Higher rates ‘won’t bolster banks’

Raising interest rates is not the best way to deal with the fallout from erratic property lending, the deputy governor of the Central Bank has said.

In a speech at NUI Galway yesterday, Stefan Gerlach said Ireland could follow examples set by other small eurozone economies in guarding against the fallout of property sector crashes.

“Capital requirements for mortgages for buy-to-let properties could be increased, relative to those for primary dwellings.

“This would tend to reduce this type of lending, which appears to be associated with greater credit risk, and ensure that banks’ resilience is bolstered by the additional capital buffer.

“Dynamic provisioning requires banks to hold provisions against expected losses due to credit risks.

“This tool has been implemented in Spain, where banks are required to build up buffers against performing loans in an upturn, which can then be drawn down in a recession. This naturally slows bank lending in the boom phase and leaves banks in a better position to withstand loan losses in a crash.”

The Central Bank’s second-in-command also said that a tightening of limits on loan-to-value and loan-to-income ratios, at the beginning of a boom, can raise the ability of the financial system to cope if the bubble bursts.

“Their potential use in Ireland warrants further reflection,” he said.

“It is sometimes argued that tighter monetary policy — higher interest rates — is the appropriate way to deal with property bubbles.

“However, monetary policy is a blunt tool that affects all lending, risky and less risky.

“In contrast, macro-prudential tools can be targeted narrowly on the most risky borrowers. Such a sharp focus may lower the overall cost of preventive action.

“We need to explore whether such macro-prudential tools play a useful role in Ireland.”