Governor Makhlouf launches Central Bank of Ireland’s Financial Stability Review 2022:1

• Medium-term risks have grown in the past six months, with the focus shifting from pandemic related distress to concerns around the impact of lower global growth expectations, significant price pressures and tightening financial conditions.
• Inflationary pressures present new challenges for borrowers, which are mitigated by the building of resilience over the past decade.
• The Central Bank is updating its strategy for macroprudential capital tools, and will use the Counter-Cyclical Capital Buffer (CCyB) as its main tool for safeguarding resilience. CCyB rate will increase to 0.5 per cent, with plans to rebuild to 1.5 per cent by mid-2023.

The Central Bank of Ireland has today (15 June) published the first Financial Stability Review (FSR) of 2022. The FSR outlines key risks facing the financial system and the Central Bank’s assessment of the resilience of the economy and financial system to adverse shocks.

The Financial Stability Review indicates:

• Following a rapid economic recovery from the pandemic, Russia’s invasion of Ukraine has led to lower global growth expectations and intensified inflationary pressures. Global financial conditions have tightened considerably, amid the beginning of a period of monetary policy normalisation.
• Domestically, price pressures coupled with a tight labour market point to emerging cyclical pressures in certain sectors, including the housing market.
• Inflationary pressures and rising interest rates present new challenges for borrowers, but from a starting point of stronger resilience over the past decade.
• Profitability in the banking sector has recovered and is set to be bolstered with cost savings from consolidation and potential interest rate increases, which are likely beneficial for profitability.
• Consistent with previous guidance on the rebuilding of macroprudential capital buffers, the Counter-Cyclical Capital Buffer (CCyB) rate will increase to 0.5 per cent. This increase acknowledges a shift in the risk environment and the resilience required to ensure the banking system can serve households and firms in future periods of stress. Should macro-financial conditions evolve consistent with the central economic outlook, a CCyB rate of 1.5 per cent is expected to be announced by mid-2023.

In his opening remarks, Governor Gabriel Makhlouf said the latest review comes following a series of shocks to the economy in sequence.

He said: “The invasion of Ukraine by Russia is first and foremost a human and societal tragedy for the people of Ukraine. This horrific war has amplified many risks around the world, and inflation is now running at the highest levels seen in four decades in many developed economies, including here in Ireland.”

He explained: “It is this inflationary environment – and the range of unprecedented and unexpected shocks to have hit the global economy in recent years – which forms the key backdrop to our risk assessment in June 2022. The world is now a more uncertain place than it was only six months ago. In this context, forward-looking judgements around the evolution of the macro-financial environment are particularly challenging.”

On resilience, Governor Makhlouf said households and businesses in Ireland continue to have important capacity to cope with these risks and are in a better position to absorb shocks when compared to the onset of the post-2008 crisis.

In relation to the resilience of the banking sector, the Governor added that retail banks have capital headroom above regulatory requirements, which puts them in a position to absorb negative shocks without adverse knock-on implications for consumers or the economy.

Countercyclical Capital Buffer (CCyB)

Governor Makhlouf said “We at the Central Bank have been conducting a review of our strategy around macroprudential capital buffers. This has included considering both the benefits and the costs of bank capital within a consistent framework, as well as the interactions between macroprudential capital buffers and the wider prudential framework, such as risk weighted requirements, and the development of the resolution framework for banks.

“Two and a half years ago, not long after I joined the Bank, we set out to conduct this review. I said then that I expected it to be a multi-year work programme and so it has proved, although we certainly didn’t expect a pandemic to get in the way. I’m glad to be closing the loop now, and that what we have learned from our experience during COVID-19 will ultimately make our banking system stronger.

“The pandemic highlighted for us the benefits of a more resilient banking system and provided insights into the effectiveness of macroprudential policies developed in the wake of the global financial crisis. Having completed our review, we are updating our strategy for our macroprudential capital buffers.”

The Central Bank will use one instrument – the Countercyclical Capital Buffer (the CCyB), rather than a combination of the CCyB and a Systemic Risk Buffer (SyRB), to safeguard resilience to macro-financial risks. As a small, highly-globalised economy, Ireland faces greater downside macro-financial risks compared to larger, more diversified economies. This strategy reflects lessons from the pandemic internationally on the value of releasable capital buffers to allow the banking system to support the economy when shocks hit. It also ensures resilience while reducing complexity in the macroprudential capital framework.

The Central Bank’s revised strategy intends to gradually build up the CCyB rate towards 1.5 per cent. The buffer was reduced to zero per cent in March 2020 to support bank lending into the economy during the pandemic. Given that the impact of the pandemic on lenders’ and borrowers’, the Central Bank no longer deem that support necessary and are announcing a rate increase to 0.5 per cent. Our guidance is that we will move to 1.5 per cent between now and this time next year, but we will remain data-driven and will adjust our position appropriately.

Mortgage Measures Framework Review

The Central Bank’s wider framework review of the mortgage measures is ongoing. The mortgage measures continue to incrementally improve the resilience of banks’ balance sheets – with close to half of all outstanding mortgages issued since their introduction. The review is considering the objectives, instruments, and factors determining calibration to ensure that the mortgage measures remain fit for purpose. Since the last FSR, a public consultation received significant volumes of stakeholder feedback and the Bank hosted a conference that gained national and international perspectives. The framework review is intended to conclude in the second half of 2022.

Macroprudential measures for property funds

In parallel, as property funds have become systemic to the Irish commercial real estate market, the Central Bank has been developing a set of macroprudential measures to limit leverage and liquidity mismatches. Relative to European comparators, these funds have higher leverage creating additional vulnerability to price falls, potentially amplifying adverse shocks to the commercial real estate market and the wider economy. The proposed measures aim to safeguard the resilience of the Irish resident property fund sector, so that this form of financial intermediation is better able to absorb – rather than amplify – adverse shocks. A recent public consultation engaged with stakeholders and feedback is informing the final design of policies.

Further information

To support the FSR, today the Central Bank also published a Financial Stability Note “Risk Weights on Non-Financial Corporate Lending by Irish Retail Banks”, authored by Paul Lyons and Jonathan Rice, which examines the risk-weighted assets (RWAs) of small and medium enterprise, corporate, and commercial real estate (collectively termed non-financial corporates or NFC) exposures held by Irish retail banks. This follows previous work examining the RWAs of mortgages held by Irish retail banks (PDF 750.73KB), which was published in early 2022. Overall, this work forms an important part of the Central Bank’s ongoing review of the macroprudential framework for bank capital.

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 on the Central Bank’s website.

Records of meetings of the Macroprudential Measures Committee are available on the Central Bank’s website.