Governor Makhlouf launches Central Bank of Ireland’s Financial Stability Review 2022:2

24 November 2022 Press Release

Central Bank of Ireland

  • The world economy is slowing, with inflation having become more broad-based and persistent. Global financial conditions have tightened amid a pronounced shift in monetary policy, exposing pockets of vulnerabilities. 
  • Irish economy is facing increased downside risks, however resilience built up over the last decade provides capacity to absorb shocks. 
  • New macroprudential policy measures introduced for Irish property funds to make this growing form of financial intermediation more resilient to shocks.
  • The Countercyclical Capital Buffer (CCyB), the main tool for safeguarding resilience in the banking system, will increase to 1 per cent as part of the gradual rebuilding of the buffer rate, as announced in June.

The Central Bank of Ireland has today (24 November) published its second Financial Stability Review (FSR) of 2022. The FSR outlines the Central Bank’s assessment of key risks facing the financial system, the resilience of the economy and financial system to adverse shocks, and policy actions to safeguard stability.

The Financial Stability Review indicates: 

  • The world economy is slowing, with inflation having become more broad-based and persistent in the last six months. Global financial conditions have tightened amid a pronounced shift in monetary policy, exposing pockets of vulnerabilities. 
  • In this environment, global markets remain vulnerable to further shocks, which could be amplified by segments of the non-bank financial system where leverage or liquidity mismatches are higher.
  • In Ireland, the economy is facing increased downside risks given the size of the energy and inflation shock, with growing numbers of businesses expected to run losses. However, the central expectation for the economy and labour market remains for growth and a strong labour market into 2023, although subject to increased global risks. 
  • Households, businesses and banks are benefitting from a decade of prudent lending and the build-up in resilience that preceded this shock, providing capacity to absorb adverse outcomes. 
  • Consistent with previous guidance, the Countercyclical Capital Buffer (CCyB) rate will increase to 1 per cent. Given the central expectation for the economy, the fact that higher interest rates are expected to be positive for banks’ profitability, and the importance of building resilience in advance of a potential materialisation of risks, the Central Bank is continuing the gradual rebuilding of the CCyB. This marks a further step towards the 1.5 per cent target rate for the CCyB in periods when cyclical risks are neither elevated nor subdued.  
  • Following a period of consultation, the Central Bank is introducing macroprudential measures for Irish property funds investing in Irish property. The measures aim to safeguard the resilience of this growing form of financial intermediation so that property funds are better able to absorb – rather than amplify – adverse shocks. To address risks from leverage, a sixty per cent leverage limit is being introduced, and Guidance on liquidity timeframes are announced to further address risks from liquidity mismatch. 

In his opening remarks, Governor Gabriel Makhlouf said the review shows the current environment is one of substantial uncertainty and we must remain vigilant. 

He said: “As we and other central banks take the necessary steps to bring inflation back to target, there are undoubtedly risks of further asset price falls and, more significantly, potential episodes of disruption in segments of global financial markets. We must remain vigilant. The vulnerabilities accumulated during the period of low interest rates, along with the increasing interconnectedness of the modern financial system, means the full impact of shocks in this period of high volatility is hard to foresee with certainty.” 

Governor Makhlouf said that while downside risks to the economy have risen since the last review in June, there are a number of reasons to believe there is resilience in the system to meet these risks. He explained: “While some mortgage customers are experiencing directly the effects of our interest rate decisions, there is substantial resilience across the mortgage market. Lower levels of indebtedness, a gradual shift towards fixed rate borrowing, pandemic savings and substantial housing equity, are all ensuring that the mortgage market as a whole has significant capacity to absorb shocks. Even in the SME sector, where cost increases will severely tighten profit margins for many, indebtedness has fallen continually for a decade, reducing the risk of macroeconomic spillovers between the financial sector and the real economy.” 

The Countercyclical Capital Buffer will increase from 0.5 to 1 per cent on domestic banking exposures, consistent with previous guidance and a gradual rebuilding of the buffer towards the 1.5 per cent rate that, under the Central Bank’s framework, is envisaged would be announced when risks to the banking sector are neither elevated nor subdued. Under current economic projections there are positive implications for banks through higher interest margins and continued positive growth in the Irish economy. While downside risks are rising, it is important to continue to build resilience in the banking sector. The increase to 1 per cent will increase banks’ capital resilience at a time before risks have crystallised.

Echoing recent comments on the need to address the systemic risk posed by non-banks, Governor Makhlouf announced the Central Bank’s first macroprudential policy measures on non-banks, the third pillar of its macroprudential policy framework. Following extensive analysis and listening to feedback received from the public consultation, the Governor announced that the Central Bank is activating measures on Irish property funds. Property funds have become a key participant in the Irish commercial real estate (CRE) market, itself a sector that can have implications for wider economic and financial stability. 

To address risks stemming from leverage in Irish property funds, the Central Bank is introducing a leverage limit of sixty per cent. Reflecting both the current macroeconomic environment, and the expectation that funds make gradual and orderly progress to the limit, there is a five-year implementation period for existing funds. The Central Bank is also introducing new Guidance to address risks stemming from liquidity mismatch, with an 18-month implementation period. Both measures will apply immediately to newly authorised Irish property funds. The Governor noted: “These measures are being applied to ensure that investment funds are better able to absorb, rather than amplify, downturns in the commercial property market. This will, in turn, better equip the sector to continue to serve as a sustainable source of financial intermediation.”

Further Information

The Governor’s opening remarks can be viewed here

To support the FSR, today the Central Bank also published a number of Financial Stability Notes and Research Technical Papers.

The Countercyclical Capital Buffer (CCyB) is a time varying capital requirement which applies to banks and investment firms. It aims to promote a sustainable provision of credit to the economy by making the banking system more resilient and less pro-cyclical.  The Central Bank is the designated authority for setting the CCyB rate in Ireland and as such sets the rate for Irish exposures on a quarterly basis, following consultation with the European Central Bank. A positive CCyB rate is generally subject to a phase-in period whereby it would take effect 12-months after announcement.  Further information is available here.

Records of meetings of the Macroprudential Measures Committee are available here