Irish economy has proven resilient, but risks are becoming more visible – Financial Stability Review

23 November 2023 Press Release

Central Bank of Ireland

The Irish economy has proven resilient to the inflationary shock, although some previously identified risks are crystallising and the full impact of higher interest rates still lies ahead, the Financial Stability Review published today (23 November 2023) by the Central Bank of Ireland shows. 

The report 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 second Financial Stability Review of 2023 indicates: 

  • Headline inflation is falling, but underlying inflation is proving more persistent. The global economy continues to face higher interest rates for longer than previously expected, raising risks across financial markets. 
  • The global economy is at risk of further inflationary shocks from, for example, geopolitical tensions, signs of fragmentation of the global economy, and extreme weather events. 
  • The Irish economy has continued to expand but at a slower rate, and risks are rising and becoming more visible. Commercial real estate prices in Ireland have fallen by more than 20 per cent since mid-2020, while there are tentative signs of a slowdown in export flows and corporation tax receipts following years of exceptional growth.
  • Households continue to prove resilient and benefit from robust income growth, low indebtedness and prudent borrowing, although there are early signs of repayment challenges for some vulnerable borrowers. Anyone in such a position should contact their lender at the earliest opportunity. The full extent of higher interest rates and monetary policy pass-through still lies ahead.
  • Lending patterns for the first half of this year suggest the refreshed mortgage measures framework continues to achieve its aim of promoting sustainable mortgage lending standards. The Central Bank continues to view the measures as a permanent feature of the housing and mortgage market and does not foresee regular changes to their calibration.
  • Growth in revenues has supported domestic businesses, but pockets of vulnerability are visible in businesses that have struggled since the pandemic, with a moderate increase in the insolvency rate and early arrears on business loans now emerging.
  • The profitability of the Irish banking sector continues to increase, driven by higher interest margins. At a time when broad, systemic risks have not yet materialised, the Countercyclical Capital Buffer (CCyB) rate will be maintained at 1.5 per cent. In light of the changing banking landscape, Permanent TSB has been designated a systemically important institution and will be subject to additional O-SII capital buffers. Ulster Bank’s O-SII designation has been removed as it continues its phased exit from the market.
  • The Central Bank continues to develop the macroprudential framework for non-bank financial intermediation. Today, we are launching a public consultation on the proposed codification of the existing yield buffer for Irish authorised sterling denominated Liability-Driven Investment (LDI) funds. We are also considering feedback received to the Discussion Paper on an approach to macroprudential policy for the sector. The deadline for feedback closed last week and a feedback statement will be published next year.

In his opening remarks at today’s press conference, Governor Gabriel Makhlouf said: “Since our last Review in June, inflation has fallen in many economies but we remain some way from our target .

“The Irish economy has continued to expand since the last Review, albeit at a slowing pace. The labour market remains resilient, with strong wage growth. However, we must also acknowledge that a range of previously-flagged risks are now closer to materialising than in June. Commercial real estate prices have now fallen more than 20 per cent since their peak three years ago , while slowing exports and corporation tax receipts may mark the beginnings of the weaker global economy feeding its way through to Ireland. The lagged effect of monetary policy actions remains a source of uncertainty for the domestic economy, as the financial system continues to pass through higher interest rates gradually to borrowers and depositors.

“Despite these emerging signals of risks crystallising, the domestic household, business and banking sectors continue to demonstrate resilience in aggregate, with a strong labour market being a key factor. Low levels of debt, prudent and appropriate macroprudential policy, and the fixed borrowing costs for many are also supporting resilience to the shock.” 

The Governor continued to say that while bank profitability has increased strongly: “We must be clear-eyed in our assessment that this will not last forever. There are significant risks to the outlook, including increases in financial distress, a repricing in global and local commercial real estate markets, weakening loan growth and increased funding costs.  In light of these headwinds, this is a time to be prudent.”

On policy decisions to support the resilience of the financial system, the Governor said it was appropriate to maintain the CCyB at 1.5 per cent. He added: “A key feature of the CCyB is that, if a shock were to hit the economy, its release would better enable the banking system to absorb losses and facilitate a sustainable flow of credit to the economy.”

On today’s consultation for LDI funds and the Central Bank’s wider policy work to safeguard the resilience of the non-bank sector, the Governor said: “Given the cross-border nature of these funds, we have sought to ensure international coordination in codifying these measures, as exemplified by the fact that the Commission de Surveillance du Secteur Financier (CSSF) in Luxembourg is also publishing a similar consultation paper on LDI funds. Given the international nature of these funds, such coordination is important to ensure the effectiveness of these measures.” 

The Governor said the Central Bank will continue to closely monitor risks and adopt appropriate policy responses to ensure our economy and financial system remains resilient.

Notes - 

  • To support the FSR, today the Central Bank also published two Financial Stability Notes:
  1. Exploring missed mortgage payments in the first year of monetary tightening - Sameer Shaikh, Paul Kilgariff and Edward Gaffney
  2. Debt service capacity across Irish households: New survey evidence - Anuj Pratap Singh and Fang Yao
  • 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.  
  • View Consultation Paper 157 for macroprudential measures for Irish authorised sterling denominated Liability-Driven Investment (LDI) funds.