud's silver lining but the drop in house prices is not all bad news for consumers. Affordability indices show that affordability for first-time buyers has improved significantly and will continue to do so. The average loan size to customers remains steady. Therefore, the correction taking place in the housing market puts properties more in the reach of customers. Regardless of liquidity issues, some behave in accordance with sentiment and believe house prices will fall further. So long as they believe this, they will not go into the market, regardless of what mortgages are available or the level of house prices.
I am sure the positive comments of Deputy Andrews about the sector are rooted in the fact that, as he looks across the River Liffey from his constituency each day, he sees the huge benefits the IFSC has brought to what were completely rundown docklands, now providing high quality employment for between 20,000 and 30,000 people. The pattern is increasingly being followed with service companies which have set up in the south docklands.
I thank Mr. Farrell, Mr. O'Connor and Ms O'Rourke for their attendance and submission and their very open and frank answers to questions from committee members.
With the agreement of members, I will omit to deal with correspondence, except for one important matter, namely, the fact that a meeting has been arranged for Wednesday, 21 May with the Dyslexia Association of Ireland.
The joint committee adjourned at 4.30 p.m. sine die.