Second annual ECB macro-prudential policy and research conference – 12 May 2017
guests, it is a pleasure to speak on this policy panel today.1
Significant progress has
been made in recent years in developing the EU’s macro-prudential framework and
much credit for this must go to institutions like the ECB, ESRB and European
Commission, as well as national macro-prudential authorities.
The manner in which we now
conduct macro-prudential policy emerged in the context of the global financial
crisis and recession. The relative impact of these and the interaction with
diverse domestic factors has led to a policy framework which, in broad terms,
shares common themes and objectives, while also reflecting important country
and region-specific characteristics.
It is timely that we now
consider our broader framework in the EU as the economic recovery has become more
firmly established, and we see a normalisation of the financial cycle.
At the same time, we are
potentially presented with broader and more diverse sources of risk than when
the parameters of the current framework were being designed. These include the increasing
role of non-banks in financial intermediation and the challenges arising from
the decision of the United Kingdom to leave the EU.
To date, we have learned ‘a
lot by doing’, and indeed a lot has been done in the establishment of the
framework and the activation of macro-prudential policy instruments across the
Today, I would like to focus
my remarks on some of the challenges in implementing macro-prudential policy through
borrower-based measures for the mortgage market.
The Central Bank of Ireland introduced
caps on loan-to-value (LTV) and loan-to-income (LTI) ratios in early 2015. Both
the introduction of the measures and the first review in 2016, threw up some
interesting challenges, some of which I would like to share with you
today. These include the need to
frequently communicate on the objectives of the measures and the need to regularly
review their impact and effectiveness. More generally, some other challenging
issues with respect to these instruments include whether there should be a more
coordinated European framework for their introduction.
Borrower-based measures such
as loan-to-value and debt-service-to-income, debt-to-income or loan-to-income
ratios have been introduced in a number of European Member States over recent
Prior to the financial
crisis, these type of measures were deployed in mainly non-European countries
(including South Korea, Hong Kong, Singapore and others) and there is empirical
evidence regarding their potential effectiveness in reducing risks to financial
stability.3 The evidence however is rarely clear cut and
the impact of such measures can vary depending on, among other things,
characteristics of national housing markets and the position in the financial
Whilst subject to intense
debate, when we introduced the mortgage measures in 2015, the legacy of the
crisis was still at the forefront of many people’s minds. This, to some degree,
facilitated the subsequent broad societal understanding and acceptance of the measures.
Our two primary objectives
when introducing these measures were, first, enhancing the resilience of
households and banks to economic and financial shocks and, second, reducing in
a structural way the pro-cyclicality that can be inherent in housing and credit
markets by capping the amount of high LTV and LTI mortgages allowed at any
However, while we have
emphasised in all our public communications that it is not our objective to
target house prices, this has proven in fact to be a very difficult message to
get across to the public. Underlying much of the public discourse on the mortgage
rules is the central issue of affordability. In this context, it has been
challenging to explain (i) that house prices are determined by a complex
interaction of supply and demand side factors, (ii) that although our measures
may impact on prices – that is not their primary goal, and (iii) that housing
market policy issues like taxes, building measures and the shortage of supply
of housing for buyers and renters are outside of our remit.
Our view is that not only
would it be extremely difficult to choose an appropriate target for house
prices but also extremely difficult to hit this target. Financial sector
regulations cannot address these issues, which must instead be addressed by
other targeted policies.4 To
banks, we have also had to carefully explain that these are limits, not
targets. We continue to monitor their risk appetites in this regard.
Figure 1 shows the recent history of property prices in Ireland. It also
shows some uptick in mortgage lending across some segments of the market. Although
the overall numbers remain modest because of the scale of deleveraging
following the crisis, the volume of new lending is going up. In terms of
transactions, cash buyers continued to account for a large relative proportion
of activity, at 42% in 2016.5
Given these market dynamics,
existing supply constraints and strong demand factors are unlikely to moderate
significantly in the short term. This requires us to reinforce our
communication of the objectives of these measures.
In terms of their design,
the measures create a framework which allows us to better take into account the
balance of risks to the economy, by adjusting the parameters according to
current market conditions.6 Having
this flexibility is particularly important for a small open economy like
The mortgage measures are
complementary to existing micro-prudential supervision and to lenders’ own risk
management practices. They are not intended to capture all aspects of credit
risk associated with the borrower, nor to replace or substitute for a bank’s
existing internal credit assessment policies and procedures. Rather they are
designed to reinforce and strengthen the existing suite of credit risk
mitigation tools employed by prudent lenders.7
Following the crisis, we introduced comprehensive loan-level reporting
requirements on the main Irish banks. This data provides information on a wide
range of loan characteristics including outstanding balances, loan terms and
loan repayment for the population of mortgage and consumer loans and is
critical in the calibration and evaluation of the measures. The activation of
our Central Credit Register in June will further enhance our analytical
capacity with respect to our evaluation of the measures. It may also facilitate
us in moving toward a debt-to-income ratio in the future.
Our measures, as initially calibrated,
set out a loan-to-income ratio of 3.5 as the anchor of the framework, with the
value of loans exceeding the LTI limit of 3.5 not to be greater than 20% of new
lending in a given year. This only applies to primary dwelling homes and there
is no LTI limit for investment purchases.
A maximum LTV of 80% was set for non-first time buyers. For first time buyers a higher cap of 90%
applied for house purchases for the first €220,000 and the 80% LTV then applied
to that part of the value of the house above €220,000. Banks were allowed to
issue up to 15% of their primary dwelling home (PDH) loans above these LTV
limits on an annual basis. We apply a
more stringent limit to the purchase of houses for investment purposes and here
the limit is 70% LTV, with up to 10% of new lending on this basis allowed above
At the time of introduction
of the measures, we committed to regular reviews of their impact and
effectiveness. This we believe represents good practice, and mitigates against
any potential inaction bias. It is also consistent with the commitment for
quarterly reviews of counter-cyclical capital buffer (CCyB) settings and annual
reviews of the identification of, and buffer setting for, other systemically
important institutions (O-SIIs) as prescribed in CRR/CRD IV.
The review process was overseen by a new Macro-prudential Measures
Committee and involved a range of analytical projects looking at issues such as
borrower impact, the early performance of the measures against the stated
objectives, and any side effects, including in relation to impact on the rental
market, or leakages. To enhance
transparency and understanding, research outputs on all these issues and records
of the meetings are published on the Central Bank’s website.8
In addition, feedback from external stakeholders was gathered through a
call for evidence on the impact of the measures. Submissions were received from
a variety of property and construction industry stakeholders, financial
services firms and groups, political parties, government departments, academics
and individual members of the public. The submissions were a very useful input for our review, and were
also published on the Central Bank of
It is obviously the case
that it was very early after their initial introduction to be able to find much
causal impact from the introduction of the measures, but still our review threw
up some interesting findings and resulted in some changes to the design of our
We saw a reduction in high
LTV mortgages and simulations from loan-loss forecasting models indicate that
resilience of banks and households increased. We found that the introduction of
the measures had an immediate and material impact in moderating price
expectations. Actual price increases
also moderated although it is more difficult to ascribe any causality to our
In general, we found that the overall framework of the measures is
appropriate and effective in meeting the objectives. Nonetheless, following our
2016 review some changes to these parameters were applied to improve the
sustainability and effectiveness of the overall framework. Most notably the higher
90 per cent LTV available to first time buyers is now available at all house
prices. The change was in part to avoid
a situation whereby the €220,000 cut-off point would have to be recalibrated at
regular periods as house prices increased. This change was also supported by
new research findings of lower credit risk for first time buyers at all house
The other main change arising from the review was to the structure of
proportionate caps such that instead of a LTV allowance of 15 per cent for all owner-occupier
mortgages, separate allowances for first time buyers (5 per cent) and second
and subsequent buyers (20 per cent) are now allowed.
High levels of
household indebtedness and a large number of households in mortgage arrears
and/or with negative or low positive equity in their houses, are prominent
features of the Irish residential real estate market. Whilst
not materially affecting the
amount of allowances available, differentiating the allowances of first time
buyers and second and subsequent buyers allows for a more precise calibration
of the rules by borrower type if in future they need to be tightened or
loosened in response to emerging risks and developments in the property market.
Negative equity borrowers are exempt from the measures. As more second and subsequent buyers move from negative equity into small levels of positive equity, the higher level of exemptions will ensure the measures would not act as an excessively binding constraint.
Taking communication and
calibration together, people broadly understood the rationale for the limited
refinements and minor recalibration of the framework. However, with such levels
of house price increases, we have found the need to communicate that policy
stability is important for both households and banks. As central banks, we have
the responsibility to reduce regulatory uncertainty and therefore annual
reviews are most appropriate.9 In
the case of the LTV/LTI caps, it is intended that the annual reviews will allow
for both evaluation of the structural design of the framework, analysis of any
side effects or unintended consequences, and assessment of whether the
parameters are calibrated appropriately for current housing and credit
The experience so far in
Ireland corresponds with the broad international experience as to the
effectiveness of borrower-based measures for the mortgage market given
country-specific features. A framework
for transparent and accountable policy making in this space, supported by
consistently communicated, well-defined objectives and related evidence base,
are necessary conditions for their acceptance and effectiveness.
At present national
macro-prudential authorities play the central role implementing borrower based
measures. The ESRB however has an important coordinating role via the
notification process. National authorities also benefit in their deliberations
from interactions with the ECB. The ECB also has an important ‘top-up’ power
with regard to capital-based instruments like the CCyB and O-SII buffers.
The impact of borrower based
measures when they are binding is much more evident to the public at large than
capital and liquidity restrictions imposed directly on banks. Borrower-based
measures can have important distributional and welfare effects in society,
particularly in relation to access to home ownership. These factors underline the importance of
getting the design of the measures right, taking into consideration country-specific
factors, and also the need to communicate the overall framework and ensure it
becomes generally acceptable in society as a permanent feature of the mortgage
As well as the wide range of national-specific institutional features
which influence the design and calibration of such instruments, this suggests
that responsible authorities must be accountable at national level. Although, we
should be humble enough to acknowledge that the interactions between
macro-prudential policy measures may not be fully or correctly identified ex
Significant progress has
been made in the analytical toolkit to support macro-prudential policy across
the euro area, as was outlined in some of the presentations yesterday. As
policy-makers we should continue to draw on this input, encourage its further
development, and understand where judgement in evaluating policies impact,
effectiveness and interactions is necessary.
In this regard, particularly as we are still in the early stages of an
active macro-prudential policy framework in Europe, we should aim to avoid
underlaps to ensure systemic risk is mitigated.
As the framework in the EU develops, national designated authorities
should continue to have a sufficiently broad set of tools to target identified
systemic risks. We should continue to
learn by doing. Combined with a
commitment to regularly, rigorously and transparently review policy measures,
we will ensure the most effective tools are in operation, both in isolation and
jointly, to mitigate systemic risk.
Today, I have touched on a
number of challenges that we have before us when considering the appropriate
macro-prudential policy framework for Europe.
As we well know, past performance is no guarantee of future returns. However, I believe we can look back at the
first generation of the EU macro-prudential policy framework and how it has been
adopted at both national and at Union level in a broadly positive light.
Important features should
remain, such as the prominent role national authorities have in identifying
systemic risk and designing policy measures, the effective cooperation across
the euro area and ESRB and the appropriate acknowledgement of the implications
of our policies in other dimensions and countries. While the challenges we face are ever-changing,
the foundations we have laid and the commitment shown over the past few years
can give us some confidence going forward.
Webcast available on the ECB YouTube channel
Photos from the conference available on the ECB Flickr
would like to thank Mark Cassidy, Martin O’Brien, Eoin O’Brien, Mícheál
O’Keeffe and Jean Quin for their contribution to my remarks.
2 By the end of 2016, legislation formally establishing national macro-prudential authorities had been passed in 26 Member States and there has been a very high level of effective operationalisation of the framework. National authorities in the EU and Norway had notified the ESRB of 83 significant measures in the three years up to end-2016. See ‘A Review of Macro-prudential Policy in the EU in 2016’, ESRB, April 2017.
Eugenio, Claessens, Stijn and Laeven, Luc, (2015), The use and effectiveness of
macro-prudential policies: new evidence. Journal of Financial Stability. 2016,
4 See FAQ – Outcome of the Review of Mortgage Measures, 23 November 2016.
a fuller discussion see Coates, Dermot, McNeill, Joe and Brendan Williams,
(2016), Estimating Cash Buyers and Transaction Volumes in the Residential
Property Sector in Ireland, 2000-2014, Central Bank of Ireland Quarterly
Bulletin 03 / July 16. The full year
2016 estimate is derived using data on mortgage drawdowns from the BPFI and the
Residential Property Price data from the CSO.
6 See ‘Lessons from the past, safeguarding stability for the future’ Address by Sharon Donnery, Deputy
Governor of the Central Bank of Ireland, at the Centre for Economic Policy
Research (CEPR) Economic History Symposium, Dublin, 9 June 2016.
8 Records of the Macro-prudential Measures Committee meetings. Accompanying research papers regarding the mortgage measures, submissions and feedback
statements are also published.
9 See ‘ ‘Macro-prudential policy: action in the face of uncertainty’. Address by
Sharon Donnery, Deputy Governor of the Central Bank of Ireland at the Dublin
Economic Workshop Annual Economic Policy Conference. 24 Sep 2016.