Address by Bernard Sheridan, Director of Consumer Protection, to Griffith College Dublin

Mortgage Arrears and Personal Debt – Protecting Consumers

Good afternoon everyone and I would like to thank Lisa Hegarty at Griffith College Dublin for inviting me along today to share some of my thoughts on the changing relationship between borrowers and lenders, the need for this relationship to be developed and the role of the Central Bank in helping shape this relationship in the interests of protecting consumers. The Central Bank plays a key role in relation to the provision of credit. It is not only responsible for licensing and regulating the providers of credit but also for ensuring that all lenders treat their customers fairly throughout the term of the relationship. While regulation plays an important role there is also a responsibility on all lenders to re-examine how they treat their customers not only when establishing a relationship with a new borrower and in the initial provision of credit, but also how they can help them and work with them to avoid debt problems and to deal with debt issues should they arise.

I will focus on three key aspects of this relationship namely

• How well do they know each other;
• How are surprises avoided during the relationship; and
• How well does the relationship work when difficulties arise.

 I will also highlight how we are strengthening the framework around this relationship and making sure that lenders are complying with our requirements.

I think that one of the lasting consequences of the recent economic and financial crisis is that the nature of the relationship between lenders and consumers has changed. Credit was seen as a basic product that could be bought and sold with relative ease and where it was seen to be in the best interests of both the customer and the lender that the maximum amount possible was made available. In the booming economy little thought was given to the possibility that the borrower’s circumstances could change and that the loan may not be repaid and the consequences for both parties should this happen. In the new environment we have to look at credit as more of a valued product which is provided based on a longer term relationship where both parties know and understand each other much better and have thought through the implications of their decisions. This may mean that more consumers may be refused credit or provided with smaller loans. It also means that lenders will have to dedicate more resources to the ongoing relationship with existing borrower’s rather than on new sales. The relationship needs to be able to deal with unexpected events where the customer feels comfortable in engaging with the lender when problems arise and before they escalate. The consumer protection measures we already have and additional measures being put in place provides the framework within which this relationship will develop. However simply strengthening the framework is not enough, we need to ensure that it is working and intervene where it is not.

Mortgage arrears has become one of the biggest issues facing us. The Bank’s quarterly data on arrears and repossessions show that mortgage accounts in arrears over 90 days have almost doubled since September 2009 rising from over 26,000 accounts to almost 50,000 accounts in March 2011. Data on arrears does not show the full extent of the problem. We now also publish data on restructured loans which show that over 86,000 accounts are either in arrears or are restructured. It is worth noting that over half of all restructured accounts are either paying interest only or less than full interest only which means that outstanding debt is not decreasing for those families. While I acknowledge that any case of repossession involves very difficult circumstances for the family, the level of repossessions remains low with 140 occurring during the first quarter of this year. The publication of this data has brought greater transparency to the extent of the problem and helps us see trends as they develop. While mortgage debt represents the biggest part of household debt we know consumers are struggling to keep up repayments on other loans as well as paying off credit card debt.

How well do borrowers and lenders know each other?

Knowing the consumer, understanding their needs and their overall financial position, particularly their ability to meet repayments, is a critical component in ensuring the relationship is put on a sound footing from the start.

The most significant piece of new legislation governing the provision of retail credit has been the introduction of the Consumer Credit Directive (CCD) which was transposed into law on 11 June 2010.

The Regulations apply to creditors engaging in the provision of non-mortgage credit agreements to consumers for amounts between €200 and €75,000. The Regulations require lenders to assess the consumers creditworthiness on the basis of having obtained sufficient information from the consumer before providing credit. The Regulations also require lenders to provide adequate explanation to a consumer to enable them to assess whether a proposed credit agreement is appropriate to his or her needs and financial situation. This involves a two-way process of exchanging information between the potential borrower and the lender, assessment of that information and translating that information into a recommendation that results in the consumer obtaining an appropriate outcome. The use of the word “explanation” is interesting as this goes beyond purely providing information and means there is a greater onus on the lender to ensure the consumer understands.

In terms of mortgages the Central Bank’s Consumer Protection Code (“the Code”) applies to credit not covered by the CCD including mortgages. It requires mortgage lenders to gather sufficient information to enable it to recommend a suitable product. Our existing Code is largely principles based. In the absence of detailed rules this provision is open to interpretation as to the extent of the information needed and how it is used to determine suitability. We are now proposing to be more prescriptive in the new code and in our consultation paper on proposals to revise the Code, we set out a number of new provisions including:

• The lender must gather information on the consumers’ needs and objectives, personal circumstances, financial situation and attitude to risk.
• Before offering, arranging or recommending credit, a regulated entity must fully assess the consumer’s ability to service the repayments.
• A regulated entity must, when assessing the consumer’s ability to repay, calculate the impact on the repayment amount of a 2% interest rate increase above the interest rate offered to the consumer. Where the consumer is availing of an introductory interest rate, the calculation must be based on the lender’s standard variable rate or fixed rate, whichever is to be applied after the introductory period. This information must be provided to the consumer.
• Regulated entities are prohibited from accepting a self-certified declaration of income from a consumer as evidence of his/her ability to repay a mortgage.
• In the case of interest-only mortgages, a regulated entity must be satisfied that the consumer will be able to repay the principal at the end of the mortgage term.
• Where a mortgage is interest-only for a limited duration, a regulated entity must be satisfied that the consumer will be able to meet the increased mortgage repayments at the end of the interest-only period.
• If consumer unwilling to provide information, suitability cannot be determined and service/product cannot be offered.
• When carrying out the know the consumer and suitability assessment for a mortgage, a regulated entity will be required to gather information on a customer’s income, savings, assets, debts and financial commitments and use this information to assess whether any mortgage is affordable for a consumer.

 These proposals may mean that there is less flexibility and room for interpretation by lenders which could result in lesser choice for the consumer. However the benefits are that there should be no surprises for either party as the loan progresses and they should significantly reduce the risk that the loan will not be repaid. The proposal may seem to be very onerous and consumers may feel the lender is being too intrusive as the information is quite detailed. However it means that there would be a discipline for consumers to fully understand their current financial situation before becoming more indebted. It is also important that the consumer has provided all of the relevant information to the lender who can make a proper assessment if they can see the full picture.

No surprises

I was surprised when lenders recently started to increase the variable interest rates on mortgages that they were not giving consumers any notice of the proposed increase. In the current environment many borrowers have limited capacity to absorb higher costs and therefore would need time to plan for such an event. Lenders need to think through the consequences of their decisions on their customers before making changes. We informed all lenders that in future they must give at least one month’s notice of any increase in their standard variable rates. The Consumer Credit Directive also requires advance notice to be given of any changes in rates on consumer loans.

It is also important that borrowers are getting what was promised particularly in terms of the interest rate being charged. Earlier this year we published the findings of a themed inspection of the moneylender sector. Inspections were conducted in 11 of the 46 licensed moneylenders currently operating in Ireland and focused on whether consumers were being charged in accordance with moneylenders’ authorised APRs (Annual Percentage Rates) and costs of credit as set out in the moneylenders’ licence. It also examined whether firms had their licences on display and if they indicated the high-cost nature of loans on loan documentation issued to consumers, as required by the Moneylender’s Code. Overall the inspections found a high level of compliance with the requirements and consumers were charged in accordance with moneylenders’ authorised APRs and costs of credit.

In May this year we published the results of a themed inspection of products sold by banks with promotional interest rates. The inspection identified a number of concerns including interest rate errors on homeloan products and misleading advertising.

The inspection examined deposit and homeloan promotional interest rate products from six banks in terms of how they were advertised and sold to consumers and whether the terms and conditions of products were complied with by banks, particularly when the promotional interest rate period expired. Deposit and homeloan promotional interest rate products were identified as potential areas of consumer risk based on the experience of dealing with charging errors previously identified in banks. Our inspection examined five deposit products and six home loan products in six banks, for over 112,000 customers, and 200 customer and 40 complaint files were reviewed. In the case of several homeloan products, errors were identified where customers did not receive the full period (365 days) at the promotional or discounted rate. Fixed rate homeloan customers were also affected, although fixed rate homeloans were not within the scope of this inspection. It was found these errors could have been avoided if the product development process included a thorough end-to-end check of IT systems at the banks concerned. An investigation is ongoing at one bank to rectify the issue, while refunds are in the process of being issued to customers affected at another.

How well does the relationship work when difficulties arise?

When borrowers start struggling to keep up repayments the whole relationship with the lender changes dramatically. The customer is no longer seen as a customer but as a problem. In the vast majority of cases the problem has arisen as a result of a loss of employment or a reduction in wages or an increase in interest rates. However in the past little allowance has been made for the circumstances. I believe the new Code of Conduct on Mortgage Arrears (“CCMA”) has fundamentally changed how mortgage arrears customers are treated. It is worth pointing out what the introduction to the CCMA says:

“Lenders must treat borrowers in or facing mortgage arrears, with due regard to the fact that each case of mortgage arrears is unique and needs to be considered on its own merits... All such cases must be handled sympathetically and positively by the lender, with the objective at all times of assisting the borrower to meet his/her mortgage obligations”.

The revised CCMA applies to all mortgage arrears cases from 1 January 2011.

Some of the key provisions include:

• Lenders must have in place a Mortgage Arrears Resolution Process (MARP) as a framework for handling arrears and pre-arrears cases. The CCMA sets out the steps and processes that lenders must include in the MARP. The major elements of the MARP include:
• A centralised and dedicated Arrears Support Unit (ASU) to manage and access cases under MARP;
• A standard financial statement must be used by all lenders to obtain financial information from borrowers and to make an assessment in relation to alternative repayment measures;
• Lenders must establish an appeals process to consider any appeals submitted by borrowers.
• Pre-arrears borrowers must be treated under the MARP.
• Specific information must be provided to borrowers in a clear and customer friendly manner.
• Borrowers in arrears must not be required to change from a tracker mortgage to another mortgage type.
• Where borrowers are co-operating with lenders, lenders must wait at least twelve months before applying to the courts to commence enforcement of any legal action on repossession of a primary residence. The twelve-month period switches on and off depending on whether the borrower is meeting the agreed repayments either under the original mortgage contract or under a revised repayment arrangement. In the previous version of the CCMA, the lender was required to wait at least twelve months from the time the arrears first arose.
• Anyone in or facing mortgage arrears difficulties is already very distressed and while lenders do need to engage with them in an effort to address the issue, our view is that there must be some limits on the extent of contacts with already stressed borrowers. Consequently, lenders may only attempt to make unsolicited contact to arrears customers three times in a calendar month, regardless if the attempted contact is successful or not. Contacts required by the CCMA are excluded from this limit.

 The CCMA has shifted the focus of the relationship away from an adversarial approach to one of working together. It specifically requires lenders to have procedures in place to allow for a flexible approach in the handling of arrears cases and they must be aimed at assisting the borrower as far as possible in his/her circumstances. The CCMA applies to pre-arrears cases and requires lenders to pro-actively encourage its borrowers to engage with them about financial difficulties. We have been criticised by some lenders for limiting unsolicited contact to three times in a calendar month as this may prevent lenders making necessary contact. I believe that this requirement is consistent with the spirit of the CCMA and that this level of contact is more than appropriate.

It is true that these measures do not go as far as providing for debt forgiveness or write off. The challenge is, as stated in the CCMA, that each mortgage arrears case is unique and needs to be considered on its own merits. The Mortgage Arrears and Personal Debt Group did not recommend a formal debt forgiveness scheme and could not identify any such schemes internationally other than in some parts of the US. I believe the recommendations from the Law Reform Commission in its Report on Personal Debt Management and Debt Enforcement form a sound basis for making further progress. The CCMA clearly envisages that there will be circumstances where the mortgage is unsustainable and therefore may proceed to repossession if any appeal is unsuccessful. In those circumstances the Law Reform Commission argues that any shortfall on a mortgage debt where the asset on which the loan is secured should be treated in the same manner as other unsecured debt.

In addition to strengthening the CCMA we have also examined the issue of mortgage arrears charges which lenders can impose on consumers in arrears. Some of these charges can be significant including the charging of surcharge interest on top of the normal interest charge. We have now advised all lenders that these charges may no longer be imposed in respect of mortgage arrears. We have carried out a number of inspections recently to check that such charges were not being imposed. While we have not yet published the detailed findings we have found that those lenders which we visited had not been imposing charges and where they had done so it was not material and has now been rectified.

I must acknowledge the role played by the Money Advice and Budgeting Service (MABS) in supporting those struggling with debt and also working with lenders to try to reach agreement. They provide a necessary support and advisory service to many consumers. However it is important that wherever possible lenders work directly with their customers in resolving issues. There is a clear responsibility on the lender as well as an obligation under the CCMA.

We are also considering applying some of the best practice from the CCMA to the non-mortgage lending including limiting unsolicited contact and advising consumers of the MABS. These measures are designed to ensure lenders engage in a more positive way with their customers.

Where next?

We must learn from the crisis. Lenders need to be far more conscious of the need to engage in responsible lending to protect not only their own balance sheets but also their customers. They will have to recognise the need to build a more sustainable longer term relationship with their customers. Customers will have to accept that they will have to be more open in terms of the information they provide to lenders which will also help them assess their own needs and ability to afford the debt.

The revised CCMA came into force on 1 January this year. All lenders must have fully implemented all of its provisions by 30 June. It will be important that lenders fully embrace this new regime to ensure the important protections it affords to customers are working. We intend to carry out further inspections later this year to ensure this has happened. We intend to finalise our review of the Code by the end of September so that by the end of the year additional measures to protect consumers regarding non-mortgage debt arrears will be in place. We are also considering what additional protections need to be put in place to help small companies who may be viable but who currently have arrears on existing loans.

As the regulator of the sector we will need to ensure the framework, both from a domestic and European legislative perspective, is robust to protect consumers interests but also that we are out there ensuring that the framework is working as it should and that lenders are meeting our standards.

Our focus must be to try to ensure that lenders behave responsibly in working with their customers, both at the time of provision of credit and also when the borrowers circumstances change.