on an assessment of the risks facing borrowers, the financial position of the banking sector as well as recent stress - testing of the system, is that the banking system is well placed to withstand the impact of any major adverse developments in the short to medium term. this central expectation does not preclude the possibility of adverse developments, which should they materialise, would have serious financial consequences for banks. stress - testing exercises a round of stress testing was launched earlier this year by the bank with the 11 domestic retail credit institutions, whereby each institution was required to assess its vulnerability to hypothetical shock scenarios. these include a major fall in foreign direct investment, a negative world trade shock, exchange - rate appreciation of differing magnitudes, interest - rate increases, and house price falls. at the same time, there was a separate overall assessment by the central bank of the banks ’ vulnerability to various risks. the results of both stress - testing exercises, notwithstanding some important caveats, suggest that the banking sector ’ s shock absorption capacity is strong. house prices and private sector indebtedness i would like to comment a little more on two vulnerabilities of the financial system. residential house prices following the publication of last year ’ s report a reacceleration emerged in annual house price increases. in more recent months, however, there have been tentative signs of a re - emergence, from both housing indicators and anecdotal evidence, of some easing of price pressures. if these signs were to be confirmed and to continue into 2007, the vulnerability posed by house prices would be reduced somewhat. accordingly, the recent indications that the momentum in the rate of increase in house prices may be easing is a welcome development which we would like to see continue. while a soft landing in the residential property market still seems to be the most likely outcome, the run - up in residential property prices until recently has been unwelcome for two reasons. first, it is not obvious that this was driven by fundamental factors. house prices would have enjoyed some support from continuing strong demographics and higher income growth, but increasing interest rates and continuing high levels of housing supply were acting to counteract this. there is an interesting new research study contained in this report which explores the role of interest rates and disposable income in determining house prices. while, as with all such estimations the results are not necessarily definitive, the study suggests that these variables largely accounted for increases in house prices over the sample period 1980 to 2005.

however, the study points to some possible overvaluation emerging towards the end of this period. i referred to this possibility at the time of our annual report in july. consequently the latest information on price developments is to be welcomed. we would be concerned if this trend is not confirmed in the months ahead and if prices were to reaccelerate once again. i should stress, however, that even if there is some overvaluation, this should not necessarily mean that house prices would fall ; the most likely way that the overvaluation would be corrected is via a period of low and stable house price inflation while the economy continues to grow. bearing this in mind, a soft landing for house prices is the most likely outcome. secondly, the strong increases in house prices, along with increasing interest rates, is contributing to a deterioration in affordability in the residential market. this is of concern for two reasons. first, a deterioration in affordability could increase the risk of an abrupt correction in house prices, should the risks i referred to earlier materialise. second, it may create an environment where there is pressure for some liberalisation of lending standards. private - sector indebtedness at present, total private sector debt has reached €300bn, equivalent to approximately 205 per cent of gnp ( 174 per cent of gdp ) ; this is very high both absolutely and in comparative terms and will be higher by the end of the year. historical experience from a number of countries suggests that high indebtedness may increase the vulnerability of the economy to shocks. the rate of debt accumulation has remained strong and virtually all categories of bank debt are increasing at rapid rates. these developments are inextricably linked to developments in the property market. if the signs of easing in house price increases were to be confirmed and to continue into 2007, along with confirmation of the apparent leveling off in housing output, the rate of increase in credit growth should reduce. it would be necessary to see a sizeable reduction in the current very high level of housing output before the increase in the rate of indebtedness returns to more sustainable levels. furthermore, conditions in the labour market are critical to borrowers ’ continuing ability to service these debts. it is noteworthy therefore that labour market conditions have been very favourable over the last number of years, with the economy operating at effectively full - employment, and the prospects for the immediate future seem favourable. ireland ’ s private - sector debt to gnp ratio is already high