Gabriel Makhlouf: The publication of the Financial Stability Review
2021:2
Remarks by Mr Gabriel Makhlouf, Governor of the Central Bank of Ireland, on the publication of
the Financial Stability Review 2020:2, Dublin, 25 November 2021.
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Today we publish our latest Financial Stability Review (FSR). This publication sets out our
judgements on the main risks facing the economy and financial system. It also outlines our
assessment of the capacity of the financial system to withstand those risks. As is the case each
year, our FSR for the second half of the year includes a number of significant macroprudential
policy decisions, namely the annual review of the mortgage measures and the other systemically
important institutions (O-SII) buffer, as well as our fourth quarterly review of the counter cyclical
buffer (CCyB). We make these decisions with the express aim of safeguarding financial stability
in Ireland, acting in the public interest.
We are speaking at a moment of re-emergence of public health concerns stemming from the
path of the pandemic. This underlines the inherent uncertainty of the current environment.
Despite the success of the vaccination programme, the speed of change in pressure on the
health system in recent weeks has caused a re-assessment of the likely future duration and
nature of public health restrictions. Of course, we are in a very different place relative to where
we were at the beginning of the year or indeed last year. The link between cases and
hospitalisations has weakened due to the vaccines, large parts of the economy remain open and,
more broadly, households and businesses have adapted to the environment. Still, we must
acknowledge that there remains significant uncertainty about what lies ahead.
Despite the re-emergence of these pandemic-related developments recently, our overall
assessment of the macro-financial environment is that near-term macro-financial risks have
receded since our last Review in June. The vaccination programme has had a supportive effect
on economic activity, reducing the risks stemming from the pandemic-related economic
disruption. Indeed, we are now in an environment where medium-term risks of imbalances are
beginning to build, both domestically and globally. Risk-taking behaviour in global financial
markets has continued in recent months, leading to ever more stretched valuations in some
market segments. At the same time, we have seen a continued increase in global levels of
indebtedness, especially for governments and companies. Domestically, labour market recovery
during the second half of the year has been strong and has been associated with sectoral labour
shortages, while house prices are now rising at rapid levels driven by an imbalance between
supply and demand.
The challenges that have arisen in labour markets and global supply chains mean that inflation is
now running well ahead of many developed economy central bank targets. While our baseline
scenario is that these inflationary pressures will gradually fade, we must also acknowledge the
uncertainty involved and the prospect of the risks that would ultimately be associated with a more
prolonged inflationary period. There are potential risks arising in both financial markets and the
real economy from a mispricing of the future path for monetary policy. First, an unexpected
monetary policy tightening could trigger a widespread re-pricing of risk with potential adverse
effects for borrowers and many indebted governments. Second, more long-lasting inflation could
erode real income growth (constraining the recovery) or lead to overheating dynamics in the real
economy (which require a more aggressive monetary policy response). There is substantial
uncertainty over how likely these scenarios are.
Turning to resilience, the impact of the pandemic-related shock on the financial position of
lenders and borrowers is starting to dissipate. In particular, in the business sector, the role of
policy supports from the government and widespread forbearance from all types of creditor has
been critical in helping SMEs and larger firms to weather the worst of the pandemic, with
insolvency rates remaining remarkably low. The true financial health of the most affected
businesses will only become apparent over coming months and years, as policy support and
forbearance are gradually removed. Our analysis suggests that, based on current forecasts,
emergent financial distress will be of a magnitude that can be absorbed without significant
adverse knock-on effects in the financial sector or the economy, testament to the success of the
rapid policy support deployed from March 2020 to avoid scarring effects of the pandemic. The
local banking system continues to appear to have sufficient capital to absorb losses that may
result due to the pandemic and associated averse events.
Let me now turn to what this means for macroprudential policy.
Our macroprudential policy framework has three broad pillars: instruments relating to bank
capital, the mortgage measures, and market-based finance. In each of these pillars, we are
currently in a period of review - reflecting on international best practice, lesson-learned from the
COVID-19 shock, and changing global economic developments - in an attempt to ensure that
our frameworks remain fit for purpose and appropriate in the face of a rapidly-evolving operating
environment.
In line with previous guidance, we today maintain the CCyB rate at 0 per cent. Looking ahead, if
pandemic-related risks continue to contract as currently expected, the Central Bank would
expect to announce a gradual re-introduction of a positive CCyB rate during 2022. Moving at this
point would be consistent with our objective of promoting financial resilience early in the cycle.
Our review of the bank capital framework will conclude next year. This review is considering the
way in which the different elements of the macroprudential capital stack are calibrated, as well as
how our macroprudential buffers interact with each other, as well as key dependencies that also
reflect balance sheet risk such as risk-weighted asset regimes. All of this will bring us to a
position where we can communicate a clear strategy for the calibration of these capital buffers,
ensuring that the strategy balances the risks facing the banking system with the system's
resilience to absorb shocks.
Today we also announce the results of our annual review of the mortgage measures. The
mortgage measures have the twin objectives of strengthening borrower resilience and reducing
the likelihood of an adverse credit-house price spiral emerging. Two operational changes are
being made to the measures following the annual review.
First, the regulations will be amended to clarify the participation of retail banks in the 'First Home'
shared equity scheme. This reflects our judgement that based on the characteristics of this form
of financing, other safeguards in place (including bank capital as well as the initial scale and
scope of the scheme), it would not be proportionate for the mortgage measures regulations to
altogether restrict lenders from participating in the Scheme on financial stability grounds.
Second, reflecting the challenges to the operationalisation of the allowances during the recent
uncertainty posed by the COVID-19 pandemic and the changing structure of the banking system,
a carry-over system for loans approved in the previous calendar year will be introduced. This
change should allow lenders to more smoothly plan their allocation of this important type of
lending above the stated LTV and LTI limits.
In light of the ongoing mortgage measures framework review, the current calibration of the level
of the LTI and LTV limits and size of the pools of allowances will remain unchanged.
The mortgage measures framework review itself continues with extensive analysis and
stakeholder engagement. This review is focussing on our choice of instruments, our strategy for
calibrating their level, taking into account the many changes that have occurred globally and
locally since we introduced the measures. The shape of the review and the emerging themes of
focus have been informed by the extremely high quality of engagement we have had with the
public already, through our online engagement survey and a number of Central Bank Listens
events during the summer. We will launch a public consultation in December, where we will
invite the public and other stakeholders to provide us with feedback on a range of specific
questions. We aim to complete our framework review during the second half of next year.
Finally, on property funds, the Central Bank is today consulting on a set of measures to limit
leverage and liquidity mismatches for these entities that have become increasingly linked to the
domestic economy in recent years. They are now a systemic part of the Irish commercial real
estate market, holding more than 40 per cent of the estimated investable stock. Leverage is
higher among Irish resident property funds than European peers, creating additional vulnerability
to price falls, which could lead to selling pressures in the market. The Central Bank is seeking
feedback on new macroprudential policy measures aimed at increasing 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.