Macro-prudential Tools and Credit Risk of Property Lending at Irish banks

The high level of mortgage arrears in the Irish financial system and the associated overhang on economic growth underlines the importance of prudent lending standards throughout the property cycle. Macro-prudential tools such as loan-to-value (LTV) ratio caps and loan-to-income (LTI) ratio caps improve the resilience of the banking system by reducing the credit risk on new lending. Loan-level data are used to analyse the relationship between originating levels of these ratios and mortgage defaults. We find that there is a positive relationship between originating LTV and LTI ratios and subsequent defaults, with the strength of the relationship dependent on the point of the property cycle at which a loan is originated. Default rates on loans issued near the peak of the cycle to first-time buyers are particularly sensitive to LTV at origination while those issued to non first-time buyers are sensitive to both LTV and LTI at origination. In addition, there is a sharp increase in the losses on defaulted loans for loans issued above 85 per cent LTV. Although lending at higher LTI ratios has decreased significantly, 50 per cent of new lending to owner occupiers was at LTV levels above 80 per cent in 2013.