Good morning, Chairman and committee members. I am joined by Mr. Ed Sibley, deputy governor, prudential regulation, Ms Derville Rowland, director general of our financial conduct function, and Ms Helena Mitchell, head of consumer protection supervision. I will first briefly give an overview of the current economic environment and then turn to some of the specific issues that the committee raised in its invitation to me, including the tracker examination where we published our most recent report on 25 April.
The Central Bank is committed to serving the public by safeguarding stability and protecting consumers. We operate as one bank, recognising the operational effectiveness of deploying the whole resources of the bank in meeting our goals. For example, our macro-prudential mortgage measures contribute to both financial stability and consumer protection by guarding against over-lending and over-borrowing. Equally, our work to ensure that financial firms are prudentially sound is essential if these firms are to meet their obligations to consumers and investors. In these ways, consumer protection is embedded in all key aspects of our work through close co-operation between our central banking, prudential regulation and financial conduct pillars.
In terms of the macroeconomic outlook, we are currently experiencing buoyant domestic activity and a strong international economy, which has lead to a broad-based expansion in employment and an increase in earnings. Our projections for the labour market indicate that Ireland is heading towards full employment, although some extra capacity is possible through broader participation in the labour market. While the near-term outlook is positive, Ireland faces substantial tail risks. These include hard Brexit scenarios, protectionist pressures and any change in the international tax system that would effectively penalise small economies as locations for multinational production activity. In addition, a sudden shift towards tighter conditions in international financial markets is widely cited as a possible trigger of a contraction in international economic activity. We think it is important that policymakers are mindful of such vulnerabilities in order to ensure that Ireland is resilient if any of these tail risks are triggered.
In terms of the Irish housing market, the increase in house prices seen in recent years in part reflects the strong increase in employment and the increase in aggregate household incomes, together with a low interest rate environment. However, a primary influence has been the limited supply response even if there is some evidence of increasing levels of construction activity. Our research points to house completions of approximately 23,500 units in 2018 and an increase of 28,500 in 2019. However, these projections remain below the estimated housing demand of between 30,000 and 35,000 units per annum outlined in Project Ireland 2040.
On the composition of the housing market, second and subsequent buyers remain the largest single cohort of purchasers accounting for 45% of market activity. We have seen a significant role played by non-household buyers, including private equity firms and real estate investment trusts that mostly operate in urban markets, which accounts for 14.3% of transactions. We also highlight the fact that non-mortgaged transactions or cash transactions are also quite significant.
In terms of the mortgage policies of the Central Bank, this is now an annual process. Last November, we released our review of mortgage measures. Our assessment is that the system is important and appropriate in ensuring that the credit market does not lead to unsustainable dynamics in the mortgage market. We look at credit developments every three months and we stand ready to respond to changes in credit dynamics. Our assessment feeds into our policies on bank capital policies, both from micro and macro-prudential perspectives. Behind all of this is the intention to make sure that both those taking out mortgages and those providing mortgages are better equipped to deal with any future shocks.
In terms of commercial real estate, we have seen the dynamics here moderate in recent quarters so that Dublin is no longer an outlier in terms of market activity. However, Dublin remains at the heart of activity with 80% of commercial property transactions last year but transactions outside of Dublin are also rising. What we have now is a record low in terms of vacancies. While the stock of office space is visibly increasing throughout the city, it is also the case that Brexit is contributing to additional demand in the near term.
We know that a lot of the funding here is international in nature. Having an international investor base for commercial real estate aids recovery from the lows in the market. It also provides increased levels of liquidity and provides non-bank sources of credit. This means that the risks in the commercial real estate market are internationally shared and are not concentrated in the domestic financial system. At the same time, as part of a global system, it is important to recognise that if these flows go into reverse that this carries some risks here in terms of disorderly market price dynamics. Having said that, when one considers the amount of debt in the system and the amount of adjustment since the last boom then one will see that the market is a lot more sustainable than it was. At this point, the Irish banks have commercial real estate lending of just under €19 billion of which 20% is non-performing. It is important to note that the domestic banks, the capital situations of the banks and their resilience is far different than a decade ago. It remains the case that this area is the focus of our supervisory approach, and it is part of the Single Supervisory Mechanism.
The tracker mortgage examination is one of the prime remaining changes in terms of dealing with the legacy of the crisis, both between the tracker examination and our work on addressing the high levels of non-performing loans that remain. In our most recent report, we have given the latest update in terms of numbers. We remain committed to the follow-on work to makes sure, through our inspections and challenge, that all cases should be included are included. We reported that as of the end of March the number of customers who are now included in these schemes stands at 37,100, which is an increase of 3,400 compared with the end of December. In terms of the scale of what is involved, by the end of March the payout was €459 million - an increase of €162 million since December.
Eighty-eight per cent of identified accounts have received offers of redress and compensation and the vast majority of the remaining cases will be dealt with by the end of June.
Provisions by lenders in respect of the examination now stand at €969 million, of which €626 million relates to redress and compensation and €343 million relates to costs. The total cost of this to the banks is virtually at the €1 billion mark.
I mentioned that there will be some exceptions to the end of June. That relates to those customers who we have had included in the scheme in recent weeks. Essentially, it is down to the fact that we are finding some cases now. In some of these cases, they can be paid out within the end-of-June timeframe. In other cases, it will take a bit longer. I would say, however, the supervisory phase of getting all customers included is reaching its end.
In relation to enforcement, we stated there are enforcement proceedings against six lenders. We are including all possible angles, including potential individual culpability, in these investigations.
What I have given the committee in my submission is a process answer about all that we are doing but, of course, it remains the case that whatever financial compensation can be delivered will never make up for the personal impact on the families which have been most affected by this scandal, including those who have lost homes and properties.
The other leg of our work here is the issue about the culture of the banks because it is quite important for the future conduct of these banks that they take responsibility for building a consumer-centred culture. This is a matter for the top level of these organisations, for the boards and the senior management, and we as regulators must have an effective toolkit in pressing for the development of a consumer-focused culture. We will report on this in mid-year. This culture report will feed in to our ongoing supervisory work.
Turning to the issue of non-performing loans, non-performing loans cause considerable distress to those who are having to grapple with unsustainable debts. Of course, it is also a major issue for the banking system. Ireland has been to the forefront over the past decade in dealing with this. Much has happened in Ireland, both in terms of our work but also in terms of the legal system, which has been identified in many places as a barrier to resolving non-performing loans.
What we have seen here is a lot of restructuring of loans rather than loss of ownership. The protection of consumers who have arrears has been a key priority throughout with the code of conduct on mortgage arrears, CCMA, playing a critical role. According to our data, there have been 120,000 restructured owner-occupied mortgages, 87% of which are meeting the terms of the restructuring arrangement. This shows restructuring has been possible and has played a big part in managing the non-performing loan problem.
In relation to loss of ownership, which always must be one possibility in a mortgage system, there have been just over 8,000 cases, where 5,500 cases have been from voluntary surrenders and 2,700 through court ordered repossession. This has to be the last resort. Restructuring, where possible, is desirable. Let me emphasise that compared with the international evidence, the Irish system's ability to deliver many restructured loans has meant the numbers of properties lost would have been much higher without these efforts.
We continue to press on this issue because there is a clear risk to the financial system if the number of non-performing loans remain at an elevated level on bank balance sheets. This creates uncertainty about the financial positions of the banking system. While in good times that might not be an immediate issue, in any future downturn, if those non-performing loans remain unresolved, that creates a clear sustainability issue in the markets. Therefore, it is important, here and across Europe, to continue to work to bring down non-performing loan ratios.
In the grand scheme of things, back at the peak of the crisis, commercial real estate and small and medium-sized enterprise loans formed the majority of non-performing loans. At this point, much of that has been worked through. Approximately, two thirds of the remaining non-performing loan balances are residential mortgages. This is why it is important at this point to recall that we have a strong consumer protection framework in place here and all that will happen in resolving these loans is within the context of a strong consumer protection framework. In terms of how the Irish banks have been handling these loans, there has been a mixed approach. There has been loan restructuring, voluntary sales, use of the legal system and loan disposals through a sales process.
What we have now is an unusually large amount of loans which are in long-term arrears of over two years. We continue to encourage anyone in this situation to engage with his or her lender because we have seen evidence that sustainable restructurings are possible in many cases. Where a restructuring is not possible, I emphasise that the development of the Insolvency Service of Ireland has been an important innovation and this can be an important support to debtors in reaching debt solutions. However, for those who do not engage either with their banks or with the Insolvency Service of Ireland - I remind all of those in this situation that there is much support for them - the legal system remains the last resort outcome.
Turning to non-bank entities, whether these are retail credit firms or unregulated loan owners, they hold 7% of owner-occupied loans and 11% of buy-to-let mortgage accounts. Within this category, 2% of owner-occupied mortgages and 5% of buy-to-let mortgages are owned by non-regulated loan owners. What is clear, however, is that these are not like for like. The unregulated loan owners hold a disproportionately high share of the long-term arrears cases with half of their owner-occupied mortgages and three quarters of their buy-to-let mortgages in arrears of over 90 days. In 2017, non-bank entities accounted for 148 or 10% of repossessions of owner-occupied cases. On those repossessions, half were voluntary and half were by court order.
While it is only one option in the resolution of non-performing loans, loan sales can play an important role in transferring risks from the banks to other types of investors, which reduces the vulnerability of the Irish banking system. It is important to emphasise that, no matter who owns the loans, all of our codes of conduct are afforded to debtors. Ireland has been a leader through developing the credit servicing regime in 2015, which means that we have a way to ensure that consumer protection rights are enforced through regulating the credit servicing firms while not adding frictions to the sale process for mortgages. It bears repeating that customers whose loans are sold continue to have the benefit of the same consumer protection regulations they had before the sale. As the committee will be aware, we are currently reviewing the operation and effectiveness of the CCMA in the context of the sale of loan books. This review provides an opportunity to assess whether any revisions to the code are necessary.
I will turn to the EU developments in banking regulation because there is a relevant initiative at present.
In March the Commission published a proposal for a directive on credit servicers, credit purchasers and the recovery of collateral. The aim is to have a European approach to the sale of non-performing loans. Across Europe the same imperative is shared more widely - that it is important for the banking system to have a lower ratio of non-performing loans. It is important that one of these options, the sale of non-performing loans, be taken in a way that protects consumers. Essentially, the European directive will arrive at a very similar system to what we have in place here where there is a distinction between credit servicing and the ownership of a loan. The European directive will provide that the credit servicing firm should be regulated, but the loan owner will not require authorisation. Essentially, the solution we have found in Ireland is being used as a template. It should be the pan-European approach because regulating credit servicing firms will deliver consumer protection, while allowing the sale of loans to happen, which is important to the overall stability of the banking system.
I will now comment on the European deposit insurance scheme, the final leg in completing banking union. We think it is important that it move along in the coming weeks and months. Together with progress on capital markets union, the completion of banking union is important to allow the European Union to deal with future challenges.
On credit unions, we have a clear strategy and our vision for the sector is of strong credit unions in safe hands. That underpins our statutory responsibility to ensure the protection by each credit union of the funds of its members and the maintenance of the financial stability and well-being of credit unions generally. The past decade has seen many challenges for credit unions in dealing with the financial crisis, increased competition, the challenges to the business model, restructuring and increased regulation. Considerable progress has been made, but significant challenges remain because of declining investment returns on assets which, in turn, interact with the reduction in the loan-to-asset ratio, low investment yields and rising costs. People who look at this sector have made the consistent observation that not all credit unions have developed future business models that are robust to deal with these structural changes. While there has been an increase in governance standards across the sector, this remains a key risk. It is essential that sound governance and control systems be in place for the credit union sector.
As regulator, we support efforts to undertake the transformation of business model in line with our vision. In 2018 we are introducing a number of important changes as follows: a refinement of our supervisory approach to strengthen core foundations; a review of lending to accommodate the future lending growth ambitions of the stronger credit unions as part of a balanced loan portfolio; a new chief executive officer forum to support advancement of the development of new business models; and workshops to support credit unions in addressing key risk vulnerabilities.
I hope this overview of some key topics has been helpful.