Brendan Burgess
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On Nov 26th, Governor Honohan appeared before the Oireachtas Finance Committee and got some very searching questioning from Michael McGrath, Kieran O'Donnell and Pearse Doherty.
The full transcript is here and is worth reading.
But here are some critical extracts on whether the CB should have the power to control interest rates.
Deputy Michael McGrath:
I welcome the Governor, Professor Honohan, today. I thank him for his response to the detailed information sought by the committee and his ongoing co-operation. I will begin with the issue of standard variable interest rates for mortgage holders, which the Governor dealt with in the early part of his opening statement. I get the impression from what the Governor said that he believes rates are high. However, the Central Bank is not willing to intervene in the sense since it does not want to be setting interest rates, which is understandable. The Governor said it would be counter-productive to exert administrative control. Does the Governor believe that the variable rates being charged by banks at the moment, which are in the region of 4.5% for new mortgages, are too high?
Professor Patrick Honohan: There are certainly on the high side. However, we must ask what we mean by "too high". As the committee was told by the banks that presented to it in the past few weeks, they cannot fund themselves at the ECB policy rate. That is not the way it works, as everyone knows. The 4.5% should not be compared with 0.05% in terms of the cost of funds. Approximately 300 basis points or 3% is the spread over the banks' average cost of funds, although less over their marginal cost of funds. It is a bit on the high side, but not by all that much. We do not have the power to intervene.
I will jump ahead to the question of whether the Oireachtas should consider giving us that power. I would suggest not. In terms of the provision of mortgage credit and the in-flow of banking services into the economy, the confidence around the way banking and the financial system work - I am not referring to national confidence - is not well served by there being tight control over interest rates. In the 1960s to 1980s when a cartel of bankers was setting interest rates subject to some kind of approval by the Minister for Finance and the Central Bank, it was a facade because our control did not influence the rates, which were largely coming in from abroad. It would not be a good idea to introduce a regime of tightly controlled mortgage rates.
However, I would make an exception. The committee will presumably be considering legislation in the near future about the mortgages that are sold to non-banks, ones that are simply harvesting those mortgages without getting involved in new business. It may be that there should be some limitation on the degree to which they could deviate from market practice. What locks the standard variable rate contract into reality is the fact that it should be the rate that is charged by the lender on new and old business, more or less keeping lenders in line with market conditions. However, if an entity is not making new business, it might not have this natural restraint.
Deputy Pearse Doherty: In regard to variable interest rates, Professor Honohan basically acknowledged that the banks are overpricing new customers but the Central Bank will do nothing about it.
Professor Patrick Honohan: Put like that, it sounds bad.
Deputy Pearse Doherty: That is the way the Governor put it. We can dress it up whatever way he wants, but that is the reality.
Professor Patrick Honohan: The first point to make here is that the Central Bank does not have the power to intervene in this regard. Second, I do not think it should. As an adviser to the Government and the committee, I would not recommend doing that. I have seen what happens in other countries when it is done. The temptation is there to say the banks are charging too much, but they always seem to be charging too much. Eventually, that type of process either is a joke and ineffective, as it had been here for many years, or it presses down so much that the banks end up shutting up shop and not doing any business. If the situation became egregious, one would have to do something. It is not egregious at this time.
Deputy Pearse Doherty: We have a problem with competition in the banking sector. One can make the case that to take action on this issue would encourage competition among the banks.The problem is they are not competing. As they are dominating the market, there is a need for the Central Bank or the Government to act. I do not have the time to tease out the matter further.
The full transcript is here and is worth reading.
But here are some critical extracts on whether the CB should have the power to control interest rates.
Deputy Michael McGrath:
I welcome the Governor, Professor Honohan, today. I thank him for his response to the detailed information sought by the committee and his ongoing co-operation. I will begin with the issue of standard variable interest rates for mortgage holders, which the Governor dealt with in the early part of his opening statement. I get the impression from what the Governor said that he believes rates are high. However, the Central Bank is not willing to intervene in the sense since it does not want to be setting interest rates, which is understandable. The Governor said it would be counter-productive to exert administrative control. Does the Governor believe that the variable rates being charged by banks at the moment, which are in the region of 4.5% for new mortgages, are too high?Professor Patrick Honohan: There are certainly on the high side. However, we must ask what we mean by "too high". As the committee was told by the banks that presented to it in the past few weeks, they cannot fund themselves at the ECB policy rate. That is not the way it works, as everyone knows. The 4.5% should not be compared with 0.05% in terms of the cost of funds. Approximately 300 basis points or 3% is the spread over the banks' average cost of funds, although less over their marginal cost of funds. It is a bit on the high side, but not by all that much. We do not have the power to intervene.
I will jump ahead to the question of whether the Oireachtas should consider giving us that power. I would suggest not. In terms of the provision of mortgage credit and the in-flow of banking services into the economy, the confidence around the way banking and the financial system work - I am not referring to national confidence - is not well served by there being tight control over interest rates. In the 1960s to 1980s when a cartel of bankers was setting interest rates subject to some kind of approval by the Minister for Finance and the Central Bank, it was a facade because our control did not influence the rates, which were largely coming in from abroad. It would not be a good idea to introduce a regime of tightly controlled mortgage rates.
However, I would make an exception. The committee will presumably be considering legislation in the near future about the mortgages that are sold to non-banks, ones that are simply harvesting those mortgages without getting involved in new business. It may be that there should be some limitation on the degree to which they could deviate from market practice. What locks the standard variable rate contract into reality is the fact that it should be the rate that is charged by the lender on new and old business, more or less keeping lenders in line with market conditions. However, if an entity is not making new business, it might not have this natural restraint.
Deputy Pearse Doherty:
In regard to variable interest rates, Professor Honohan basically acknowledged that the banks are overpricing new customers but the Central Bank will do nothing about it.Professor Patrick Honohan: Put like that, it sounds bad.
Deputy Pearse Doherty:
That is the way the Governor put it. We can dress it up whatever way he wants, but that is the reality.Professor Patrick Honohan: The first point to make here is that the Central Bank does not have the power to intervene in this regard. Second, I do not think it should. As an adviser to the Government and the committee, I would not recommend doing that. I have seen what happens in other countries when it is done. The temptation is there to say the banks are charging too much, but they always seem to be charging too much. Eventually, that type of process either is a joke and ineffective, as it had been here for many years, or it presses down so much that the banks end up shutting up shop and not doing any business. If the situation became egregious, one would have to do something. It is not egregious at this time.
Deputy Pearse Doherty:
We have a problem with competition in the banking sector. One can make the case that to take action on this issue would encourage competition among the banks.The problem is they are not competing. As they are dominating the market, there is a need for the Central Bank or the Government to act. I do not have the time to tease out the matter further.