FINANCIAL STABILITY REPORT 2007

The Situation in Ireland
Like their international peers, Irish banks are operating in an environment where liquidity is not as readily available as heretofore. In addition, notwithstanding the fact that the larger institutions have diversified their businesses outside the Irish economy, the banking sector is operating in an economy where growth will be slower by comparison with recent years. Investor sentiment towards the banking sector globally has been negative in recent times. However, the current situation and outlook for Irish banks, based on an assessment of developments so far, is positive. Firstly, the sector’s shock absorption capacity has been largely unaffected by the turbulence in international financial markets. The domestic banking system reports no significant direct exposures to US sub prime mortgages and essentially negligible exposures through investments and through links with other financial companies or special purpose vehicles which themselves were negatively affected by the current market turmoil. The Financial Stability Report contains an article summarising the results of a survey conducted with the banks on this issue. Secondly, given the extent of the disruption to normal market functioning internationally in recent months, it is inevitable that Irish banks – like all banks - would experience some impairment in their access to liquidity in the interbank market. However, the comprehensive liquidity framework within the Eurosystem and the significant volumes of collateral held means that Irish banks are well positioned to access Eurosystem liquidity. Also, a fuller assessment of the funding patterns of Irish banks indicates that there is a significant medium-term element to much of their funding, as well as a relatively wide range of funding options available to them. Finally, our stress-testing of the banking system and our extensive financial stability analysis indicate that Irish banks are solidly profitable and well-capitalised. In this context, it is worth noting that they have one of the lowest rates of non-performing loans among banks in all EU countries.

Lessons from the Current Episode of Financial Market Turbulence
As the evolution and duration of the current episode is uncertain, it is difficult to draw firm conclusions at this early stage. Nevertheless, EU Finance Ministers have looked at recent events and have set out a roadmap of issues to address, to help avoid a repeat of recent events. A number of areas would seem to require attention in the near future:
There is a need to improve transparency about where financial risks lie. The lack of accurate and timely information on exposures and underlying risks has been an important factor in triggering the loss of investor confidence in recent months;
While securitisation and financial innovation have significantly enhanced credit risk transfer, they have had other, less benign - effects. In particular, the ‘originate and distribute’ model behind securitisation has changed the incentives for lenders regarding the monitoring of risk and we probably need some more checks and balances here;
Clearly, rating agencies play a very important role and should continue to do so. However, there are some potential conflicts of interest and how these are handled needs to be thought through, as does the question of whether a more differentiated scale of ratings for structured credit products is appropriate; the issue of how to value complex products, many of which are not traded on markets with genuine liquidity, also needs further consideration.

Conclusion
The publication of this Report is one way in which the Central Bank & Financial Services Authority of Ireland fulfils its financial stability mandate. In addition, we maintain an active dialogue with the domestic credit institutions in order to highlight issues for the financial system, and the Central Bank works in close co-operation with the Financial Regulator to help maintain financial stability in Ireland. The Financial Regulator conducts regular on-site inspections and monitors banks’ exposures on a regular basis. Finally, we continue to develop procedures to assess and deal with any concern of a financial stability nature that might arise in the future. I may add that, in the current environment, we have had more extensive dialogue with financial institutions to ensure that we and they are cognisant of the main risks and challenges in financial markets at this time.
I hope that the comprehensive analysis in our Financial Stability Report conveys the importance of a stable financial system and that it may stimulate discussion of the current financial stability climate in Ireland among financial market participants and the wider public.

To conclude, I am pleased to report that, notwithstanding some significant vulnerabilities and downside risks noted earlier, our overall conclusion is that the Irish financial system continues to be in a good state of health.

The Irish Central Bank