Ireland: Financial System Stability Assessment
Author: International Monetary Fund. Monetary and Capital Markets Department
Publication Date:
07 Jul 2022
eISBN:
9798400213564
Language:
English
Keywords:
risk analysis; resolution function; enforcement power; FSAP bank stress test; commission member; Commercial banks; Financial Sector Assessment Program; Global
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This Financial System Stability Assessment paper highlights that the Irish financial system has grown rapidly and in complexity, especially after Brexit, and Ireland has become a European base for large financial groups. Risks to financial stability emanate from a much larger and more complex financial system, persistent legacy issues, as well as emergent ones from non-bank lending, Fintech, and climate change. Stress tests confirmed banks’ resilience to severe macrofinancial shocks, with some caveats. While broadly adequate, supervisory resources and capacity need to keep pace with a growing and more complex sector with significant cross-border linkages. Efforts are needed to further strengthen supervision of banks’ credit risk and develop capacity and skills on new areas such as climate, non-bank lending, and Fintech. Insurance oversight should prioritize intra-group complexities. Resolution and crisis management can be enhanced through greater planning and collaboration between the Central Bank and the Department of Finance to bolster the ability to deal effectively with institution failures and systemic crises.

Abstract

This Financial System Stability Assessment paper highlights that the Irish financial system has grown rapidly and in complexity, especially after Brexit, and Ireland has become a European base for large financial groups. Risks to financial stability emanate from a much larger and more complex financial system, persistent legacy issues, as well as emergent ones from non-bank lending, Fintech, and climate change. Stress tests confirmed banks’ resilience to severe macrofinancial shocks, with some caveats. While broadly adequate, supervisory resources and capacity need to keep pace with a growing and more complex sector with significant cross-border linkages. Efforts are needed to further strengthen supervision of banks’ credit risk and develop capacity and skills on new areas such as climate, non-bank lending, and Fintech. Insurance oversight should prioritize intra-group complexities. Resolution and crisis management can be enhanced through greater planning and collaboration between the Central Bank and the Department of Finance to bolster the ability to deal effectively with institution failures and systemic crises.

Executive Summary

Ireland is a small open economy with a major international financial center featuring extensive cross-border linkages, mostly through the MBF sector. It has seen exceptional economic and financial sector growth over the past decade, as it recovered from the GFC. The GFC was a particularly adverse economic event in Ireland and has had long-lasting effects. Many lessons were learned, the banking system was de-risked and restructured, and an effective macroprudential framework was introduced. Brexit drove a large increase in the size and complexity of the financial system, notably of international banks, for which Ireland has become an operations base for Europe. Cross-border insurance activities and the MBF sector, which is primarily linked to the U.S. and Europe have also grown markedly, the latter to the second largest in Europe. In contrast, retail banks have struggled with low credit demand, post-GFC scarring and legacy policies, and low collateral recovery, which weigh on their performance. Recently, the last two foreign retail banks announced their exit from Ireland. Non-bank lenders and fintech firms have been growing rapidly, taking market share from the retail banks. Despite global headwinds, Ireland is exiting the pandemic with strong economic growth and a highly capitalized and liquid banking system.

Ireland has come a long way in strengthening financial regulation and supervision since the 2016 FSAP, aided by its membership in the European System of Financial Supervision (ESFS). This strengthening is evidenced by a successful navigation through the challenges of Brexit, the pandemic, and now the war in Ukraine. The authorities have been working with European and international regulators to strengthen financial system oversight across most relevant areas, including credit risk, captive insurance, and supervision of cross-border business and group supervision. The macroprudential framework is sound and has been up to the increased challenges. The authorities need to keep pace with the large, complex, and globally interconnected financial system, and the non-bank lending, Fintech, and AML/CFT issues.

Risks to financial stability emanate from a much larger and more complex financial system, persistent legacy issues, as well as emergent ones from non-bank lending, Fintech, and climate change. The potential impact of the unwinding of public pandemic policy support and global shocks, against the backdrop of the war in Ukraine, may increase pressures on the banking system in the near term. Still opaque linkages in certain segments of the MBF sector with the economy could act as a source of risk transmission and amplify external shocks. GFC legacy issues and policies—including restrictions on bank pay and bonuses, dominant government ownership, and persistent impediments to repossession of mortgage collateral that keep risk weights and the cost of credit high—result in low profitability in the retail banking system. The direct impact of the war in Ukraine and related sanctions imposed on Russia appear limited. Direct financial sector linkages to Russia also appear limited.

Stress tests confirmed banks’ resilience to severe macrofinancial shocks, with some caveats. On the solvency side, banks’ high initial capital provides strong buffers, but there are some risks as the economy exits from pandemic-related policy support. The liquidity stress tests suggest banks are resilient to adverse liquidity conditions, although maturity mismatches may expose banks to shortfalls in a sustained liquidity stress environment, with some cross-currency vulnerabilities. Insurers were also broadly resilient in the solvency and liquidity stress tests. Linkages of an MBF subsector—”Other Financial Institutions (OFI) residual”, with total assets of about 1.6 times GDP— with the economy remain opaque.

The FSAP recommendations reflect steps to address existing risks and meet new challenges:

  • Cross-cutting measures aim to further enhance the de jure independence of the central bank; extend supervisory and enforcement powers against individuals; and implement an action plan on risks from climate change.

  • Supervisory focus and resources. While broadly adequate, supervisory resources and capacity need to keep pace with a growing and more complex sector with significant cross-border linkages. Efforts are needed to further strengthen supervision of banks’ credit risk and develop capacity and skills on new areas such as climate, non-bank lending, and Fintech. Insurance oversight should prioritize intra-group complexities. For the MBF sector, the authorities should provide guidance to investment funds on liquidity management tools to enhance their resilience. Additionally, they should intensify efforts to better understand the linkages between the OFI residual segment and the economy.

  • The macroprudential framework can be further extended, to cover risks from the nonbank sector, including introducing leverage limits on property funds.

  • Resolution and crisis management can be enhanced through greater planning and collaboration between the Central Bank and the Department of Finance (DoF) to bolster the ability to deal effectively with institution failures and systemic crises.

  • Addressing policies and legacies from the GFC that are a drag on retail banking require measures to address impediments to the repossession of mortgage collateral, complete the sale of government bank ownership, and lift operating restrictions.

  • AML/CFT policy. Efforts are needed to better understand and address risks from non-residents and cross-border activity. Adequately resourcing AML/CFT capacity, broader data collection and the use of advanced data analytical tools will be crucial.

The FSAP thus recommends targeted measures outlined in Table 1.

Table 1.

Ireland: FSAP Key Recommendations

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* Timing: C = Continuous; I = Immediate (within one year); ST = Short Term (within 1–3 years); MT = Medium Term (within 3–5 years). ** Parliament of Ireland.

Background

A. Macrofinancial Developments

1. Ireland has seen exceptional economic and financial sector growth over the past decade as it recovered from the GFC, which was a particularly adverse event in Ireland. Under a favorable tax regime, large multinational enterprises (MNEs) have driven exports, economic growth, and national income. Brexit drove a large increase in the size and complexity of the financial system, notably of international banks, cross-border insurance activities, and of the MBF sector, that is primarily linked to the U.S. and Europe. In contrast, the retail banking system has continued to shrink until recently, as it struggled with low credit demand from deleveraging by SMEs and households, driven by the still live memory of the GFC shock.

2. The Irish economy has rebounded strongly from the pandemic. GDP grew by 13½ percent in 2021, largely driven by MNEs, while GNI* growth (which excludes most MNE activities) is estimated at 6 percent (Figure 1). The economy fully reopened in early 2022 as COVID-19 infections declined. The labor market continued to rebound strongly, reflecting the waning pandemic and ongoing effect of policy support, and employment and participation rates have exceeded pre-pandemic levels. However, recent energy and commodity price increases are pressuring inflation, which reached 7 percent in April 2022. While direct trade links with Russia and Ukraine are small, with the impact of energy price increases and lower external demand, growth is expected to decelerate to 7.5 percent in 2022 and gradually decline to its medium-term potential of 3 percent by 2025.

Figure 1.
Figure 1.

Ireland: GDP Growth

Citation: IMF Staff Country Reports 2022, 215; 10.5089/9798400213564.002.A001

3. While uncertainty remains, the pandemic’s impact on borrowers’ financial position has so far been limited. Household balance sheets improved slightly since the start of the pandemic, largely due to extraordinary public income support (Figure 2). Similarly, the nonfinancial corporate (NFC) sector, aided by the support measures, has seen limited impact on the aggregate, though, there was a large heterogeneity across sectors hit by COVID-19 (Figure 3).

Figure 2.
Figure 2.

Ireland: Household Sector Developments

Citation: IMF Staff Country Reports 2022, 215; 10.5089/9798400213564.002.A001

Source: Central Bank.
Figure 3.
Figure 3.

Ireland: COVID-19 Sectoral Impact

Citation: IMF Staff Country Reports 2022, 215; 10.5089/9798400213564.002.A001

Note: Debt at risk is defined as share of debt with Interest Coverage Ratio below one.Sources: Thomson Reuters, Capital IQ, and IMF staff estimates.

4. While the pandemic was a significant shock to the economy, banks continued to maintain strong capital and liquidity buffers. As of Q3–2021, the average Common Equity Tier 1 (CET1) ratio was 22 percent (well above the euro area average of 16 percent), the Liquidity Coverage ratio (LCR) stood at 178 percent, and the Net Stable Funding Ratio (NSFR) was about 150 percent, with liquidity benefiting from ECB liquidity measures and higher customer deposits (Figure 4). While the NPL ratio of the aggregate banking system continued to decline to under 3 percent at mid-2021 and the system returned to profitability, retail banks carried higher NPLs of about 4 percent.

Figure 4.
Figure 4.

Ireland: Banking Sector Indicators

Citation: IMF Staff Country Reports 2022, 215; 10.5089/9798400213564.002.A001

Notes: RWD stands for risk weight density. “CET1 Ratio” reflects traditional (non-fully loaded) measure of CET1. EA comparison charts are based on data for the total Irish banking sector which is different from sample used in the FSAP bank stress test.Sources: ECB Statistical Data Warehouse and Central Bank.

B. Financial Sector Landscape

5. The financial sector has grown both in asset size and complexity, especially after Brexit. The funds sector’s assets reached €4.5 trillion in 2021, more than ten times the GDP (Figure 5). Additionally, some large international banks relocated their EU-related activities to Ireland after Brexit, these focus on international corporate and investment banking and are supervised by the Single Supervisory Mechanism (SSM). The insurance sector, especially the non-life segment, has also seen significant growth in recent years partially driven by Brexit.

Figure 5.
Figure 5.

Ireland: Financial Sector Assets

Citation: IMF Staff Country Reports 2022, 215; 10.5089/9798400213564.002.A001

Source: Central Bank.

6. The MBF sector is the largest component of the financial system1, with total assets at over 15 times GDP. It is comprised of the funds sector —money-market funds (MMFs) and investment funds (IFs)— as well as other financial institutions (OFIs). Funds hold primarily non-Irish assets on behalf of non-Irish investors, although they also have domestic interlinkages, primarily through property funds. OFIs, with total assets of four times GDP, are comprised of special purpose entities (SPEs) and a catch-all category entitled “OFI residual.” SPEs are commonly used for securitization as well as intra-group and external financing. The OFI residual segment, with total assets of about 1.6 times GDP, includes entities that engage in non-bank lending (Figure 6).

Figure 6.
Figure 6.

Ireland: MBF Sector Structure

Citation: IMF Staff Country Reports 2022, 215; 10.5089/9798400213564.002.A001

Notes: IFs – investment funds, MMFs – money-market funds, OFIs – other financial institutions, SPEs – special purpose entities, SPVs – special purpose vehicles, FVCs – financial vehicle corporations.

7. The banking sector comprises two segments, retail and international banks, which vary considerably in their business models and market orientations. Retail banks (about 42 percent of total banking system assets) focus mostly on the domestic economy, with some exposures in the U.K. (Figure 7). They rely on domestic household and corporate deposits and have increasingly turned to mortgage finance, but face high costs, including from legacy mortgage NPLs and the relatively long time it takes to recover collateral. Issues around mortgage collateral recovery impact credit risk, raising risk weights and the cost of lending. International banks, primarily European subsidiaries of international groups, focus mostly on cross-border activities.

Figure 7.
Figure 7.

Ireland: Banking Sector Segments

Citation: IMF Staff Country Reports 2022, 215; 10.5089/9798400213564.002.A001

Note: Figures showing comparisons between banking segments are based only on the sample of banks used in the stress test. “CET1 Ratio” reflects traditional (non-fully loaded) measure of CET1.Sources: ECB, Central Bank, Fitch, and IMF staff estimates.

8. Retail banks have weathered well both the Brexit and the COVID-19 shocks and ongoing consolidation in the retail segment will boost profitability in the short-term. They are making progress, albeit slow, in improving cost efficiency (digitalization, closing of branches, headcount reduction) and have taken steps to diversify income sources (e.g., acquisitions of wealth management firms).

9. Ireland’s insurance sector is large, primarily due to cross-border business. Ireland hosts the fourth largest sector in the European Union (EU) by premiums, and assets managed by the insurance industry amount to 117 percent of the GDP. Most Irish insurers are subsidiaries of international groups and often have significant financial links with intra-group entities. Cross-border business plays an essential role, and many firms operate on an ‘outward’ basis, with less than 30 percent of total premiums being written in Ireland (Figure 8).

Figure 8.
Figure 8.

Ireland: Insurance Sector

Citation: IMF Staff Country Reports 2022, 215; 10.5089/9798400213564.002.A001

Note: Market concentration includes domestic and outward cross-border business, and life insurance includes unit-linked business.Source: Central Bank, EIOPA, Eurostat, and IMF Staff calculations.

10. Financial sector’s linkages to Russia are limited. SPEs have the largest links to Russia as they held €37 billion of Russian-issued assets at end-2021 (3.6 percent of their total assets). Investment funds held €11.5 billion Russian-issued assets (0.3 percent of their total assets). Banking asset exposures were within international banks and small (€1.1 billion).

Systemic Risk Assessment

A. Macrofinancial Challenges

Dealing with the long-tail effects and policies of the GFC that weigh on retail banks

11. Efforts are needed to fully address the legacies of the post-GFC era to protect financial stability and support the financing of growth. Following the GFC, the banking system went through a necessary deleveraging and restructuring, with the government rescue resulting in the state becoming a majority shareholder in several banks. The last two foreign retail banks are leaving the market in 2022, after which only three will remain. While the small size of the domestic market is a factor, post-GFC policies are contributing to a challenging retail banking environment. While understandable at the time, these policies have outlived their usefulness. Chronic low profitability and operational challenges represent financial stability concerns, especially that concentration has risen markedly.

  • The NPLs of retail banks remain above the EU average and these weigh on profitability, including via high risk weights. While much progress has been made in reducing bank NPLs since the GFC, progress has slowed down recently. Very long-term mortgage arrears (LTMA), some more than a decade, persist. A push to clear the final stock is needed, as well as steps to improve insolvency and collateral recovery procedures to see a meaningful drop in risk weights that are contributing to higher interest rates in Ireland than in EA peers.

  • Policies introduced at the time of the government bailout significantly handicap critical talent acquisition and retention, especially for key risk management and compliance positions, and should be ended. The measures include caps on executive pay,2 a penal tax on all employee bonuses (89 percent), and a bank levy to reduce the impact of large loss carryforwards on tax revenue. These policies also result in an uneven playing field for the retail banks, which are in a catch-up game with more nimble and digitally advanced non-banks.

  • Long-term government ownership, not envisaged at the time of rescue, may be contributing to slow progress in cost reduction, innovation, and normal commercial/credit risk-taking. While the government has been unwinding its stake in recent years, it remains a majority owner of two of three remaining retail banks.3 Irish banks stand out compared to peers with the low share of loans to non-financial corporations (13 percent of total loans vis-à-vis the EU average of 22 percent) and high concentration on mortgages. Surveys of SMEs point to difficulties in acquiring bank credit.

B. Systemic Risks

12. There are risks associated with the withdrawal of public pandemic support. While the economy is expected to grow strongly, the effects of the withdrawal of public support need to be monitored closely. While all moratoria have now expired, 40 percent of household loans in Stage 2 were previously under moratoria, indicating credit quality deterioration. Against this background, the FSAP performed a sensitivity analysis to gauge the risks from the end of broad policy support on bank capital positions (Figure 9).

Figure 9.
Figure 9.

Ireland: Take-up of COVID-19 Loan Moratoria

Citation: IMF Staff Country Reports 2022, 215; 10.5089/9798400213564.002.A001

Note: Data as of 2021Q2.Source: Central Bank.

13. Although households have been deleveraging, house prices have been rising in recent years, largely due to supply constraints. Credit growth has continued to be muted as SMEs and households continue to deleverage (Figure 10) and MNEs are largely funded internationally. The credit gap, based on both GDP and GNI*, has been negative since 2016. However, annual house price increases accelerated to 14 percent in December 2021. Staff’s house-price-at-risk estimation points to downside risk of about 30 percent cumulative decline over a three-year horizon.4

Figure 10.
Figure 10.

Ireland: Credit Developments and Leverage

Citation: IMF Staff Country Reports 2022, 215; 10.5089/9798400213564.002.A001

Source: Capital IQand IMF staff estimates.

14. The commercial real estate (CRE) sector has been largely resilient during the pandemic, but with significant sub-sectoral divergence. The retail sector has been the hardest hit, while demand for industrial space has been robust throughout (Figure 11). Investment in CRE rebounded in 2021 with significant cross-border flows, often intermediated via investment funds. While these flows provide funding diversification, they may also act as a channel of contagion for global financial shocks. Banks’ exposures to the non-retail real estate activities warrant continued monitoring amidst sectoral adjustments.

Figure 11.
Figure 11.

Ireland: Property Prices

Citation: IMF Staff Country Reports 2022, 215; 10.5089/9798400213564.002.A001

15. High reliance on wholesale and non-resident deposits combined with large contingent liabilities may expose international banks to funding stress.5 Unlike retail banks which mostly rely on retail deposits, Irish international banks obtain significant funding from either parents or large corporates via cross-border wholesale deposits, which are considered more volatile under stress. Off-balance sheet exposures, including credit lines and guarantees, are also sizeable (40 percent of total assets) for large international banks, which may increase credit impairments through an unexpected expansion/conversion of risky exposures.

16. The large OFI sector has significant linkages to the domestic economy, some parts of which remains opaque. The Central Bank collects and analyzes granular data on SPEs and has a better understanding of their links to the domestic economy. However, information on the “OFI residual” is more limited, so the full extent of linkages of these institutions remains opaque.

C. Banking Sector Solvency and Liquidity

17. The FSAP carried out a top-down stress test (ST) covering 12 banks, which constitute around 80 percent of sector assets. Five of these banks are retail banks, and seven are international banks. For the five retail and three large international banks, a scenario-based ST was conducted, while a sensitivity analysis was conducted for the four other international banks, which are all less significant institutions (LSIs).

Solvency Analysis

18. The FSAP identified the following key macrofinancial risks that could pose challenges for the banking sector if they materialized.6 The adverse scenario is constructed on the joint realization of these risks.

  • Russia’s invasion of Ukraine leads to escalation of sanctions and other disruptions, which could lead to even higher commodity prices and tighter financial conditions. This, in turn, would put additional pressure on domestic inflation and hurt consumers, further stifling economic activity in Ireland.

  • Outbreaks of lethal and highly contagious COVID-19 variants, which could result in extended supply chain disruptions, a deterioration of fiscal balances, financial tightening, and an impact on growth.

  • De-anchoring of inflation expectations in the U.S. and/or advanced European economies prompting central banks to tighten policies faster than anticipated, resulting in a sharp tightening of global financial conditions and spiking risk premia.

  • Geopolitical tensions and deglobalization, which could cause, among other things, economic disruptions, a decline in global trade, and lower investor confidence.

  • Continued trade frictions and uncertainty related to the detailed implementation of post-Brexit arrangements, which could cause increased costs for Irish businesses with close relationships with the U.K. leading to a slowdown in growth.

19. The exercise uses bank data as of mid-2021 and the baseline and adverse scenarios span a five-year horizon starting from this date. The baseline scenario aligns with staff projections as of March 2022,7 while the adverse scenario features a shock to GDP and GNI* growth equivalent to 2.6 and 3.2 standard deviations, respectively, from their baselines (Figure 12).8

Figure 12.
Figure 12.
Figure 12.

Ireland: Solvency ST Scenarios

Citation: IMF Staff Country Reports 2022, 215; 10.5089/9798400213564.002.A001

Sources: Haver Analytics, World Economic Outlook, and IMF staff estimates.

20. The solvency ST confirmed banks’ resilience to severe macrofinancial shocks, while pointing to some risks as the pandemic-related policy support is being withdrawn (Figure 13). The baseline scenario indicates banks will maintain their strong capital positions, with additional capital accumulation. Both retail and large international banks would see their CET1 ratios trend upwards, which will further increase existing buffers.

Figure 13.
Figure 13.

Ireland: Results of Scenario-based Solvency Stress Test

Citation: IMF Staff Country Reports 2022, 215; 10.5089/9798400213564.002.A001

Source: IMF staff.Notes: Data correspond to the stress testing bank sample, which is a subset of the full banking sector. Hurdle rates in the figures are displayed as minimum CET1 ratio plus the average of the bank specific O-SII buffers.

21. The adverse scenario confirmed banks’ resilience when facing severe adverse shocks. No bank would see its capital ratio fall below the hurdle rates,9 supported largely by the high initial capital position for both retail and large international banks, as well as the high pre-provision income generation capacity of the large international banks. Retail banks experience a larger impact, with their fully-loaded CET1 ratio declining by 6.7 percentage points vs. 0.4 percentage points for large international banks by the 5th year. At the trough, the capital depletion would reach 7.2 and 2.3 percentage points for retail and large international banks, respectively. Retail banks experience a higher capital depletion, due to losses from their larger holdings of domestic corporate portfolios with a higher share of CRE loans and their lower pre-provision income. Credit risk provisioning is by far the largest contributor to the decline in capital ratios, with the cumulative effect amounting to 7.4 percentage points across five years.

22. The ST results paint a slightly more adverse picture when assuming an additional impact from the unwinding of support policies. The sensitivity analysis, which assumes that 50 percent of loans with either active or expired moratoria flows from stage one and stage two assets into stage three assets, results in one retail bank’s CET1 and Tier 1 ratio falling below the hurdle rates under the adverse scenario, with the capital shortfall against the CET1 hurdle rate amounting to 0.2 percent of GDP.

23. The sensitivity analysis for other international banks indicated overall resilience of, albeit with notable variation across banks. The FSAP assumed joint realizations of shocks to all major components of banks’ income to test their resilience. No bank would see its capital ratio fall below the hurdle rate, and the results highlight bank-specific sensitives to different shocks given their highly diverse business models.

Liquidity Analysis

24. The LCR-based ST suggests that banks are resilient to adverse liquidity conditions (Figure 14). Retail banks experience a larger impact under the retail stress scenario while international banks are more adversely affected by the wholesale stress scenario. The relatively lower initial level of the LCR for large international banks brings this group closer to the 100 percent threshold under stress; nevertheless, all banks can withstand the most severe shock within the 30-day window, underpinned by their high initial level of liquidity buffers.

Figure 14.
Figure 14.

Ireland: Results of Liquidity Stress Test

Citation: IMF Staff Country Reports 2022, 215; 10.5089/9798400213564.002.A001

Source: ECB, Central Bank, and IMF staff.

25. The cashflow-based ST suggests potential liquidity gaps when extending the stress beyond 30-days. This is due to maturity mismatches characterized by more frontloaded cash outflows and backloaded cash inflows, with sustained liquidity stress leading to liquidity shortfalls over the longer term. International banks are more prone to liquidity shortfalls across various maturities, due to their high share of wholesale funding (largely, group parental support) and larger off-balance sheet exposures.

26. Both LCR and cashflow-based ST for major foreign currencies reveal vulnerabilities of banks to USD- and sterling-denominated outflows. Currency-specific analyses signal vulnerabilities across major foreign currencies, in particular for USD outflows for international banks. This is largely due to weaker currency-specific initial liquidity positions and high reliance of international subsidiaries on foreign currency backstop from parent entities.

D. Banking Sector Interconnectedness

27. The domestic interbank analysis indicates limited interbank exposures within Ireland, with retail banks playing a more prominent role in the network (Figure 15).10 Both inward and outward spillover risks for the domestic interbank network appear to be small, due to limited interbank activity. The results suggest that all banks have sufficient capital to withstand domestic interbank shocks via direct exposures.

Figure 15.
Figure 15.

Ireland: Interconnectedness Analysis

Citation: IMF Staff Country Reports 2022, 215; 10.5089/9798400213564.002.A001

Note: Index of vulnerability is defined as the average loss of a bank due to the failure of all other banks (inward spillover). Index of contagion is defined as the average loss of other banks due to the failure of a bank (outward spillover). Panels showing comparisons between banking segments are based on the sample of banks used in the stress test and use large exposures of the sample banks.Sources: ECB, Central Bank, and IMF staff calculations.

28. Similarly, the cross-border interbank analysis indicates limited integration of Irish retail banks to the global network. Irish retail banks’ foreign asset claims and liabilities have declined substantially since the GFC, from US$234 to US$15 billion and from US$358 to US$31 billion, respectively. Accordingly, both cross-border inward and outward spillover risks for the Irish retail banks are well-contained.

29. Beyond the interbank market, however, there are significant linkages between large international banks and foreign non-bank financial institutions (NBFIs). The bank-NBFI contagion analysis focused on banks’ inward spillover risks, which measures average credit loss of a bank due to the failure of all other banks and NBFIs. After adding NBFIs to the domestic interbank network, the potential for inward spillover risks, via the credit channel, rises sharply for the large international banks, suggesting larger vulnerabilities for these banks to shocks from NBFIs.

E. Interconnectedness of the MBF Sector

30. The FSAP analyzed the interconnectedness of the MBF sector with a particular focus on funds, while also assessing the linkages of OFIs with the domestic economy. The MBF sector is the largest component of the financial system, with total assets at almost 15 times GDP. While this sector is largely oriented abroad, it also has domestic interlinkages, which highlights the importance of understanding its linkages with the bank, non-bank, and real sectors in Ireland.

31. There are four main findings based on the analysis:

  • First, Irish funds have limited links to domestic banks and households. Bank asset claims on Irish funds are negligible, while bank liabilities to funds are comprised mostly of deposits corresponding to only around 4 percent of GDP. Similarly, households do not have significant linkages with the funds.

  • Second, in contrast, Irish funds have significant interlinkages with OFIs resident in Ireland, as part of Ireland’s large, internationally-oriented financial sector. The financial linkages of Irish funds with OFIs are sizeable, with fund asset claims and liabilities to the total OFI sector close to 30 and 50 percent of GDP respectively.

  • Third, OFIs—while largely internationally focused—also have significant linkages to the domestic economy. Most of these transactions relate to internationally focused activities, but entities within the OFI sector also have meaningful linkages with domestic banks, households, and firms.

  • Fourth, funds and banks have common exposures to the domestic CRE sector, which represents a potential channel of contagion.

32. Ireland has made good progress in implementing the 2016 FSAP recommendations, but some important data gaps remain to be closed. While many linkages between the domestic economy and the MBF sector have been analyzed, work remains to be done to elucidate fully the linkages between parts of the MBF sector and the rest of the financial system, and to the domestic economy. A key area of risk lies in the opacity and lack of granular data on financial transactions of entities in the OFI residual sector. The authorities should intensify collaboration both domestically and with international regulators to better understand the OFI residual entities and their linkages, and to conduct risk analysis at a granular level for this segment.

F. Investment Fund Liquidity Analysis

33. The FSAP assessed the liquidity resilience of the investment fund industry in Ireland, the largest component of the MBF sector, to severe redemption shocks. If individual funds were to experience significant redemption shocks, they may be forced to liquidate assets. Should this happen on a collective basis, there is the potential for wide scale fire sales not being absorbed smoothly by markets.

34. Investment funds are generally resilient to shocks, but pockets of vulnerability exist. Resilience is measured here in terms of ability to meet large redemption requests in a stressed market, without the use of liquidity management tools or the sale of less liquid assets. The majority of fixed-income investment funds in Ireland, which are the focus of the liquidity stress test, would be able to weather severe but plausible redemption shocks under a wide range of shock scenarios. However, certain categories of funds, including high-yield (HY) bond funds and emerging-market focused fixed-income funds, which are more susceptible to liquidity mismatches, may be less resilient in events of severe market stress.

35. The key recommendations to the authorities are to review the use of liquidity management tools by funds and to expedite the completion of the internal stress-testing framework. As part of its ongoing policy development on fund liquidity risk management, and taking into account developments at the EU and international level, the Central Bank should review the use of liquidity management tools by HY bond funds and emerging market fixed-income funds. The Central Bank has made significant strides in building a fund stress-testing framework based on recommendations of the 2016 FSAP, but the model remains a work-in-progress. Given the size, accelerating growth, and systemic importance of the sector, the Central Bank should prioritize the completion of its stress-testing framework.

G. Insurance Sector Solvency and Liquidity

36. The solvency ST focused on market and credit risks and followed a top-down approach covering 25 insurers and 70 percent of each sub-sector (life, non-life, and reinsurance). Shocks derived from the banking sector adverse scenario were assumed to occur instantaneously at the reference date end-Q2 2021. This approach did not recognize potential management actions that insurers utilize to de-risk balance sheets and improve solvency positions.

37. Irish insurers are broadly resilient under the adverse scenario (Figure 16). Portfolio asset values decline due to higher spreads, which is partially offset by the effect of higher interest rates which reduces firms’ liabilities. Most insurers remain well capitalized under the scenario and only one insurer falls below the 100 percent Solvency Capital Requirement (SCR) threshold. The aggregate shortfall in eligible own funds to meet the SCR is less than €10 million. Non-life insurers are affected more adversely from the shocks while life insurers on aggregate see smaller balance sheet effects.

Figure 16.
Figure 16.

Ireland: Insurance Solvency ST—Solvency Impact

Citation: IMF Staff Country Reports 2022, 215; 10.5089/9798400213564.002.A001

Source: IMF staff calculations based on Central Bank data.

38. The FSAP also assessed insurers’ resilience to variation margin calls in their interest rate swap portfolio. This top-down analysis confirmed the low vulnerabilities stemming from this channel, albeit reporting data for other derivative types being incomplete. The results highlight the importance for the supervisor to understand liquidity flows and liquidity risk management, which also needs to include the intra-group structures. Similarly, the Central Bank’s bottom-up analysis indicates that a broader liquidity shock is unlikely to have a systemic impact in the Irish insurance sector; instead, the results are driven by company specifics (Figure 17).

Figure 17.
Figure 17.

Ireland: Insurance Sector Liquidity Risk Analysis

Citation: IMF Staff Country Reports 2022, 215; 10.5089/9798400213564.002.A001

Source: IMF staff calculations based on Central Bank data.

H. Climate Risk Analysis

39. The FSAP assessed climate-related financial risks for the banking and insurance sectors, covering both transition and physical risks.

40. The Irish banking system’s exposure to climate risks is moderate but material. About 15 percent of corporate loans is to sectors with a high carbon footprint and more than 20 percent of loans are to sectors exposed to high physical hazards (largely floods), well above euro area average, suggesting vulnerability of banks to potential carbon tax shocks and sea level rises (Figure 18).

Figure 18.
Figure 18.

Ireland: Bank Exposure to Climate Risks

Citation: IMF Staff Country Reports 2022, 215; 10.5089/9798400213564.002.A001

Sources: Eurostat, ECB, Central Bank, and IMF staff estimates.

41. A scenario-based physical risk analysis was conducted to gauge the impact of a severe flooding event on banks, focusing exclusively on retail banks given the high domestic nature of the simulated scenario. A severe flooding event was first mapped to a set of macrofinancial variable shocks over a 5-year horizon, which were then translated to bank capital impact (Figure 19).

Figure 19.
Figure 19.

Ireland: Results of Banking Sector Climate Risk Analysis

Citation: IMF Staff Country Reports 2022, 215; 10.5089/9798400213564.002.A001

Note: The bank climate risk analysis follows the general approach developed under the recent Norway and UK FSAPs.Source: ECB, Central Bank, and IMF staff.

42. The transmission from the severe flood-induced macroeconomic shock to capital impact is mainly through credit and market risk. The results suggest that retail banks could experience non-trivial depletion of CET1 capital (up to 2.4 percentage points) at trough, before recovering to close to the pre-shock capital levels at the end of the scenario period.

43. The transition risk analysis aimed to assess the impact of transition to a low carbon economy on banks by assuming an instantaneous increase of carbon tax from €33.5 to €100 per ton of CO2 emissions. Higher carbon prices are expected to hit firms that have heavy carbon footprints, leading to higher defaults, which would result in impaired credit quality for the banks that extend loans to those entities.

44. Energy-intensive sectors saw the largest increase in defaults under various scenarios based on firm-level behavioral response assumptions. The cumulative CET1 depletion resulting from the projected default paths can approach 3.5 percentage points of CET1 capital (or 15 percent of existing CET1 stock) under the most severe scenario, suggesting meaningful exposure to transition risks and highlighting the importance of enhanced monitoring of banking sector’s exposure to climate-sensitive segments.

45. The insurance sector is exposed to physical risks mainly through its non-life underwriting, but also through investments. Domestically, the most important natural perils are windstorms, floods and freezes, but several Irish (re)insurers underwrite business globally, exposing them also to international climate-related risks such as U.S. hurricanes and wildfires. The FSAP analysis indicates that even large natural catastrophes, when seen in isolation, would likely not have a pronounced impact on solvency levels.

46. The impact of transition risk is larger for life insurers, mainly due to comparably larger asset allocation towards sectors with high carbon footprints. Transition risks were analyzed by assuming that the effect of the NGFS scenario of an orderly 1.5 degree increase until 2050 is priced by investors instantaneously, resulting in lower asset valuations. The resulting loss on investment portfolios of insurers would be around €7 billion, or 2.3 percent of total investments.

Financial Sector Oversight

A. Macroprudential Policy Framework

47. The Central Bank is responsible for macroprudential policy in Ireland, sharing some responsibilities with European institutions. Macroprudential policy is a particularly important tool for a small open economy that is part of a monetary union. The macroprudential policy framework has developed since the 2016 FSAP, with the implementation of new measures, including the residential mortgage measures and macroprudential capital buffers. In January 2015, loan-to-value and loan-to-income limits were introduced and empirical evidence shows that the measures have been working as intended. In 2016, the Financial Stability Directorate of the Central Bank (with responsibility for macroprudential policy and crisis management), and the Macroprudential Measures Committee (MMC; to advise on macroprudential measures and their calibration) were established. The Financial Stability Group (FSG) was formed in 2017 as a non-statutory, intra- agency coordination mechanism to improve cooperation at the national level

48. The institutional framework is appropriate, although some areas could be strengthened. The Central Bank has a clear financial stability mandate. Decision-making on tools under the Central Bank’s power is divided between the Commission and the Governor under advisement by the MMC. The Central Bank has broad powers to implement measures and gather information, as relevant for financial stability. Opening the MMC to external advisory members would align the committee with best practice, strengthen diversity of perspectives, and act as a safeguard against the risk of potential inaction.

49. The systemic risk monitoring framework is sophisticated but would benefit from closing data gaps and improving non-bank monitoring. The process for monitoring systemic risks is structured around the bi-annual production of the Financial Stability Review, facilitating an exchange of views at multiple stages of the development cycle. Completion of a dynamic macroprudential stress-testing framework will provide additional information, to inform the calibration of capital buffers. Filling gaps in CRE investment flows, in coordination with international institutions especially for direct cross-border flows, would enhance the Central Bank’s monitoring of a potential channel of contagion. Broader limits on total debt should be considered should leakages emerge from unsecured credit.

50. Risks from non-banks are diverse. Irish property funds, with total assets of about €33 billion, account for more than 40 percent invested CRE market and are largely financed by overseas investors. A cohort of these funds has leverage above 50 percent, while liquidity mismatches are generally moderate. Non-bank lending to SMEs has been increasing,11 but a currently small share of non-bank (peer-to-peer and crowdsourced) funding is not measured in the Central Credit Register. The Central Bank has proposed a leverage limit and liquidity management guidelines for property funds, and the details should be finalized and implemented. The Central Bank should consider counter-cyclical adjustments to leverage limits on property funds, more regular reporting requirements, and the tradeoff between timelines on compliance if the limit is breached with the risk of fire sales in the funds returning to compliance.

51. The Central Bank must continue to work through European and international institutions to address non-bank risks and to develop a non-bank macroprudential framework. Various data gaps, including direct cross-border investments into CRE, can only be closed through international collaboration. The Central Bank has also been innovative in considering macroprudential measures for non-banks through the EU AIFMD regulation. As the lack of reciprocity may impact effectiveness, the Central Bank should continue to work with European institutions to address cross-border issues.

B. Microprudential Oversight Cross-Cutting Issues

52. As the integrated regulator of an increasingly large and complex financial services sector, the Central Bank has adequate supervisory resources and enforcement powers. Although de facto independence is strong, some further de jure enhancements would be beneficial. The grounds for dismissing Central Bank commission members should parallel those for the Governor, namely on specified grounds of serious misconduct. While the Central Bank has stable and secure funding, the determination of the “supervisory levy” should be put on a firmer legal basis. Actions are needed, and are under preparation, to enhance the Central Bank’s enforcement powers and facilitate the pursuit of sanctions against individuals. This will be addressed by the new Individual Accountability Framework (IAF), the adoption and implementation of which should be prioritized.

53. The Central Bank has been expanding its analysis and management of climate risks. The recent adoption of a strategic plan, which includes a particular focus on resilience and the establishment of the Climate Change Unit, is welcome. The strategic plan needs to be operationalized by a sequenced action plan for banking and insurance supervision, which should include indirect effects and litigation risks, and with an emphasis on robust data and quality disclosure.

Banking

54. Prudential regulation of banks has improved greatly since the 2016 FSAP. The Central Bank applies the entire SSM regulations to its LSIs, which provides a strong supervisory framework. EU regulatory initiatives on nonperforming exposures (NPEs) helped Irish banks to dramatically decrease the stock of non-performing loans since the 2016. This was complemented by the Central Bank’s actions to ensure fair and transparent treatment of financially distressed borrowers and to ensure that lenders are implementing sustainable long-term solutions. Through these efforts, non-performing loans have been sharply reduced to under 5 percent of total loans.

55. Supervision of LSIs is largely effective in Ireland. The Central Bank’s supervisory approach is intrusive and well-developed supervisory tools are appropriately applied. Supervision has sufficient rigor, and the new IAF, planned for 2022, will allow more efficient enforcement. The supervisory responses to changing conditions are timely and agile. The expertise of supervisors is expanding with the development of the market, although keeping pace is a challenge. The independence of banking supervision is strong in practice, and benefits from the safeguards of the SSM, including methodological support and guidance. Recent efforts to enhance cooperation between prudential and conduct supervision of banks (“One Bank”) has raised the quality of supervision, although further enhancements can be made.

56. Credit risk supervision should be enhanced by the lessons learned during the pandemic. During the pandemic, the Central Bank undertook enhanced monitoring of emerging credit risk and NPLs. This enhanced monitoring should continue, and the Central Bank should engage with banks to draw lessons from the pandemic, to inform a systematic upgrade to monitoring tools and ensure that banks’ reviews of latent credit risks are robust and reflected in credit risk indicators.

Insurance

57. The Central Bank has made good progress in implementing the recommendations from the 2016 FSAP. Credit risk and reinsurance transactions have become key components of the Central Bank’s risk-based supervisory approach. Solvency II—which created an economic valuation regime for assets and liabilities, a risk-based solvency framework, enhanced risk management practices, and greater public transparency—has been fully implemented without any significant frictions. The Central Bank applies a risk-based supervisory framework—the Probability Risk and Impact System in the supervision of insurance firms. This framework sets out the minimum engagement model for supervisors and comprises extensive off-site reviews and on-site inspections. The Central Bank regularly scrutinizes the Own Risk and Solvency Assessment reports of larger insurers.

58. Implementation of International Financial Reporting Standard (IFRS) 17 will be a major operational challenge for insurers. IFRS 17 (effective January 2023), will necessitate substantial efforts by insurers and audit firms to upgrade their accounting frameworks, but its longer-term implications on pricing, product design, asset-liability management, and investment policies still need to be fully understood. The Central Bank should continue to closely liaise with insurers, the Society of Actuaries in Ireland, and audit firms in the final phase of the implementation and monitor the operational risks resulting from underlying changes in data, processes, and systems. Furthermore, it will be critical to develop an understanding of how IFRS 17 might change insurers’ business strategies. The Central Bank should provide enhanced staff training to ensure adequate preparedness for the changes.

59. The Central Bank should continue strengthening its monitoring of the considerable exposures many subsidiaries have to group internal reinsurance or retrocession for capital management. Many cross-border entities have considerable exposure to their parent. The Central Bank undertook a thematic review of intra-group reinsurance in 2020 and is undertaking further work on intragroup transactions and exposures, which is expected to be finalized in 2022. It is recommended that the Central Bank continues strengthening the supervision of intra-group transactions and concentrations, with a focus on post-Brexit group structures, recovery planning, and liquidity risk management.

60. There is scope for the Central Bank to leverage its expertise and experience to promote further EU convergence on insurance oversight. The Central Bank has been very active in policy discussions at the European Insurance and Occupational Pensions Authority (EIOPA) and is well placed to take a leading role in efforts to achieve consistent application of EU legislation; specifically, supervisory convergence on the supervision of cross-border business, the supervision of intra-group transactions and group concentrations, and the supervision of captives.

Market-Based Finance

61. Ireland has made good progress in implementing MBF-relevant recommendations from the 2016 FSAP, but some gaps remain. The EU Money Market Fund Regulation has introduced detailed rules on MMFs, including on liquidity, diversification, and stress testing. This has been complemented by the European Securities and Markets Authority’s stress testing guidelines for Undertakings for Collective Investment in Transferable Securities (UCITS) and Alternative Investment Fund (AIFs). The Central Bank has also strengthened its approach to collection, monitoring and analysis of data on MBF.

62. There is scope for the Central Bank to leverage its expertise and experience to promote further EU convergence on MBF oversight. The Central Bank is well placed to maintain its leading role in the efforts to achieve consistent application of EU legislation on IFs in a manner that strengthens financial stability. The authorities should also build on Ireland’s status as a MMF hub to promote reforms that would materially strengthen resilience of these vehicles, including by decoupling gates and fees from liquidity thresholds and increasing liquidity buffers.

63. Closing data gaps would further enhance the Central Bank’s robust regulation and supervision of the MBF sector. This includes data on delegation of portfolio management, IF credit lines, underlying investors of IFs and leverage in the UCITS sector. This would build on the steps the Central Bank has taken in recent years to broaden the set of data it collects and use it more effectively for the purposes of ongoing supervision and mitigation of systemic risk.

64. The Central Bank should intensify its work to assess and mitigate financial stability risks of MBF. Regulatory action is desirable to broaden the set of liquidity management tools used by Irish IFs and encourage the adoption of tools which result in subscribing or redeeming investors bearing the associated transaction costs, such as swing pricing and anti-dilution levies. The Central Bank should also engage closely with exchange-traded fund providers to ensure their arrangements with authorized participants and market makers are robust and promote the smooth functioning of the sector, including in times of market stress.

65. Finalization of work already under way on IF pricing errors should be prioritized, while oversight of SPEs deserves regulatory and supervisory attention. The introduction of a comprehensive framework for pricing errors will lay the foundation for greater investor protection and more consistent industry practices. Oversight of SPEs has improved from the perspective of statistical analysis, but more efforts are needed to strengthen governance practices. Gaps in the framework for winding-up of IFs should also be filled, including by clarifying the steps to be taken when unit-holders of an IF cannot be contacted.

Financial Safety Net and Crisis Management

66. Since the 2016 FSAP, the authorities have adopted a comprehensive set of new policy, procedure and coordination frameworks for bank resolution and crisis management. While there have been no bank failures during this period, new crisis management frameworks at the interagency and Central Bank levels have been invoked several times in the context of Brexit and the COVID-19 pandemic, leading to enhancements to the frameworks. The authorities have utilized simulation exercises to test and enhance different aspects of their bank failure and crisis management frameworks. This program of testing and enhancement is well institutionalized, overseen at the interagency level by the FSG chaired by the DoF Secretary General and within the Central Bank by the Financial Stability Committee chaired by the Governor. The FSG’s Terms of Reference should be extended to encompass an annual discussion of member agencies’ contingency plans and testing regimes as they relate to systemic bank failures and financial sector crises.

67. The Central Bank’s resolution functions are adequately staffed and resourced. Staffing levels have been increased in response to developments, notably Brexit and the resulting new entry and expansion of regulated firms. A unit in the Central Bank is tasked with guiding the development and testing of bank failure and crisis preparedness arrangements.

68. Recovery planning by banks and oversight by the Central Bank are well advanced. Having been initiated in 2015–16, recovery plans are now quite mature. The requirement for recovery planning has recently been extended to insurers. The Central Bank has extensive powers to take actions to ensure that banks rectify identified weaknesses, including requiring them to implement measures specified in their recovery plans.

69. As throughout the Euro Area, the bank and insurer winding-up and liquidation regime is governed by national insolvency laws. That legal framework in Ireland is sound with respect to banks but has deficiencies with respect to insurers. The legal framework for bank resolution, other than by liquidation, is the Irish transposition of the EU’s 2014 Bank Recovery and Resolution Directive, as amended. At present, there is no comparable legal framework for insurers.

70. The Central Bank has statutory obligations to notify the Minister of certain steps taken with respect to failing banks and must obtain the Minister’s prior consent to take resolution action in limited circumstances.12 The Central Bank and the DoF have agreed a framework promoting effective coordination for bank failures. Government ownership of banks that might be subject to Central Bank resolution action requiring the Minister’s prior consent does, however, give rise to the appearance of potential conflict of interest. Steps to limit the Minister’s consent to circumstances that require the use of fiscal resources should be considered.

71. Unlike in some Euro Area states, the High Court plays a decisive role in the resolution of bank failures whether by liquidation or alternative action. The Court must approve all relevant actions proposed by the Central Bank. The Central Bank has elaborated policies and procedures to facilitate prompt Court petitions and adequate arrangements are in place to mobilize the external experts needed to support it in the process of petitioning the Court and implementing the Court’s orders. Legal amendments to specify a short timeframe for Court decision-making pertaining to resolution powers should be considered.

72. Resolution planning by the Central Bank and within banks is well advanced. Substantial progress has been made in ensuring that banks not likely to be liquidated are able to be effectively and efficiently resolved. The Central Bank has in place detailed policy, procedure, and coordination frameworks for executing winding-up and resolution actions.

73. The authorities have made substantive efforts to propose a resolution regime for insurers and to identify scope for improving the existing insolvency framework for insurers. Adoption of an insurer resolution regime will depend on progress at the European level where an Insurance Recovery and Resolution Directive recently has been proposed, but remedies to the insolvency framework shortcomings can be implemented independently.

74. The Central Bank is developing a structured framework on the use of its early intervention powers and its determination as to whether a bank is likely to fail. Its emergency liquidity assistance (ELA) framework has in recent years been undergoing testing and enhancements and this effort will continue. The DoF is developing an Incident Response Protocol that should complement comparable protocols at the interagency level and in the Central Bank. The Central Bank should adopt policies and procedures for assessing the prospective solvency of a bank undergoing resolution to determine its eligibility for ELA.

Fintech Sector

A. An Evolving Landscape

75. Ireland’s fintech sector is growing through the entry of innovative new players as well as the transformation of incumbents’ business models and products. The largest sub-sector is represented by payment and e-money institutions (PIEMIs), which continues to grow rapidly. Fintech activities are developing on a smaller scale in areas such as insurance and investment management. Meanwhile, the importance of cloud service providers (CSPs), and their interconnectedness with financial institutions, continues to grow.

B. Regulatory and Supervisory Approach

76. The authorities’ approach to fintech seeks to encourage innovation while ensuring prudent oversight of the sector. The Central Bank has an Innovation Hub that provides a single point of contact for stakeholders, experience under which can be used to inform development of the regulatory framework.

77. Most crypto-assets and related services fall outside the scope of existing EU legislation, except for AML/CFT requirements. The Central Bank has issued warnings to consumers on the risks of investing in crypto assets but has not adopted a bespoke regulatory framework. A common EU framework is due to be put in place in H2–2023 via the Markets in Crypto-Assets (MiCA) Regulation. The Irish authorities should continue to contribute actively to the MiCA negotiations, advocate for its earliest possible introduction, and prepare to introduce domestic legislation in the event of significant delay or material gaps in MiCA. Additionally, the Central Bank should, together with its European peers, further intensify its efforts to monitor developments in this area through systematic data collection.

78. There is reliance by Irish regulated entities on a limited number of CSPs. The Basel Principles for Operational Resilience, European Supervisory Authority (ESA) guidelines, and Central Bank guidance provide a strong framework for indirect supervision of CSPs. However, the CSPs themselves—some of which may be systemically important—are not within the regulatory perimeter. The Central Bank should continue to advocate for CSPs of systemic importance to the Irish financial services to be included in the Union Oversight Framework under the EU’s new Digital Operational Resilience Act; failing which, the authorities should seek additional statutory powers to review and examine the resilience of systemic CSPs.

79. Under the EU’s passporting framework, host regulators receive limited information on the activities that passporting entities are carrying out in their jurisdiction. Cross-border activity is typical of many fintechs’ business models. To broaden its knowledge of activities happening in Ireland, the Central Bank should engage with the ESAs on how to expand the information that host regulators receive from home regulators.

80. PIEMIs represent one of the largest and growing sub-sectors within the fintech universe in Ireland. An increasing number of these firms are offering services that are comparable to banking-type services through the provision of e-money wallets, which are not covered by the DGS. The Central Bank has proactively strengthened the governance expectations for this sector informed by best practice corporate governance requirements, such as the Corporate Governance Requirements for Credit Institutions, as well as from supervisory learnings. The Central Bank and the DoF should actively contribute to the review of the EU framework and push for the regime to be strengthened, particularly in the areas of governance and risk management, safeguarding, crisis management, and corporate insolvency. In the absence of such changes forming part of the revised EU legislation, the authorities should work to introduce these reforms at the national level.

81. Incumbent retail banks in Ireland are dedicating significant resources to digital transformation, while fintechs are enlarging consumer choice through innovative services. Progress on several issues could facilitate the modernization of the incumbents’ business models while also allowing relatively new players to fulfil their potential. The Central Bank, working with the Competition and Consumer Protection Commission, should continue its efforts to address IBAN discrimination. The Central Bank, in addition to its primary financial stability mandate, can play an important role in encouraging banks to adopt instant payments and helping consumers realize the full benefits of open banking.

Insolvency and Creditor Rights

82. Ireland has a well-developed legal toolkit for corporate debt resolution, largely in line with international best practice. Examinership is the standard corporate reorganization procedure, although the law also provides for the ability to reach restructuring agreements outside of court, if a qualified majority of creditors agree. A newly-adopted procedure—the Small Company Administrative Rescue Process (SCARP)—allows for a quicker, less court-involved reorganization process than examinership for small and micro-sized companies. Companies may also be resolved via receivership, whereby a receiver takes over the administration of the company on behalf of creditors. Finally, the insolvency regime also provides for liquidation proceedings, both voluntary and compulsory.

83. Despite its sophistication, the corporate reorganization procedure is little-used and costly, and a review of the framework is in order. A review should seek to identify ways to increase use, lower costs, and close gaps with the international insolvency standard. Policy makers should also consider creating a hybrid procedure to complement examinership, with limited judicial intervention, subject to constitutional constraints, consistent with the spirit of the EU Directive on Preventive Insolvency. While SCARP is a welcome development, key aspects—such as the ability of public creditors to opt out—may limit its effectiveness. The authorities should monitor SCARP’s implementation and revisit the law as experience is gained and data is collected. Data on corporate insolvency procedures is scarce. Collecting and publishing meaningful data would support more effective analysis and inform policy. The institutional framework would benefit from dedicating more judges to insolvency-related matters. Modernization programs to support electronic filings and remote hearings should be intensified.

84. While mortgage-backed arrears in Ireland are largely a legacy of the GFC, they still constitute almost one-half of all NPLs in the retail banks. LTMA pose a challenge to the effectiveness of the overall system for debt resolution and creditors’ rights, and failure to fully resolve these arrears has the potential to undermine credit growth and affordability, given the impact on credit risk of uncertainty of realizing collateral. The authorities have pursued a multi-faceted strategy over the last decade to resolve LTMAs, however, further efforts are needed.

85. A key hindrance to creditors’ rights remains the inability to predictably and efficiently enforce mortgage security on primary dwelling homes. Repossession is not the optimal solution for many distressed borrowers and resolution of LTMAs necessitates further engagement from both borrowers and lenders. A more efficient enforcement regime is crucial to an effective creditors’ rights system. Accordingly, enforcement should be streamlined and simplified. Recommendations to improve the process include clear rules and guidelines for judges with respect to proceedings and ensuring hearings take place in a timely manner (e.g., through more frequent court sessions). The courts should also strengthen data collection and publication on repossession cases to better understand and address potential bottlenecks.

86. More broadly, the Government should adopt a coordinated, multi-agency strategy for resolving mortgage arrears. Such a strategy should be informed by the data on borrowers’ financial situation and debt servicing capacity. Consideration should be given to publishing more granular guidelines on solutions that creditors offer to borrowers, based on capacity to repay parameters. Broader social housing would also reinforce such an approach, given that many borrowers may lack capacity to repay, even if meaningful restructuring solutions are offered. Personal insolvency can also play a role, by ensuring that court-approved mortgage repayment plans provide sustainable solutions.

Financial Integrity

87. Ireland faces increasing money laundering threats from foreign criminal proceeds. As a fast-growing international financial center, Ireland is exposed to inherent transnational ML/TF risks from illicit proceeds of foreign crimes. The authorities have demonstrated a deep and robust experience in assessing and understanding their domestic ML/TF risks but to a lesser extent of transnational ones. Conducting a thematic risk assessment focusing on non-resident and cross-border ML/TF risks would improve the understanding of transnational ML/TF risks and inform AML/CFT policy priorities.

88. Priority should be given to enhancing the risk-based supervision of banks focusing on cross-border activity. The Central Bank has a comprehensive and well-designed AML/CFT supervisory approach with a depth of engagement determined by an entity’s overall risk rating. Given the considerable expansion of the financial sector, an augmentation of resources and skills would be necessary to maintain the depth of supervisory engagement. Since 2017, the Central Bank broadened access to data from supervised entities, but collection of cross-border data and use of analytical tools, such as machine learning and big data, can be improved. Desk-based and on-site inspections, while robust, should be reassessed to ensure that they adequately reflect the risks of the fast-growing entities, with significant increase in cross-border financial flows. The Central Bank has a broad enforcement toolkit and should continue to vigorously pursue enforcement actions, in line with compliance breaches and risk-levels.

89. The commencement of the registration process of virtual asset service providers (VASPs) is a welcome move. The Central Bank is seeing a significant number of VASP applications and expects a high volume of transactions in the sector. The Central Bank has not yet commenced active supervision of the sector; however, a comprehensive assessment of applicants is undertaken as part of the registration process. The Central Bank should invest in developing supervisory tools for the sector and increase resources commensurate with risks.

90. Efforts to raise awareness of key ML/TF risks for lawyers, accountants and Trust and Company Service Providers (TCSPs)—professional gatekeepers—are positive developments, however, supervision of these sectors is fragmented, undermining effectiveness. The AMLCU and self-regulatory bodies continue to take extensive efforts to improve the understanding of TCSPs of their AML/CFT obligations. The recently published risk assessment of the TCSP sector is a welcome move and should inform supervisory engagement with the sector. Fragmentation leads to inconsistent supervision and the potential for regulatory arbitrage, particularly in the accountancy sector. Further, enhancing the enforcement toolkit, through the power to impose administrative fines could also help improve supervisory outcomes.

91. Ireland has taken an important step forward with the creation of three beneficial ownership registries (BOR) in 2019–20 for companies, trusts, and certain financial vehicles. A sectoral risk assessment for legal persons and legal arrangements was published in 2020, which showed a significant risk of money laundering, particularly for entities with complex ownership structures. The Pandora Papers also recently highlighted potential misuse of limited partnerships. Although significant efforts have been made to collect the information, the BORs should ensure registration is accurate, complete, and up-to-date. Professional gatekeepers should assist in improving the quality of information, sharing any discrepancies found during their customer due diligence activities.

Authorities’ Views

92. The authorities welcomed the FSAP, reflected in their open and constructive engagement with the IMF team throughout the process. They appreciated the IMF’s extensive work and engagement with a wide range of stakeholders and valued the insights provided by an external, in-depth assessment of the resilience of the financial sector and the overall framework for financial sector oversight and crisis management in Ireland. More broadly, the authorities are strongly supportive of the FSAP as a global financial stability tool.

93. Overall, the authorities broadly agreed with the IMF team’s assessments and recommendations. They welcomed the IMF’s positive endorsement of Ireland’s continued progress in strengthening regulation, supervision, and crisis management since the last FSAP in 2016, aided by its active collaboration and engagement with the ECB/SSM, the Single Resolution Board and, more broadly, the ESFS. They noted that their determined efforts to bolster financial sector oversight and crisis preparedness have proven their value recently, with the financial sector remaining resilient through the shocks stemming from Brexit and the pandemic. Looking ahead, as Ireland’s financial sector continues to grow in size, complexity, and interconnectedness, the authorities acknowledged the importance of ensuring that the regulatory framework and supervisory capacity keep pace with the evolving landscape. Furthermore, work on continuing to strengthen the AML/CFT framework is a priority, including in respect of cross-border activity, as European and international AML/CFT standards continue to be enhanced as part of ongoing efforts to more effectively combat ML/TF. The authorities welcomed the FSAP’s recognition of Ireland’s demonstrated commitment to cross-border collaboration on financial sector oversight and regulation. They noted that several areas of focus of the FSAP team, including in relation to market-based finance or fintech, require effective regulatory co-ordination at a European and global level. In that context, the authorities underscored their commitment to continue driving work with European and international counterparts, including in relation to extending macroprudential oversight to the market-based finance sector. The authorities indicated their intent to follow up on the FSAP recommendations and agreed to publish the FSSA and the Technical Notes.

94. The authorities welcomed the work and recommendations across the technical workstreams, which were tailored to Ireland’s needs. The authorities welcomed the insights of the IMF team’s risk assessments, which had shown that Irish banks and insurance companies are resilient to possible future adverse shocks. The authorities also acknowledged the importance of addressing the remaining legacy issues from the GFC on the retail banks and completing government divestiture. They noted that further efforts are being undertaken to enhance supervisory powers regarding individual accountability and to conduct further deep dive analysis on the market-based finance sector, including its domestic and global interlinkages. The analysis on insolvency and creditor rights provided helpful insights and recommendations for efforts to raise the efficiency of collateral recovery that would have the potential to benefit the economy as a whole. The authorities also welcomed the FSAP’s focus on managing climate-related risks to the financial sector, consistent with their own focus and plans to implement a sequenced work program in this area.

Table 2.

Ireland: Selected Economic Indicators

(Percentage change, unless otherwise indicated)

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Sources: CSO, DoF, Eurostat, and IMF staff estimates and projections.

The reported real GDP growth is changed to non-seasonally-adjusted (NSA). The annual SA versus NSA differences in 2018–2020 arise principally due to the lumpy, irregular pattern of IP Imports over the past three years.

IFSC indicates international financial services.

Nominal GNI* is deflated using GDP deflator as proxy, since an official GNI* deflator is not available.

Table 3.

Ireland: Financial Soundness Indicators

(In Percent)

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Source: IMF Financial Soundness Indicators.
Table 4.

Ireland: Financial Sector Structure

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Source: Central Bank of Ireland.Notes: “Banks” category inlcudes credit unions and other banks. “Incurance Co. and Pension Funds” includes 186 insurance companies and 123,122 pension funds.

Appendix I. Status of Key Recommendations of 2016 FSAP

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“NT-near-term” denotes up to 2 years; “MT-medium-term” denotes 2–5 years.

Appendix II. Ireland Risk Assessment Matrix

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Appendix III. Banking Sector Stress Testing Matrix (STeM)

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Appendix IV. Insurance Sector Stress Testing Matrix (STeM)

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Appendix V. Investment Fund Liquidity Stress Testing Matrix (STeM)

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1

Close to 83 percent of the total financial sector assets.

2

See the FSB Principles for Sound Compensation Practices for guidance on best practice in this area.

3

The government stake in Bank of Ireland has been drawn down to under 4 percent at end-May 2022. The government owns 69 percent of Allied Irish Bank and 75 percent of the smaller Permanent TSB. NatWest will take a 16 percent stake in PTSB, diluting government’s stake to 62 percent.

4

Estimated at 5th percentile.

5

However, non-resident deposits have declined significantly since the GFC (by 65 percent), therefore their systemic relevance has been reduced.

6

For details, see the Risk Assessment Matrix (Appendix II).

7

The baseline scenario reflects staffs view on the impact of war in Ukraine as of March 2022.

8

When measured against historical means, shocks to GDP and GNI* are equivalent to 2.1 and 2.4 standard deviations, respectively.

9

Hurdle rates considered for the adverse scenario are: (i) CET1:4.5 percent plus O-SII buffer; (ii) Tier 1: 6.0 percent plus O-SII buffer. Capital Conservation Buffer (currently at 2.5 percent) is considered useable in the adverse scenario, hence not included in the hurdle rate.

10

Due to data limitations, the network only covers large exposures of the sample banks.

11

NBFIs account for around 30 percent of new lending to SMEs.

12

Where it is likely to have systemic implications, creating a serious risk to the stability of the financial system or the economy of the State, or where it would have a direct fiscal impact.