The following is the text of the letter sent by Mr Maurice O'Connell, governor of the Central Bank, to the chairmen of the banks and building societies
"Recent analysis (in relation to the approval of housing loans) by the Central Bank, in the course of routine inspections, has revealed some disturbing practices. The quality and quantity of information in relation to the income of applicants were inadequate in several instances. A number of files had no evidence as to the source of funding of the balance of the house purchase price. Increasingly, lenders have been including additional income, from sources such as room rental, parental guarantees or potential future earnings, when assessing an application. In a number of cases there was a lack of evidence to confirm that stress testing had been carried out. A particularly disturbing feature has been the use in some instances of excessively high thresholds of disposable income as criteria for loan approvals.
The pressure to be flexible in the face of increasing competition and rapidly increasing house prices is understandable. At a time of very low interest rates there is obviously an added incentive to adopt generous guidelines on mortgage lending and the expectation of a continuing low interest rate environment increases the demand for higher mortgages.
However, while the immediate case for a more relaxed approach to lending might be persuasive, it remains vitally important to take a medium-term perspective as well and to reckon with the potential consequences of rising interest rates and economic downturn in due course. All credit institutions have a duty to consider the economic and financial outlook, both in their own interests and in the interests of borrowers. They have an obligation to be actively aware of the economic and social consequences of a lending policy that is excessively flexible. The level of house price inflation in the recent past has been excessive by any standards and prices continue to rise. There is evidence, that, in part, this has been driven by the ready availability of mortgage finance on generous terms.
I would ask you once again, therefore, to ensure that the mortgage lending policies being implemented by your institution are well understood at branch level and reflect acceptable prudential standards. In the exercise of its supervisory functions, the Central Bank intends to intensify its analysis of mortgage lending practices as part of its inspection routines. Please bring this correspondence to the attention of your board and I would welcome a response from the board on the issues that I have raised here. I would ask that, in future, the Central Bank be kept informed at all times on changes of significance in your criteria for assessing applications for mortgage finance.
Finally, may I draw attention to the recent report on the housing market by Peter Bacon & Associates. The Central Bank will be initiating discussion with the associations representing mortgage lenders about the recommendations in the report when there is evidence of a general easing of supply pressures within the housing market.
