Report examines mortgage supply

Innovation and income fraction in the financial markets helped expand the supply of mortgages for most of the last decade.

This in turn spurred house price growth to the highest rate in the EU between 1995 and 2007, according to a new paper by the Central Bank.

The dramatic improvement in the economy over the course of the 1990s created a pent-up demand for housing.

However, developments in the financial markets helped banks meet the demand for mortgages.

“One of the most significant developments in international banking finance over the past 15 years has been the extent to which financial institutions have been able to fund credit provision outside of their deposit base,” according to the authors, Yvonne McCarthy and Kieran McQuinn.

“Traditionally, in many countries, the amount of credit provision was directly related to the level of deposits within the financial system.

“However, the emergence and subsequent increase in the use of alternative sources of funding enabled credit institutions to secure funds from elsewhere and, consequently, respond, on a much more aggressive basis, to perceived lending opportunities.

“In the case of the mortgage market, this increased level of credit was extended through a variety of different channels — increased loan-to-value ratios, greater income fractions being facilitated, and mortgage lengths of greater duration.”

The paper identifies the income fraction channel as being one of the most important factors in ratcheting up the number and value of mortgages over the boom years.

The income fraction is the value of a mortgage relative to the total income.

“As well as being one of the main causes of price increases, variations in the fraction would appear to be one of the significant reasons for the sharp contraction experienced by Irish house prices since 2007,” the report states.

“Thus, the fraction would appear to be highly pro-cyclical, fuelling house price increases in the upturn and exacerbating the decline in the downturn.”