Committee Reports > List of Committees > Joint > 1988 > Committee on the Secondary Legislation of the European Communities (5th Committee) > Report No. 05 - Proposed Directive Relating to Mortgage Credit

DEPUTY NOLAN’S DRAFT REPORT ON PROPOSED DIRECTIVE RELATING TO MORTGAGE CREDIT

A. INTRODUCTION

Proposed Directive

1.On 24th January, 1985 the Commission adopted a proposal (COM) (86) 730 final) for a Council Directive on the freedom of establishment and the free supply of services in the field of mortgage credit, which was submitted to the Council on 28th January, 1985. Following on consideration of this proposal by the European Parliament and the Economic and Social Committee and in light of amendments recommended by those bodies the Commission adopted an amended proposal (COM (87) 255 final) on 22nd May, 1987 and this amended proposal was submitted to the Council on 27th May, 1987. The Joint Committee has now completed its consideration of this amended proposal, the benefit of which is to extend to credit institutions falling within the ambit of Council Directive 77/80/EEC engaged in mortgage credit. The proposal covers both the freedom of establishment, namely, the right to establish a branch in another Member State and the freedom to provide services, namely, the right to provide mortgage credit in a Member State without establishing a branch there. The proposal is at present under examination at working party level in Council. The Joint Committee is informed that progress has been slow, many different viewpoints remain to be reconciled and amendments of the Commission’s draft can be anticipated.

Consideration by Joint Committee

2.The draft Directive was examined in detail for the Joint Committee by a Sub-Committee under the chairmanship of Deputy M.J. Nolan. The Joint Committee wishes to express its appreciation of the considerable work carried out on its behalf by Deputy Nolan and his colleagues.

3.The Joint Committee consulted the Departments of Finance and the Environment, the Irish Building Societies, the Confederation of Irish Industry (representing the non-associated building societies) and the Irish Bankers Federation in relation to the proposed Directive. Written memoranda were supplied jointly by the Departments of Finance and the Environment and by the Irish Bankers Federation and the Joint Committee had also the benefit of observations on the original Commission proposal supplied to its predecessor by the Irish Insurance Association and the Financial Services Industry Association. Mr. Dermot Keane of the Department of Finance, Mr. Joe Allen of the Department of the Environment, Messrs Des Byrne and Greg Byrne of the Confederation of Irish Industry and Mr. Cathal Muckian of the Irish Bankers Federation attended a meeting of Deputy Nolan’s Sub-Committee and gave unsparingly of their advice on various aspects of the proposed Directive. The Joint Committee is deeply grateful to all those bodies and their representatives and wishes to acknowledge the considerable contribution made by them to its deliberations.

Existing Rights of Credit Institutions

4.It is clear that mortgage credit institutions already enjoy a right of establishment and to some extent a right to provide services by virtue of Articles 52 and 59 of the EEC Treaty which are legally enforceable by those institutions by virtue of those Treaty provisions alone. Moreover the institutions which the Commission’s present proposal is designed to benefit already come within Council Directive 77/780/EEC. That Directive stipulates the minimum requirements for the authorisation of credit institutions in a Member State and provides for the supervision to be exercised by the appropriate authority in a Member State in which the business is carried on. In particular national laws may not discriminate on the grounds of nationality so that, for example, nationals of other Member States can establish a building society in Ireland by complying with the provisions of the Building Societies Act, 1976. However there is a wide difference between the methods of funding and lending employed by mortgage credit institutions throughout the EEC and between the national laws governing those institutions. The main beneficiaries of the 1977 Directive have been those credit institutions which are engaged in general commercial banking while institutions specialising in mortgage credit have been confined to their national markets. Hence, according to the Commission, a need for a new Directive arises.

Harmonising the National Laws

5.The making of loans on the security of a mortgage of property is common to all the national systems but there is a wide variation between the savings and lending techniques employed in those systems. In Ireland and the United Kingdom building societies accept short term deposits at market rates and lend long term also at market rates. In the Federal Republic of Germany, for example, a borrower from a Bausparkhase to qualify for a loan must first save a substantial proportion of the sum required at a rate of interest below the market rate and the interest on the mortgage eventually granted is also below the market rate. Moreover, the provision in Irish and British building society mortgages that the rate of interest is variable at the discretion of the society would be illegal under some continental legal systems, such as Belgium. Prima facie wide variations in national laws appear to call for a harmonisation of those laws as a prerequisite for the establishment of a common market.

However, in the area of mortgage credit, the Commission has rejected harmonisation as impracticable and commentators have accepted that harmonisation would be an enormous task. Instead the Commission has opted for the mutual recognition of the financial techniques operated in the different Member States so that, if the proposed Directive is adopted, mortgage credit institutions will be free to operate throughout the Community in the same manner as they do at present in their home States.

Exchange Control

6.Manifestly the objective of the proposed Directive will not be achieved unless obstacles presented by exchange control restrictions are removed in those Member States such as Ireland where those restrictions still exist. This problem has not been addressed in the present proposal but the Commission has indicated its intention to propose a new Directive based on Article 67 of the EEC Treaty which will liberalise those capital movements which are related to the operations mentioned in the present proposal.

B. COMMISSION’S PROPOSALS

Credit Institutions

7.The credit institutions covered by the proposed Directives are those which raise finance by taking deposits from the public or by issuing mortgage or other bonds or securities or reimbursable shares and which grant loans secured by mortgages for the purpose of acquiring or retaining property rights in building land or existing or projected buildings. The amended proposal makes it clear that the Directive will apply not only to specialised institutions such as building societies but also to institutions such as licensed banks whose activities consist in part of the foregoing activities. In its explanatory note of 24th January, 1985 the Commission states that the activities covered are those consisting essentially in granting mortgage credit for the purpose of building or acquiring residential property but in terms the proposed Directive may cover commercial property as well.

Mutual Recognition of Financial Techniques

8.The key provision in the proposed Directive would enable credit institutions to operate mortgage credit business in other Member States in accordance with the funding and lending techniques authorised in their home Member States. The home and host Member States will be obliged to amend or adapt their national laws to whatever extent may be necessary to secure this objective. In this process the existing rights of institutions are not to be restricted and where the introduction of new techniques affects the competitive position of home institutions they may be permitted to adopt those new techniques. However, by way of exception to the general rule and pending further coordination, the host Member State may require the issue of bonds in its own territory to be subject to its own laws.

9.The original proposal was that the host Member State could require both funding and lending transactions to be in its own currency though the ECU could be used as an alternative. This derogation is now being limited to a period of seven years after the adoption of the Directive. Assets and liabilities in each national currency or in ECU may be required by the home Member States. Host Member States may require funding and lending transactions to be in its own currency, or matched if in another currency.

10.All state or other public assistance, including tax benefits, must be extended to all mortgage credit activities covered by the proposed Directive and, in particular, no discrimination will be permitted on the grounds of nationality or on the grounds that a credit institution is not established in the Member State where it provides services. The home Member State may, during the first seven years, limit the transactions carried out in other Member States through branches or otherwise to 25 per cent of the credit institution’s domestic mortgage lending (in the previous year).

Freedom of Establishment

11.Branches of mortgage credit institutions whose head offices are in other Member States will under the proposed Directive be under the supervision of the competent authorities of the host Member State in accordance with its national law but close cooperation with the supervisory authorities of the home Member States will be required. A further Directive is contemplated to regulate the position in this area.

Freedom to Provide Services

12.A credit institution which proposes to transact business in another Member State must notify the supervisory authority in its own State indicating the type of business proposed and the conditions under which funds will be raised and loans granted. Unless it has doubts as to the financial soundness of the institution the supervisory authority will send the information to its counterpart in the host Member State but a refusal to forward the information will suspend the institution’s right to provide the proposed services. Supervision will be carried out by the home country supervisor in consultation with its counterpart in the host country. There will be a greater emphasis on the role of the former supervisory authority insofar as supply of services is concerned.

13.Three months notice to the supervisory authority of the host Member State is required and the credit institution must report quarterly to that authority. Under Article 10.2 the host supervisory authorities may prevent a credit institution from another Member State using financial techniques which are not in accordance with the laws of the host country and which are justified on the gounds of the general good. If compliance with those laws cannot be secured by reporting to the supervisory authority of the home Member State the supervisory authority of the host Member State can take steps to secure compliance if necessary, by suspending the activities of the institution on its territory. An appeal to a court against such penal action must be allowed. If a credit institution loses its authorisation in its home Member State it also loses its right to provide services in other Member States.

C. IMPLICATIONS FOR IRELAND

Legislative Implications

14.The proposed Directive is being considered at a time when comprehensive building society legislation is being prepared by the Department of the Environment, which, the Joint Committee is informed, will enable Irish building societies to extend the range of their services and to operate abroad. The supervision of building societies will be transferred to the Central Bank. At present a credit institution, whether or not specialising in mortgage credit with a head office in another Member State will require the prior authorisation of the Central Bank if it wishes to establish a branch in this country to provide services here from its home base. It seems to the Joint Committee that any such provision will be difficult to reconcile with the proposed draft Directive as it stands at present. While the proposed Directive would allow the Central Bank to exercise supervision of the Irish Branch of an EEC institution it does not seem to allow for the commencement of a branch business to be subject to prior authorisation. As far as services are concerned Article 9 of the proposed Directive would appear to make authorisation a matter for the supervisory authority of the home state, in the first instance. If the present requirement for prior authorisation of the Central Bank is to be maintained the proposed Directive will in the Joint Committee’s view require amendment.

15.The Irish Bankers Federation has expressed the view that if the proposed Directive is adopted the Moneylenders Act, 1933 will require amendment having regard to the decision in Cripps Warburg v Cologne Investment Co. [1984] IR321.

16.The Joint Committee is informed that in general there are no legal barriers in this country to many of the funding and lending techniques used in other Member States. However it is anticipated that there will be secondary legislation implementing the proposed Directive if it is adopted.

Commercial Implications

17.Should the Directive be adopted in its present form it may provide an opportunity for house buyers in this country to borrow foreign currency or ECUs at attractive interest rates from continental institutions. The Joint Committee is informed, however that exchange rate risks would be likely to be an inhibiting factor for most borrowers. Moreover it is not anticipated that continental institutions are likely to be attracted by the small Irish market. Many of them would, it is thought, find it difficult to compete if they have to adhere rigidly to the techniques employed at home. What seems more likely is that large British institutions might from their home base seek to provide mortgage credit facilities here. It is thought that such competition could create considerable problems for Irish institutions.

18.The flexible techniques employed by Irish building societies could prove attractive on the European market provided of course that they are free to operate there as they do at home. Of course they would have to develop the expertise to market their product, raise funds at competitive rates and minimise exchange risk exposure.

They may well find it more attractive at least in the short time to seek to secure entry into the British market if the proposed Directive is adopted.

19.Irish banks already enjoy under EEC law a right to establish branches in other Member States in order to transact banking business including mortgage credit and foreign EEC banks enjoy a corresponding right here. Banks therefore will be affected only to the extent that the freedom to provide services without establishing a local branch here is extended. A new banking directive proposed by the Commission will radically alter the position of banks. The Joint Committee will report on this proposal in due course.

D. VIEWS OF JOINT COMMITTEE

Supervision of Mortgage Credit Institutions

20.The Joint Committee cannot deny that it is in line with the completion of the internal market by 1992 that there should be a common market in mortgage credit. However the Joint Committee considers that in the area of mortgage credit for house purchase there is a particular need for adequate supervision of the institutions involved in providing that credit so as to ensure the financial stability of those institutions and the protection of their customers. Under the regime proposed by the Commission institutions operating various techniques will be exposed to exchange rate risks and foreign financial systems of which they have little experience. In the Joint Committee’s view the supervision of the activities of these institutions should at least in the first instance rest solely with the host country where those activities are carried on. The supervisory authority of the host country should be entitled to satisfy itself regarding any mortgage credit institution whether seeking to establish or provide services in its territory. In the Joint Committee’s view the commencement of such activities should be subject to the prior authorisation of the supervisory authority of the host Member State which should also have the right to exercise supervision over these activities as long as they are carried on in its territory. The Joint Committee is conscious that this conflicts with the Commission’s approach of trusting the supervisory authority of the home Member State and it would not see such a regime as excluding a more Community-orientated regime in the future. The supervision of the host Member State would of course have to be exercised in close co-operation with the supervisory authority of the home Member State and in the light of experience consideration could be given in the future to replacing such a regime by a system of Community authorisations such as is proposed in the new draft Banking Directive.

Financial Techniques

21.The Joint Committee is satisfied that what constitutes a financial technique needs clarification. Article 10 of the draft Directive enables a host Member State, after certain preliminary steps to terminate the provision of services by a mortgage credit institution which does not comply with local legal provisions “which are justified on the grounds of the general good”. The Joint Committee was informed by the Department of Finance that such legal provisions “would cover, for example, consumer protection and monetary policy issues”. However it seems that consumer protection legislation is also a source of what are described as financial techniques. From the point of view of Irish building societies it is essential to know whether variable interest rates constitute a financial technique which all Member States must recognise or infringe legislation in some Member States enacted for the “general good”. It seems therefore to the Joint Committee that it is necessary for the Directive to identify clearly and unequivocally what financial techniques must be accepted in all Member States.

Provision of Services

22.If the proposals for supervision are left unchanged it seems to the Joint Committee essential to know where the line is to be drawn between the provision of services through an intermediary and the exercise of the right of establishment.

apart from that, the provisions of services seem to the Joint Committee to pose such problems for Ireland that they ought to be subject to the prior authorisation of the Central Bank. The Department of Finance has referred the Joint Committee to the decision of the European Court of Justice in case No. 205/84 Commission v Germany the implications of which are apparently being assessed in connection with the proposed Directive. The Department states in relation to the application of this decision that Member States are taking the view that -

“The Court ruled that the Treaty itself provides for freedom of services (as agreed by the Commission) but qualified this by adding that Member States had a right to require establishment (and compliance with local rules) in the case of ‘mass’ markets (eg house insurance) where there is a legitimate consumer interest which would not otherwise be protected”.

The Joint Committee is advised that the foregoing would not be universally accepted as an accurate description of the Courts decision. In the case the Court specifically condemned as incompatible with Community law a German law requiring intermediaries through whom foreign insurers provide insurance services to be established in the Federal Republic, stating:-

“If a requirement of an authorisation constitutes a restriction on the freedom to provide services, the requirement of a permanent establishment is the very negation of that freedom”.

On the other hand the Court recognised that a requirement of authorisation by the host country does not necessarily conflict with Community law. It stated:-

“It follows from the foregoing that the requirement of authorisation may be maintained only insofar as it is justified on the ground relating to the protection of policyholders and insured persons relied upon by the German Government. It must also be recognised that those grounds are not equally important in every sector of insurance and that there may be cases where, because of the nature of the risk insured and of the party seeking insurance, there is no need to protect the latter by the application of the mandatory rules of his national law”.

In light of the foregoing the Joint Committee considers that in the area of the provision of mortgage credit services it is legitimate to press for authorisation by the host country but that there is no case for requiring a permanent establishment in that country.

Commercial Mortgages

23.The Joint Committee is informed that for working purposes within the Council’s Working Party the definition of mortgage credit being used is confined to loans secured on residential property. However in terms the definition of mortgage credit clearly includes mortgages on commercial property. Presumably this type of business would be of more interest for banks than for building societies. A body corporate may be a member though not a director of a building society and loans to bodies corporate may be subject to Ministerial regulations. Unless mortgages of commercial property are excluded from the draft Directive altogether it would appear necessary to consider the position of banks doing this type of business. As far as they are concerned the proposed Directive would seem to impose restrictions to which they are not subject at present by virtue of Council Directive 77/780/EEC.

It is thought that banks would often operate without currency matching and Council Directive 77/780/EEC places no such obligation on them. If the new Directive is adopted they may, however be required to adopt currency matching for just one facet of their business at least for seven years. This does not appear to the Joint Committee to make much sense.

Currency Matching

24.The matching of assets and liabilities in the currency of the host Member State may be required during the first seven years of the operation of the proposed Directive. This seems to the Joint Committee to be a prudent provision for credit institutions which do not have at present experience of foreign currency transactions. Indeed it might be preferable if this right of Member States did not automatically terminate after seven years and if the Commission were obliged to come forward with new proposals after the end of the seven years. The matching of assets and liabilities in particular currencies, although it may be a prudent requirement for business efficacy, presumably would not of itself alter the liability of a credit institution to all its creditors where it conducts mortgage credit business in a number of Member States. On the liquidation of such an institution under Irish law all its free assets would have to be available for distribution pari passu among all its unsecured creditors.

MARCH, 1988.