The Irish Financial Crisis Effects on Irish Banks and Subsequent Misapplication of Interest Rates
In 2008, Ireland experienced its first significant increase in unemployment in over a decade. Irish banks began reporting arrears on their loan books, and with confidence evaporating due to the global financial crisis, were faced with the prospect of significant and crippling losses. This was compounded due to the difficulty in accessing short term inter-bank lending, on which Irish banks had become heavily reliant upon for their funding during the Celtic Tiger and perhaps even more so during the years of the property bubble from 2002 to 2008.
The effects of the financial crisis on Irish banks were significant. Firstly, the cost of borrowing for banks increased significantly. Secondly, banks experienced higher levels of default (i.e. bad debts). A number of Irish banks and building societies folded or were taken into government ownership (Bank of Ireland, AIB, Anglo Irish Bank, EBS, Irish Life and Permanent and Irish Nationwide). The consequence of this was that the Irish banks lost their ability to control their levels of default as these were undertaken by external independent audits on behalf of regulators (stress/viability tests conducted by The Central Bank of Ireland and The European Central Bank).
Irish banks subsequently struggled to enhance their viability and encountered difficulties in generating income. Under normal circumstances banks have two main lines of income:
1. Non-interest income; or
2. Interest income.
Non-interest income is generated by banks by imposing fees and charges on customers. However, Ireland is unique in that it is one of a very few European countries that limits banks ability to impose such charges on customers. Section 149 of the Consumer Credit Act 1995 introduced pricing controls on financial institutions seeking to introduce or increase consumer charges. Any entity proposing to impose or increase charges on customers must get permission to do so from the Central Bank of Ireland under the Act. Because of the Government bail-out of the banks this was not deemed a viable option for the banks to pursue. Therefore, the only way Irish banks could increase their income was by generating income from interest income.
Interest income is generated by the margin banks receive on loans to customers. Banks had traditionally priced loans off the inter-bank lending rate. When the inter-bank market contracted Banks were forced seek more expensive sources of funding loans to customers. This in turn compressed the margin that banks received on loans to customers. In response to this income erosion banks sought to increase the margin they received on loans.
The issue that arose for Irish banks in this respect was that a substantial amount of the Irish banks’ lending portfolios were either (a) impaired, or (b) on tracker rates. Consequently, the only avenue available to Irish banks was to review existing loans and seek where possible to maximise interest income from all viable sources. From a customer perspective, the main parties subject to this approach were:
1. Businesses and who had taken out commercial loans; or
2. New customers.
The strategy of the Irish banks at the time was for them to, whenever an opportunity arose, to renegotiate a loan with a view to increasing the margin with customers. The question which arises is whether the Irish banks have acted bona fides in this regard, and have renegotiated or reapplied interest rates on loans in a legitimate contractual manner or have they simply arbitrarily increased interest rates on customer’s loan facilities. The latter situation would result in a breach of the terms of the legal agreement between the bank and the customer. In the alternative, it could also amount to a misrepresentation on the part of the bank who misrepresented the terms and conditions of the loan agreement with the customer. It may also amount to a breach by the bank of their fiduciary duty to their customer, in failing to fully inform them of the terms and conditions of the loan.
Significantly, the Irish courts have showed a willingness to hold banks and individuals within banks to account. A recent high court decision delivered by Hogan J. Allowed an individual to bring a private prosecution against two IBRC bank officials under the offence of making a gain or causing a loss by deception . It should be noted that the circumstances in this case involved two bankers deliberately deceiving a borrower and falsely represented to him that IBRC would be prepared to continue in a process that would allow his business to continue trading in circumstances whereby the bank was actually aware that a receiver had been appointed. Although the actions of the bankers involved in this case were particularly heinous, it nonetheless shows a willingness on the part of the courts to hold banks to account whereby they have abused their position to the detriment of the borrower who foreseeable relies on their representations and actions.
We would urge customers to exercise vigilance in their dealings with banks and in a situation where their interest rates were affected following the financial crisis, certain banks issued letters detailing a change in the bank’s ‘Cost of Funds’ meant that they were forced to alter their methods of calculating interest rates on certain accounts. Although this was allowable in certain circumstances, depending on the interest rate initially agreed to be applied to the customer’s facilities, this would have been precluded from the contractual agreement between the customer and the bank.