Ireland's financial regulator on Thursday said he was against forcing banks to pass on European Central Bank rate cuts to mortgage holders because it would discourage investment in the sector.

Local lenders have been increasing rates on standard variable rate mortgages amid losses from fixed-rate mortgages and those tied to the ECB rate, a trend the government said is pushing mortgage holders into arrears.

Matthew Elderfield, the regulator, has been under pressure from the government to force Bank of Ireland and Ulster Bank pass on the ECB's recent 0.25 percentage point rate cut to mortgage holders, but he said he was against direct regulation.

For the central bank the issue isn't whether all the banks pass on all the rate cuts and whether we should be regulating about that, because we feel there are severe downsides of regulation, Elderfield, who is also deputy governor of the Central Bank, told journalists in Dublin.

It is important to bring outside investors into Ireland and regulation in that space could deter investors from coming in to offload the 24 billion (euro) investment in AIB, he said, referring to the nationalised lender, which the government is keen to sell.

AIB passed on the rate cut to consumers under pressure from the government.

The refusal by Ulster Bank and Bank of Ireland to follow AIB has put them on a collision course with the government, which has spent nearly 63 billion euros ($85 billion) propping up the sector after a disastrous property binge.

Irish-based banks rely on their own central bank for almost 50 billion euros of emergency funding and the ECB for more than twice that, giving the central bank significant moral power -- and Elderfield said he may press banks that were charging customers rates that were out of line with funding costs.

It is a concern that there are banks that are outliers against the market that have significantly higher variable rates and have increased their variable rates significantly over the last couple of years and that is disproportionate to their cost of funding, he said.

It is something we will be pressing those individual banks on.

(Reporting by Conor Humphries; Editing by Steve Orlofsky)