Central Bank paper shows how mortgage lending fuelled boom

The banks pumped more money into the Irish mortgage market during the boom by increasing the "income fraction" that dictated the amount that could be loaned out to would-be borrowers, according to a new paper published today by the Central Bank.

The analysis shows that where Irish banks were issuing mortgages in 2000 that would cost slightly more than 16 per cent of a borrower’s gross income to service, this rose rapidly during the boom, to higher than 25 per cent by 2007.

Since the property market crashed, the income fraction has dropped again and is back near the 16 per cent level.

The paper says that at around 2000 the Irish banks – AIB, Bank of Ireland, the EBS and IL&P, who together accounted for approximately 70 per cent of the Irish mortgage market – were keen to increase the level of credit available to the residential property market and focused on using the "income fraction channel" to achieve this.

At the same time the Irish credit institutions found that they could source an increased amount of funding in the international wholesale markets due to a number of international factors, and the already thriving residential and commercial property markets in Ireland provided considerable demand for this increased funding.

“One of the most significant developments in international banking finance over the past fifteen years has been the extent to which financial institutions have been able to fund credit provision outside their deposit base,” according to the paper.

During a period when increasing property values were an international phenomenon, the Irish case stands out, the paper says. Between 1997 and 2007, real Irish house prices increased by an average of 9 per cent per annum, the highest rate for the OECD. During the same period the Irish credit market experienced a considerable degree of financial liberalisation.

“Since 2007, Irish house price declines have been the most severe across the OECD. Given that nearly 40 per cent of the total stock of Irish mortgages was issued between 2004 and 2007, when prices were at their highest, the sharp subsequent decline has given rise to a significant degree of negative equity being experienced by Irish households.”

Credit conditions in a boom and bust property market was written by Yvonne McCarthy and Kieran McQuinn.