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Opinion: Our Central Bank mortgage lending rules are vital guards against booms and busts

Vasileios Madouros of the Central Bank says the 2015 lending regulations have helped us brace against the Covid-19 shock.

Vasileios Madouros

BUYING A HOUSE is the biggest financial decision that most people will make in their lives. It typically comes with a substantial amount of borrowing, lasting for decades. Such a long-term financial commitment can feel daunting.

In considering whether to buy a house and if we can afford it, we often contemplate various scenarios. What if our incomes or house prices fall? What if we want to expand our family? What if we need to move? A tussle between head and heart can emerge.

Precisely because housing decisions are so important for individuals and families, what happens in the housing and mortgage markets is also extremely important for the economy as a whole.

From boom to bust

Housing is the single most important asset of households in the country, while mortgages are the largest form of debt owed by households and the biggest lending exposure on banks’ balance sheets. Developments in the housing and mortgage market can affect every single one of us. Whether we rent or we own. Whether we have a mortgage or not.

History offers many lessons on how things can go wrong. In the 2000s, Ireland experienced an unsustainable, credit-fuelled housing boom. Lending standards became too loose and mortgage borrowing too high. When that boom turned to bust, the costs for society – the human costs – were enormous.

Close to one in five mortgagors were in arrears in 2013. The banking system faced losses it could not absorb. The economy went into a large and protracted recession, with jobs lost and livelihoods shattered.

The impact of the financial crisis was particularly acute for young people – many of whom had not even engaged with the mortgage market by that point in their life.

Around 30% of younger people were unemployed in 2012; thousands emigrated, and wages fell sharply for graduates and new hires. Indeed, the costs of the housing boom and bust of the 2000s are still being felt today.

Housing construction fell sharply during the financial crisis and, in more recent years, the growth in demand for housing has outstripped supply. This has increased affordability pressures both for those renting and those looking to buy a house, affecting younger generations most.

Much needed regulations

Learning the lessons from our past, the Central Bank introduced in 2015 a set of measures that guard against excessively loose lending standards in the mortgage market. While not always understood as such, the measures are essential to our mission of safeguarding stability and protecting consumers.

We know that borrowers with high levels of debt relative to their income or to the value of their house are more likely to face financial difficulties in challenging economic times.

By limiting how much lending banks can extend at high loan-to-income and loan-to-value ratios, the measures guard against the risk of widespread financial distress due to high levels of debt.

We also know that excessively loose lending standards in ‘good times’ can feed unsustainable house price increases, with large costs to society when that reverses in ‘bad times’.

By constraining lending standards, the mortgage measures guard against the risk that a credit-fuelled house price boom like the one we saw in the 2000s re-emerges in future.

Room for manoeuvre

Similar policies were introduced across a number of countries in the decade following the financial crisis. But these are relatively new interventions, with direct and tangible effects on people, especially prospective homeowners.

With that in mind, the mortgage measures have been designed with significant flexibility. The measures limit how much lending can happen at higher levels of indebtedness across the economy, but do not ban that type of lending altogether.

That flexibility enables lenders to take into account individual borrowers’ circumstances when making lending decisions. The measures are also more flexible for first-time buyers than for those who already own a home and are looking to move or buy another property. For example, around one in eight mortgages to first-time buyers were extended above the loan-to-income limit last year.

Lending in Covid

Precisely because the measures can have a direct impact on people, the Central Bank reviews its effectiveness every year. This year’s review was conducted in the context of the unprecedented shock stemming from Covid-19.

Although the pandemic has had a severe impact on the economy, we entered this shock in a much less fragile position compared to a decade ago. Unlike the period preceding the financial crisis, we have not had an unsustainable, credit-fuelled housing boom.

Households have much less debt than going into the financial crisis. Lenders are in a better position to absorb the shock associated with the pandemic. The combination of these factors means that, as a country, we are in a better position to recover from this extraordinary, pandemic-related shock than we would have been over a decade ago.

The benefits of having had the mortgage measures in place since 2015 are most evident in times like these when economic conditions are challenging.

Still, there is no question that the current state of the Irish housing market poses real challenges for people, especially younger couples and families. Affordability pressures are evident in the level of rents and house prices relative to incomes, especially in urban areas.

In recent years, the supply of housing has not kept up with growing demand. Construction has been below its long-term average for about a decade. And fewer homes are being built, at any given level of house prices.
In 2019, 21,000 new homes were built in Ireland, approximately half of what was built on average each year in the second half of the 1990s. Yet house prices – adjusted for inflation – are now close to 90 per cent higher than what they were then. In a market where housing supply is constrained, additional debt will not help potential homeowners.

It will only lead to more money being spent chasing a limited amount of properties, pushing up prices and adding to affordability pressures. The focus needs to be on tackling the underlying issues around the volume and composition of housing supply.

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The lessons from our own history and from other countries are clear: if lending standards get too loose, the subsequent costs to society can be very large. The mortgage measures guard against that, protecting the economy and consumers.

At the Central Bank, we will continue to consider the operation and calibration of the measures very carefully, to ensure that they continue to safeguard the welfare of the people of Ireland.

Vasileios Madouros is Director of Financial Stability at the Central Bank of Ireland. He is responsible for the Central Bank’s work to monitor threats to financial stability and provides advice on the use of macro-prudential tools, or other policy interventions, to mitigate those risks.

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Vasileios Madouros

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