The Central Bank and Financial Regulator today published the findings and recommendations from a review of Irish banks’ mortgage lending policy for first time buyers in the retail banking sector. This review was undertaken to ensure that there are strong safeguards in place for mortgage lending, in the interests of both borrowers and lenders. The Bank says more can be done, and needs to be done, to improve practices.

The Bank said that following years of rapid growth in mortgage lending, often to inappropriate levels, current conditions in the mortgage market remain challenging, with overall mortgage lending remaining low. But despite limited activity, lending to first time buyers accounts for 38% of new mortgages in individual banks. There are also indications that a number of banks are planning to increase business in this area.

In general, the review suggests that while some progress is being made to improve lending standards and oversight, more can be done, and needs to be done, to improve practices. As lending volumes remain low, the risk that current lending decisions will impact on future losses is not high. The review says the absence of major mortgage activity creates an excellent opportunity for banks to review and enhance practices for the future. It is also important that this happens while the lessons of the crisis are fresh in the minds of market participants.

The main findings from the review are:

• Progress has been made in ensuring that lending decisions are based on more realistic risk factors. Income multiples have been reduced to more realistic levels. The uncertainty of bonuses and overtime payments in calculating income levels is also being reflected in lending decisions. Banks have also made good progress in reducing the number of mortgages which represent exceptions to policy, which is evidence that banks have tightened controls. There have also been improvements in training for underwriting staff. We expect that banks to continue these improvements as mortgage volumes rise.

• More work needs to be done across the banking sector to improve the quality and detail of mortgage lending strategies. In particular, these strategies need to be rooted in detailed expressions of risk appetite, using more sophisticated measures of risk (see below). Banks should maintain a current strategy for their mortgage business, with specific attention to strategy for first time buyers business. This mortgage strategy should address management of both new and existing business. The strategy should provide a cohesive view of risk appetite, loan pricing, funding costs and customer suitability and may need to consider multiple views of customer and product segments.

• There are concerns that, in some instances, banks are not utilising robust and reliable risk measures when developing new mortgage lending strategies or mortgage products. The absence of such measures, for example risk adjusted return on capital (‘RAROC’), can undermine risk calculations and thus the quality of lending decisions. A particular concern is the absence of such measures in circumstances where a bank is adapting its strategy in response to its competitors’ actions. All banks are expected to ground their lending in strategies appropriate to their risk appetite rather than the direction of the market as a whole. A ‘follow my leader’ approach to mortgage strategy has not served banks or their borrowers well in the past.

• There is evidence of limited involvement of non-executive directors in assessing, scrutinising and challenging new mortgage lending policies. While most banks bring mortgage portfolio and strategy reviews to their board for review, there is scope for the boards of individual banks to provide more challenge to executive decisions on mortgage lending. It is particularly important that non-executives have a firm grip on the definition of risk appetite for mortgage lending and the subsequent formulation of strategy for this market.

• The quality and quantity of feedback between mortgage policy and actual lending decisions needs to be improved. Most banks have independent oversight of their lending decisions, but boards can do more to determine whether internal controls deliver outcomes that are consistent with mortgage policy and, ultimately, risk appetite and strategy.

• Limited references to customer suitability were found in mortgage product design. Mortgage suitability is a key requirement of the statutory Consumer Protection Code and banks should evaluate whether they can do more to incorporate evaluations of customer suitability within the mortgage process. This will be an area of focus for the Central Bank in coming years.

Banks are expected to use the findings of this review to enhance their mortgage activities. Over time, the Central Bank said this should lead to better quality mortgage lending.

As mortgage lending, and credit standards more generally, are areas of focus the Central Bank and Financial Regulator said they will intervene where they are not satisfied that adequate safeguards exist within a bank. Measures which may be taken, on a bank-by-bank basis, can include:

• Imposing a loan to value ceiling;

• Capping loan to income multiples;

• Limiting the term of new mortgages;

• Removing room rentals as a criteria for mortgage assessment; and

• Imposing income verification procedures, including contacting employers

The Central Bank says the preference is that banks take the lead in developing best practices mortgage lending practices, and progress in this area will be recognised in the nature of our engagement with individual institutions.

The findings of the review are the subject of separate follow up with each of the participating banks. Further sampling work will be undertaken on recently issued mortgages to assess, in detail, the progress banks are making in introducing appropriate controls on mortgage lending. Specific follow-up action will occur on a bank-by-bank basis.