‘Macro-financial environment improving but vulnerabilities remain’ - Macro Financial Review 2015:II

• Household and Non-Financial Corporate sectors vulnerable to negative economic shocks and higher interest rates.
• The financial position of domestic banks’ improved but the sector remains vulnerable.
• Countercyclical Capital Buffer (CCB) and ‘Other Systemically Important Institutions’ Buffer (O-SII) rates announced.

Macro Financial Review

The Central Bank has published the second Macro-Financial Review of 2015, which addresses the macro-financial outlook for the banking, insurance and non-bank financial intermediary sector.

Despite an improved macro-financial environment the Review notes that both household and Non-Financial Corporation debt remain high and the outlook for the global economy has weakened in this period. This leaves these sectors, and the wider economy, vulnerable to negative economic shocks and higher interest rates, and acts as a drag on consumption and investment.

Speaking at the publication of the Review, Chief Economist Gabriel Fagan said: “The major risk to financial stability, at both the domestic and international level, is the potential for excessive risk-taking by investors seeking better return across investment classes in the current low yield environment.”

The Review notes the financial position of the domestic banking sector has improved with a more stable funding structure; nonetheless the sector remains vulnerable to a reversal of market sentiment given the high level of non-performing loans.

The Review also highlights that downward pressure on non-life insurance premiums and weak underwriting discipline in previous years have left firms exposed to a deteriorating claims environment. It notes that underwriting losses and the forthcoming requirements of Solvency II have resulted in firms taking action to restore their balance sheet.

Capital Buffers

Separately, the Central Bank also announced the ‘Other Systemically Important Institutions’ Buffer (O-SII) and the Countercyclical Capital Buffer (CCB) rate for the State. These buffers were introduced under new EU banking regulations in 2014 and are applicable in Ireland from 2016.

As a member of the Single Supervisory Mechanism (SSM) these measures will also be implemented in conjunction with the European Central Bank (ECB). Under the SSM Regulations, the ECB has the power to set higher macro-prudential buffer requirements than those set by the Central Bank.

The O-SII buffer aims to increase the resilience of institutions which are domestically systemically important. Allied Irish Banks plc and Bank of Ireland have been identified as being of national systemic importance, which reflects the particular significance of these institutions to the domestic economy and their high market share in the retail and corporate markets. The O-SII buffer rate for AIB and Bank of Ireland will be set at 1.5% to be phased in with a rate of 0.5% from 1 July 2019, increasing in steps of 0.5% per year until it reaches 1.5% in 2021.

The CCB rate for the State rate has been set at 0%. Each institution’s specific CCB requirement consists of the weighted average of the CCB rates that apply in the jurisdictions where that institution has relevant credit exposures. The CCB rate will be reviewed on a quarterly basis and aims to protect the banking sector from potential losses that can arise when excessive credit growth is associated with a build-up of systemic risk.

Mr Fagan said that in setting the CCB rate at 0%, the Central Bank took into account the subdued credit developments in the economy as the non-financial private sector continues to deleverage and the moderation in rates of growth in residential property prices.

“We also looked at a range of other indicators relating to external imbalances, the private-sector debt burden and the strength of bank balance sheets. These indicators do not currently point to emerging imbalances or vulnerabilities.”

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Notes

Macro-Financial Review provides an overview of the macro-financial environment in Ireland. Monitoring macro-financial developments and risks is an important task for the Central Bank and contributes to the formulation and adaptation of policies to mitigate risks.

Capital Buffers

The macro-prudential capital buffers were introduced under the European Union (Capital Requirements) Regulations 2014 (S.I. 158 of 2014).

The Central Bank has been designated as the national authority responsible for the implementation of both buffers.

As a member of the Single Supervisory Mechanism (SSM) these measures will also be implemented in conjunction with the European Central Bank (ECB) and any assessments conducted by the Central Bank in this area will be without prejudice to any powers of the ECB under the SSM Regulations with respect to O-SII identification and/or buffer rate settings. Under the SSM Regulations, the ECB has the power to set higher macro-prudential buffer requirements than those set by the Central Bank under S.I. 158 of 2014. See the Central Bank’s Macroprudential Framework document for further details.

Capital buffers applied to domestic systemically important institutions, also referred to as ‘Other Systemically Important Institutions’ (O-SIIs), aim to reduce the probability, and potential impact, of these institutions’ failure on the domestic economy.

Further information on the O-SII is available in Box 7 of the Macro-Financial Review.

The countercyclical capital buffer (CCB) is a macro-prudential tool introduced into European legislation in the Capital Requirements Directive (CRD) IV. It is a time-varying capital requirement for banks (and investment firms) which aims to protect the banking sector from potential losses that can arise when excessive credit growth is associated with a build-up of systemic risk.

Related documents are available here.