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Disorderly Brexit biggest risk to financial stability – Central Bank

Disorderly Brexit biggest risk to financial stability – Central Bank

A new review from the Central Bank shows that the main risk to the country’s financial stability and the wider economy is a larger than expected macroeconomic shock in a case of a disorderly Brexit.

As well as Brexit, the other risks to the financial sector are related to external developments and include a sudden tightening in global financial conditions and a re-emergence of sovereign debt sustainability concerns in the euro zone.

Domestic risks facing the financial sector include an abrupt fall in Irish property prices and banks’ profitability as well as the possibility of elevated risk-taking behaviour in the banking sector.

The Central Bank’s first Financial Stability Review outlines key risks facing the financial system and assesses the resilience of the economy and financial system to adverse shocks.

It is not aimed at providing an economic forecast, but instead focuses on the potential for negative outcomes to materialise.

The Central Bank cautioned today that the risks to the country’s financial stability have increased slightly over the last six months and some of the possible triggers have now become more imminent.

It noted that global growth prospects have been downgraded and the trade row between the US and China has created increased uncertainty about global trade deals.

A key lesson from the last crisis is that different risks can crystallise at the same time, challenging financial stability, and the Central Bank said it is key to recognise that the risks could interact.

“For example, a disorderly Brexit would act as a trigger for an abrupt tightening in global financial conditions and lead to a macroeconomic disruption in Ireland, both of which would have adverse implications for domestic property prices,” it cautioned.

However, the Central Bank also said that the banking system here has strengthened considerably in recent years – despite vulnerabilities remaining.

It noted that domestic lending is now funded mainly through retail deposits, rather than less stable sources of short-term, wholesale financing.

Non-performing loans on the banks’ balance sheets have fallen by 79% since 2014, however they still remain higher than international standards, it also noted.

“Overall the banking system is now better able to absorb shocks, rather than amplify them,” the Central Bank wrote in today’s review.

But it added that further progress is needed to strengthen resilience and maintain sustainable profitability in a changing operating environment.

It also warned that while domestic households and companies have also become more resilient, a significant number of consumers with restructured mortgages could be especially vulnerable to economic stress.

The share of mortgage holders in negative equity has fallen from 40% in 2012 to 5% last year, but the Central Bank said the level of average household debt to income – which stands at 123% – is also high compared to international standards.

Last November, the Central Bank concluded its most recent review of the mortgage measures and decided to make no changes to its loan-to-value or loan-to-income limits or exemptions.

The bank said the measures were meeting their objectives in guarding against an excessive loosening of underwriting standards, strengthening both borrower and lender resilience, and minimising the potential for a credit-house price spiral emerging.

But it said that after consultation with the Minister for Finance, the Central Bank in June decided to exempt “lifetime mortgages” from the loan to income limit.

Lifetime mortgages are equity-release home loans to elderly people whose debts are later repaid from their estates after they die.

“These products do not have a contractual regular repayment of capital and interest, so the affordability of regular repayments, which is a primary concern of the LTI limit, is not applicable in these cases,” the Central Bank explained.

Meanwhile, the level of debt owed by SMEs to Irish banks has fallen by more than a third over the last five years and SMEs are increasingly using retained earnings to fund spending and investment rather than borrowing.

“As a small and highly globalised economy, with a particular reliance on activity from foreign multinational companies, Ireland is both more sensitive to developments in the global cycle and more prone to structural macroeconomic shocks,” commented acting Central Bank Governor Sharon Donnery.

Ms Donnery said it is critical that the Central Bank continues to identify, plan and prepare to mitigate the impact of those shocks, should they materialise.

“Building a resilient system is central to this. Resilience is not something that can be built after an event, but is something that should be in place well before any issues arise,” she added.

The Central Bank also said today that it has kept its Countercyclical Capital Buffer (CCyB) rate at 1%. The CCyB aims to strengthen the resilience of the banking sector to a future downturn.

It said it stands ready to adjust the rate in either direction “as the risk environment evolves in a manner consistent with the objective of mitigating procyclicality and supporting a sustainable supply of credit to the economy”.

The Central Bank said its macroprudential policies, which currently include its mortgage measures, the CCYB and capital buffers for systemically-important institutions contribute to safeguarding financial stability here.

The Minister for Finance today has confirmed that the power to set a Systemic Risk Buffer is to be granted to the Central Bank, which will complete the macroprudential framework for bank capital, it said.

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Irish banks have higher concentration of property loans than European peers – Central Bank

Irish banks have higher concentration of property loans than European peers – Central Bank

Central Bank shows that Irish banks have a higher concentration of property lending than their European peers – with the concentration mainly in residential property.

But in a Financial Stability Note, the Central Bank said the banking system here has increased its capacity to absorb shocks – including property price falls – since the financial crisis.

It said that more stable funding sources, higher capital and liquidity ratios, more intensive supervision and the introduction of macroprudential rules all contributed to this increased resilience.

The Central Bank also said that since the financial crisis, the overall level of concentration of the Irish banking system to property lending has remained relatively stable at around 70% of total balances.

It noted that the share of residential mortgages is increasing and the share of commercial real estate decreasing.

The Financial Stability Note said that property exposures have been central to many financial crises, including Ireland’s own financial crisis from 2008 to 2013.

Commercial and residential property prices declined by 67% and 51% respectively between December 2007 and September 2013.

It said that while prices have since recovered – in line with the improved economy – the level of concentration of the Irish banking system in property lending means that it remains vulnerable to potential price corrections.

This is despite the banking system having increased its ability to absorb such shocks.

The Central Bank said the research concludes that the high degree of exposure to property in the Irish banking system underlines the importance of prudent underwriting by the banking system.

“It also concludes that the Central Bank’s mortgage market measures help in this regard, by protecting banks and borrowers against a marked loosening of such underwriting.

“In doing this, the measures serve to strengthen the resilience of a concentrated system,” the Central Bank added.

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Govt wants Central Bank in financial sector forum

Govt wants Central Bank in financial sector forum

New structures to encourage the development of international financial services will include bringing the Central Bank into a new stakeholder engagement group with industry and see overall responsibility for promoting the sector shifting to the Department of Finance.

A new strategy for the sector will be launched today by Michael D’Arcy, Minister of State with special responsibility for Financial Services and Insurance, and Finance Minister Paschal Donohoe.

Ahead of the launch, Mr D’Arcy said growth of the industry had stalled following the financial crisis.

“In the last decade we were just trying to keep the lights on,” he said.

The new strategy will mean a greater budget for the Department of Finance for its enhanced communications and promotions function.

The Central Bank lost that role following the crash.

The IDA does have a remit to bring in foreign direct investment, but has no role in developing indigenous firms.

The new push will set out broad goals, including to encouraging indigenous and foreign firms to expand here, a regional spread and more streamlined interaction with both the sector and with legislation and regulation increasingly coming from European level, he said. But he declined to give a specific target for job creation or overall value targets.

The Minister said complaints that the Central Bank here had failed to encourage banks and insurers leaving the UK as a result of Brexit – in contrast to some European peers – were wrong. “That wasn’t the case. The Central Bank were certainly unwelcoming of companies trying to trade somewhere else but pretend they were here.

“They weren’t having any of that,” he said.

However, the new strategy includes a push for greater engagement by regulators with industry.

“We want to establish a better structure with the Central Bank regulators and industry so we have agreed wording with the Central Bank that we will look at other eurozone countries and replicate what they do,” he said.

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Central Bank seeks extra power to force banks to further increase their capital

Central Bank seeks extra power to force banks to further increase their capital

The Governor of the Central Bank has written to the Minister for Finance asking him to put in place measures that would enable the regulator to force banks to hold more capital if systemic risks increase.

Philip Lane said the extra capital required by the Systemic Risk Buffer (SyRB) would help improve the loss-absorbing capacity of the main lenders here if there was a structural shock to the Irish economy.

However, if given the go-ahead and used, the new power could put further pressure on the interest rates paid by bank customers here, which are among the highest in the euro zone.

The SyRB was put in place when some countries in Europe wanted their banks to have higher capital requirements than those agreed under the 2013 Capital Requirements Directive.

Ireland and Italy were, at the time, the only countries not to transpose the new rules into domestic law.

However, the Central Bank Governor has now written to Paschal Donohoe asking that it be added to the regulatory toolkit here.

In a speech delivered in UCD this evening, Mr Lane said the move would ensure that the banking system would be resilient in the event of a structural shock to Irish economy.

“The advantage of the systemic risk buffer is that extra capital would improve loss-absorbing capacity if a systemic risk event occurred,” the soon to be European Central Bank executive board member said.

“Furthermore, credit supply could be further protected by switching off the systemic risk buffer under such circumstances.”

If the minister agrees to the request, legislation will have to be passed by the Oireachtas to give it effect.

Even then, the Central Bank would still have to carry out a full assessment of the financial risk environment before triggering it.

“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,” said Mr Lane.

“Furthermore, we adopt a holistic approach to policymaking, taking an integrated view of the interactions across the full set of macroprudential instruments…and the overall capital position of the banking system”.

The Central Bank also has a number of other macroprudential rules at its disposal, including the mortgage lending rules and the Counter-Cyclical Capital Buffer (CCyB).

The CCyB differs from the SyRB in that the former relates to domestic exposures only, while the latter is based on the whole of a bank’s book.

Countries that already have the SyRB in place require their banks to put aside varying levels of capital under it, with some demanding as much as 3%.

The Governor also told the UCD School of Economics that policymakers must look beyond the short-term horizon of the macro-financial cycle and ensure financial and fiscal resilience against tail risks.

He said it was imperative to build the resilience of both the financial system and the public finances against “tail risks” or events unlikely to occur.

Mr Lane also warned that dependence on high-tech multinational companies could amplify an economic shock here if it led to outflows of capital and labour and the loss of the technology embedded in departing firms.

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Central Bank slightly reduces estimates for economic growth this year

Central Bank slightly reduces estimates for economic growth this year

The Central Bank has slightly reduced its estimates for economic growth this year, amidst an ongoing weakening of the international trading and economic environment.

In its latest Quarterly Bulletin, the Central Bank expects GDP growth of 4.2% this year, down 0.2% since its January forecast.

It is all just a little bit weaker than even three months ago.

The forecast for both output and exports is down 0.2%, while consumer spending is forecast at just over 2% this year and next, compared with 3% last year.

It is due to a mixture of a weakening of the international trading and economic environment in which Ireland trades, and softer sentiment in the domestic economy, fueled by concerns over Brexit.

“This is mainly due to heightened uncertainty surrounding the global economy, including the risks in relation to trade disputes, higher protectionism, more stresses in international financial markets and already growth has slowed in the major economies,” said Mark Cassidy, director of economics and statistics at the Central Bank.

“Over recent years unemployment [in Ireland] has been gradually falling… and as the economy gets closer to a position of full capacity then there is diminishing scope for output growth due to less labour supply.”

Mr Cassidy also said some of the softness in the economy at present may be due to companies and individuals holding back on spending, as they wait to see what the outcome of the ongoing Brexit negotiations are.

Still the economy is set for strong growth this year of just over 4%, with unemployment set to average 5.4% for the year, dropping to 5% next year, and wages rising over the two years by 7%.

But that is based on Brexit being an orderly affair, with a deal and two year transition period.

In a disorderly no deal scenario, economic growth would be just 1% this year and next year.

“I would emphasise the inherent uncertainty surrounding any estimates in relation to a no-deal Brexit. It would be an unprecedented event,” Mr Cassidy said. “Our estimates indicate that economic growth could be of the order of 4 percentage points lower in the first year, and a further 2 percentage points lower in the second year.

“That would leave some positive growth, perhaps 1% to 1.5%, over those two years.”

Part of the Central Bank’s no-deal calculations include a significant further depreciation in the value of sterling, which it sees falling by 10% against the euro should Britain leave the European Union without a deal.

That would see one euro buy somewhere in the region of 97p – which represents an extremely unfavourable exchange rate for exporters.

“We think financial markets are currently pricing in a reasonably strong likelihood that a deal on Brexit will be agreed; it would be a shock to financial markets if there was no deal,” Mr Cassidy said. “Tariffs would come into effect also in the event of a no deal, and you would also get other disruptions to trade – difficulties in moving goods into and out of the country.

“All of those on top of each other would underlie the negative consequences for growth and employment across many parts of the economy.”

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