Banks Not Passing Rate Cuts on...!

Earlier this month, the European Central Bank cut interest rates to a record low level. This was the first cut in just over ten months and whilst the new 0.50% rate is as low a rate that has ever been seen in the Eurozone, the ECB also indicated that there was the possibility of further action in the future.

Sounds good, but it gets even better. As well as providing as much liquidity as possible to the banks and helping smaller firms to access credit, Mario Draghi, the ECB president also suggested that they were 'technically ready' to cut their deposit rate from the current 0% into negative territory. This means that they would start charging banks for holding their money overnight encouraging them to lend more money rather than deposit it at the ECB.

So we've got record low interest rates and banks being encouraged to lend. It sounds ideal but the benefits are stopping well short of those who need it most. President Michael D. Higgins has said that the banks need to restore trust and confidence, I couldn't agree more. Since 2008 they have largely been the villains of the peace and trust is at an all time low, rather like those interest rates that I started this article with.

The Irish Banks have chosen not to pass on the interest rate cuts. Everyone, rightly questions why? Senior Bank Officials regularly trot out the same rhetoric, 'If we pass it on, it will ultimately cost the tax payer more'. That' s only if they avoid another bailout which in my opinion is unlikely. The standard mantra seems to be the taxpayer pays, the taxpayer pays, the taxpayer................pays. Banking is such an easy game!! For the lucky ones who own a 'tracker' mortgage the banks have no option but to pass the rate on. For all other class of borrower, there is a degree of discretion on behalf of the bank. Rather bizarrely, earlier in the same week that the ECB cut rates, the so-called pillar banks raised them for certain types of borrowers. There is absolutely no way that trust can be restored when this happens, it's quite simply counter intuitive. I also associate the word 'pillar' with an upstanding, contributing member of society. Perhaps there is a better description.

 

Up until recently, mortgage interest rates in Ireland closely tracked movements in the ECB's main refinancing rate. This occurred because of the higher proportion of tracker and variable rate mortgage products in the Irish market which are linked to the ECB's rate. But the banks have been hammering away at you all long before this month, over the past nine months, prior to this rate cut, the average Irish interest rate on outstanding mortgages had already diverged from the ECB's main rate. The ECB's main refinancing rate has remained constant at 0.75%, whilst the applicable Irish rate increased by 14 basis points. Naturally enough this divergence is increased even further by this most recent cut. The domestic banks are clearly breaking from their traditional policy of automatically passing on rate cuts.

 

Why is this happening? Banks traditionally lend long term in the form of mortgages and term loans but borrow short term from their own deposits and the money markets. Quite simply the cost of their borrowings in the short term market have increased following the global financial crisis and as well as losing money on their loan to book values they are also losing money on the difference between the rate they have lent long term and the rates at which they are able to borrow.

 The borrower is taking all the hits and being pushed closer to the edge of despair. The banks had a duty of care when they lent you the money, they have a duty of care throughout the term of the mortgage and they have a duty of care when you are in difficulty and need assistance in solving your difficulties. There has been a certain amount of wilful neglect at each level. We see many borrowers in Ireland who have not made any payment on their mortgage in several years, this is incomprehensible but is a fair indication of how far the situation has deteriorated. Denial on behalf of the bank and the borrower has only made the situation far worse than it needed to be.

There are very few positives to find for the borrower that is being pushed around. The banks most recent methods to address the problem in the Republic of Ireland, split mortgages may solve some of the immediate problems but will present more issues long-term and many of these may be more unmanageable. Those with tracker mortgages remain in a stronger position but should resist any temptation from the banks to change these. In years gone by the borrower has been sold the 'pup' with the like of endowment mortgages, now that the banks are on the wrong end of one of their products, let them sit with it and resist any attempt luring you to change to a variable or fixed rate mortgage.

My own personal view is that this thread is going to run and run and whether you reside in the Republic of Ireland or Northern Ireland you need to watch this space very carefully to see what develops.

Author: Nick Leeson – Principal at GDP Partnership www.gdpni.com