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Opinion: To maintain economic resilience we must learn from the past and look to the future

Vasileios Madouros of the Central Bank says a fresh review of its mortgage lending measures will include submissions from the public.

Vasileios Madouros

RESILIENCE MATTERS ON many levels: for individuals, for families, for entire communities. It is a concept that we can easily relate to in our daily lives.

When our own resilience levels are low, even small setbacks can be difficult to deal with. And our reactions to those setbacks can also affect others around us, potentially adding to the stress of our families, friends or colleagues.

By contrast, when our own resilience levels are high, we are better able to adapt to setbacks. Again, our reactions can also affect those around us, but in this case, reducing – rather than adding to – the stress of others.

Resilience is also critical in finance. With one big difference: when finance is not resilient, the adverse impact is felt across society. That became painfully clear a decade ago. Before the financial crisis, we had years of unsustainably loose lending standards. During the financial crisis, the banking system faced losses it could not absorb: it was not resilient.

Indeed, the reaction of the financial system made the impact of the crisis worse: the supply of loans to households and businesses dried up, the economy went into a large and lengthy recession, jobs were lost and livelihoods shattered. Insufficient resilience in finance became a source of problems for every single one of us.

Maintaining resilience

Learning the lessons of the past, over the last decade, the Central Bank of Ireland has been focused on re-building the resilience of the financial system. We do this in different ways. For example, our mortgage measures support good lending practices, guarding against a repeat of the credit boom and bust cycle that we saw in the 2000s.

We also require banks to have more loss-absorbing capital than they had in the past. This means that, when things go wrong, they are better able to continue lending to, and supporting, households and businesses.

Of course, strengthening resilience in finance entails both benefits and costs for our society, the balance of which we always consider carefully. The challenge is that the benefits of resilience in finance are not something we can see every day. They are typically best understood in the absence of things: “what might have happened, but has not”. This can make the benefits for society seem somewhat elusive. But they are very real. And they matter for all of us.

Indeed, these benefits matter most in difficult times, such as the one we have been going through since the onset of Covid-19. The pandemic has adversely affected the finances of many businesses and households across the country.

Government supports for households and businesses have been broad-based and necessary to mitigate the economic harm of the pandemic. But – unlike what happened a decade ago – the financial system has not added to the economic damage. Banks have not turned off the lending taps. We entered this shock with a banking system that had more capital set aside for a rainy day, lower levels of indebtedness in the economy and a housing market that has not been driven by unstainable credit. This means that – as a country – we are in a better position to recover from this pandemic shock than we would have been a decade ago.

Looking ahead, to keep finance resilient, we cannot remain still. The environment in which our policies operate is evolving all the time. So we need to ensure that our policy frameworks continue to remain fit for purpose.

We achieve this by learning lessons from the past, but also by looking to the future. With this in mind, we have commenced our first in-depth review of the overarching policy framework for the mortgage measures since their introduction in 2015.

Have your say

The mortgage measures are a permanent feature of the market. At all points in time, there is a role for ‘guardrails’ to lending standards. They support good lending practices, preventing the widespread financial difficulties that we saw a decade ago due to unaffordable debt levels.

They also aim to reduce the risk of another credit-fuelled house price boom. But these are relatively new interventions, with direct and tangible effects on people. So, every year, we conduct a careful assessment of the calibration and operation of the mortgage measures. That process will continue as normal in 2021.

In addition to our annual assessment, we have also started a broader review of the overall policy framework for the mortgage measures. As the measures have been in operation for almost seven years now, we have access to a wide range of research and data on their impact.

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We can also learn from the experiences of other countries, as similar policies to our own have become common practice across the developed world in recent years. What we will focus on in our framework review are questions around our overarching approach: Are the tools we currently have in place still the most appropriate ones? What have we learned about the benefits and costs of these interventions over time? How do the factors that we take into account when calibrating the limits need to evolve, in light of any structural changes in the broader economy and financial system?

As part of this process, we want to hear from the public. We are very conscious of the challenges that the current state of the housing market poses for many people, especially younger generations. At their core, these challenges stem from an underlying imbalance between the demand for, and supply of, housing.

Policies that affect housing construction are complex and go beyond the Central Bank’s mandate. But a sustainable provision of mortgage finance is a necessary ingredient to support the broader functioning of the housing market.

We also know that, behind all the economic data and evidence that we look at, lie people’s own lived experiences. So we will be listening.

Over the summer, we will be launching a digital consultation tool, which will allow the public to share their views and experiences on the functioning of the mortgage measures to date and their perspectives on what a sustainable mortgage market looks like. The input gathered through this process will be key to our review of the framework, which will run throughout 2021 and 2022.

The resilience built in recent years means that the banking system has been in a better position to act as a shock absorber during the Covid-19 shock, rather than a shock amplifier. Looking forward, we want to ensure that our policy frameworks remain fit for purpose, amid wider changes in the economy and financial system.

This will enable us to continue to safeguard the resilience of the financial system, so that it is better able to serve households and businesses, both in good times and in bad.

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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