Policymakers must look beyond the short-term horizon of the macro-financial cycle and ensure financial and fiscal resilience against tail risks – Governor Philip R. Lane

• Imperative to build the resilience of both the financial system and the public finances against tail risks.
• As the national macroprudential authority, the Central Bank has requested the power to activate the Systemic Risk Buffer from the Minister for Finance. 
• Systemic Risk Buffer would ensure that the banking system would be resilient in the event of a structural shock to the Irish economy.

In an address to the UCD School of Economics, Governor of the Central Bank of Ireland, Philip R. Lane, spoke about tail risks facing the Irish economy. Tail risks are shocks to the economic system that are unlikely to occur, but that would have a significant impact on the economy and financial system if they did.

He said, “given the potential impact of adverse tail risks on the economy and the financial system, prudence dictates that the policymakers look to ensure that the macro-financial system is resilient to such shocks.  A system is resilient if it buffers the impact of the shock.  In contrast, the fragility of a non-resilient system serves to amplify the impact of an adverse event. In relation to the financial system, fragile banks that lack sufficient capital and liquidity buffers may respond to an adverse shock by pulling back on credit provision and thereby deepen its recessionary impact. In relation to fiscal policy, a fragile sovereign may not be able to engage in countervailing fiscal measures on account of funding difficulties.”

He said the Central Bank is committed to safeguarding financial stability and building resilience through a variety of tools including an intrusive supervisory and inspections regime; resolution powers; and macroprudential policies including the mortgage measures and the counter-cyclical capital buffer.

He added, “our plan now is to examine the potential additional contribution of the systemic risk buffer in ensuring that the banking system would be resilient in the event of a structural shock to the Irish economy.”

He confirmed that he has recently written to the Minister for Finance and Public Expenditure and Reform to request that the power to activate the systemic risk buffer be granted to the Central Bank of Ireland. He said, “the advantage of the systemic risk buffer is that extra capital would improve loss-absorbing capacity if a systemic risk event occurred.  Furthermore, credit supply could be further protected by switching off the systemic risk buffer under such circumstances.”

“With any of our policy instruments, the calibration and timing of the systemic risk buffer will be based on a thorough evidence-based assessment of its benefits and costs. Furthermore, we adopt a holistic approach to policymaking, taking an integrated view of the interactions across the full set of macroprudential instruments (the range of capital buffers; the mortgage rules) and the overall capital position of the banking system”, he added.

He concluded by reaffirming the importance a prudent approach to fiscal policy noting, “our analysis indicates that the impact of fiscal policy is quite different once the economy approaches capacity limits. In particular, the crowding out of private-sector firms if there is excessive fiscal expansion under conditions of full employment may have adverse consequences for long-term economic performance. In addition, a failure to run sufficient surpluses during phases of good economic performance may limit the ability of the government to offset adverse cyclical or structural shocks.”