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IMF Country Report No. 22/241

IRELAND

FINANCIAL SECTOR ASSESSMENT PROGRAM

TECHNICAL NOTE ON FINANCIAL INTERCONNECTEDNESS OF THE MARKET-BASED FINANCE SECTOR

July 2022

This paper on Ireland was prepared by a staff team of the International Monetary Fund as background documentation for the periodic consultation with the member country. It is based on the information available at the time it was completed on June 17, 2022.

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Title Page

IRELAND

FINANCIAL SECTOR ASSESSMENT PROGRAM

June 28, 2022

TECHNICAL NOTE

FINANCIAL INTERCONNECTEDNESS OF THE MARKET-BASED FINANCE SECTOR

Prepared By

Monetary and Capital Markets Department

Contents

• Glossary

• EXECUTIVE SUMMARY

• MARKET-BASED FINANCE IN IRELAND—AN OVERVIEW

• A. Overview

• B. Scope of the Technical Note

• FINANCIAL INTERCONNECTEDNESS FROM A NETWORK APPROACH

• A. Introduction

• B. A Bird’s Eye View of the Irish Financial Network

• C. Key Interlinkages in the Irish Financial Network

• D. The Evolution of Domestic Interlinkages

• INVESTMENT AND MONEY MARKET FUND BALANCE SHEET EXPOSURES

• A. Introduction

• B. Stability Metrics and Domestic Linkages of Funds

• C. Fund Balance Sheet Exposures to Banks, the Real Sector, and OFIs

• D. Fund Exposures to Commercial Real Estate

• FIGURES

• 1. A Comparison of Fund Assets by Country

• 2. The Irish-Domiciled Market-Based Finance Sector

• 3. Composition and Change Over Time of the Irish Financial Sector

• 4. Linkages between Funds, Other Non-Banks, Banks, and the Real Sector in Ireland

• 5. Cross-Sectoral Assets and Liabilities

• 6. Evolution of Domestic Claims and Liabilities vis-à-vis Irish Funds

• 7. Network Assets as Share of Total Assets and Network Instrument Composition

• 8. Adjacency Matrices of Total Network Exposures in 2020Q4

• 9. Layer-by-Layer Financial Networks in 2020Q4

• 10. The Evolution of the Domestic Loans Network

• 11. The Evolution of the Domestic Debt Security Networks

• 12. Composition of Irish Fund Assets by Investment Strategy

• 13. Irish Fund Liquidity and Leverage Metrics

• 14. Domestic and Cross-Border Exposures of Irish Funds

• 15. Sectoral Composition of Irish Funds Claims on Irish-Domiciled Entities

• 16. Irish Funds Exposures to Banks by Type of Fund

• 17. Irish Funds Exposures to the Real Sector by Type of Fund

• 18. Irish Funds Exposures to Other Financial Institutions by Type of Fund

• 19. Change Over Time in Irish Funds Exposures to Banks and the Real Sector

• 20. CRE Security and Property Assets of Irish Funds

• 21. Trend of Real Estate Fund Assets

• 22. Commercial Real Estate Holdings and Financing of Property Funds

• 23. Irish Funds and Banks Exposures to Irish Commercial Real Estate

• TABLE

• 1. Main Recommendations on Interconnectedness of Market-Based Finance

• APPENDICES

• I. Definitions of the Network and Balance Sheet Sectors

• II. Mapping Between the Network and Balance Sheet Datasets

• III. Properties of Nodes in the Financial Network

• IV. Financial Network Connections in 2015 and 2020

• V. Relative Claims and Obligations Matrices in 2020

• VI. Trends in Irish Funds by Legal Classification

• VII. Instrument Composition of Irish Funds Balance Sheets

Glossary

Executive Summary

This technical note¹ investigates the interconnectedness between the market-based finance (MBF) sector in Ireland and the rest of the financial system, with a view to assessing potential financial stability risks. The MBF sector, the largest component of the financial system, totals over 14 times GDP and is comprised of the funds sector—both money-market (170 percent of GDP) and investment funds (850 percent of GDP)— as well as other financial institutions (OFIs), which comprise of special purpose entities (SPEs, 240 percent of GDP) and a catch-all category entitled “OFI residual” (160 percent of GDP). Chapter I provides an overview of the potential financial stability risks associated with the MBF sector, with a focus on the funds sector, and places it in its domestic and global context. Chapter II maps out the interlinkages between the non-banks, banks, and the real sector using network analysis to assess the strength and direction of interconnectedness. Chapter III delves into the balance sheet exposures of major categories of Irish funds, the largest component of the MBF sector, to further assess channels of risk transmission. The analysis focuses on a network of complex inter-sectoral financial relationships, based on a range of lending and borrowing instruments, and several findings emerge.

Ireland has made good progress in implementing the recommendations from the 2016 FSAP, but some important data gaps remain to be closed. While many linkages between the domestic economy and the MBF sector have been analyzed, challenging data gaps and opaque linkages relating to the OFI residual should continue to be explored through ongoing cooperation at a domestic and international level. The Central Bank of Ireland (CBI) has made significant strides in the collection, monitoring, and analysis of data on MBF and improved its regulation of funds. CBI has also made progress on closing data gaps as recommended by the previous FSAP, including improving visibility on the underlying investor base in funds, reducing the size of the OFI residual, collecting information on the business models of SPEs, and researching on the use of leverage in funds. However, the CBI’s fund stress-testing model remains under development and there remain some gaps in terms of granular data collection and analysis of the interconnectedness and composition of the significant activity of the remaining OFI residual.

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 around 4 percent of GDP. Households do not have liabilities to the funds, and their claims on funds, which comprise of their holdings of fund shares, stand at less than 1 percent of GDP. As such, these linkages appear to pose relatively lower risk.

• Second, in contrast, Irish funds have significant interlinkages with OFIs resident in Ireland, as part of Ireland’s large, internationally-oriented financial sector. The OFI sector consists of SPEs and the OFI residual, which includes entities that engage in non-bank financial intermediation. 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. While there has been good progress in understanding the links between funds and SPEs, the nature, business rationale, and riskiness of many fund exposures to entities in the OFI residual sector are not fully transparent.

• Third, OFIs – while largely internationally focused – also have significant linkages to the domestic economy. OFI financial assets and liabilities are sizeable, at 250 and 270 percent of GDP², respectively. 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. OFIs hold deposits in domestic banks totaling 12 percent of GDP (about 7 percent of total bank deposits) and SPE loans to Irish households total 12 percent of GDP, or more than 30 percent of the household loan stock. SPE loans to Irish NFCs total about 15 percent of GDP, or about 10 percent of the NFC loan stock.³ A subset of those SPEs engage in new lending to the economy. Depending on their funding model, SPEs that engage in new lending to the local economy could potentially amplify financial cycles in Ireland and make the economy more vulnerable to global financial shocks. Beyond SPEs, granular balance sheet risk metrics for entities in the OFI residual sector do not currently exist.

• Fourth, funds and banks have common exposures to the domestic commercial real estate (CRE) sector, which represents a potential channel of contagion. The CBI has conducted in-depth analysis of these links, supplementing supervisory data with a deep-dive survey of property fund activity. It has also consulted on macroprudential measures to guard against potential financial stability risks from the property fund sector. This reflects the fact that property funds hold a material share of the outstanding stock of commercial real estate, and so represent a key direct channel of interlinkages between the broader funds sector and the real economy. Data on the extent of cross-border and non-bank lending to the CRE sector could be improved. Given the common exposures of multiple financial sub-sectors, shocks to the CRE market could pose risks to the financial system and lead to adverse feedback to the domestic economy through a contagion channel.

The analysis suggests that, notwithstanding progress, 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, to explore further areas of potential systemic risk. A key area of risk lies in the opacity and lack of granular data on financial transactions of entities in the OFI residual sector. Based on the analysis, the FSAP makes eight recommendations for the authorities.

Table 1.

Ireland: Main Recommendations on Interconnectedness of Market-Based Finance

^*C = Continuous; I = Immediate (within one year); ST = Short Term (within 1-3 years); MT = Medium Term (within 3-5 years).

^**H = High; M = Medium; L = Low.

Table 1.

Ireland: Main Recommendations on Interconnectedness of Market-Based Finance

#	Recommendations	Addressee	Timing*	Priority**
1.	Disaggregate the OFI residual into foreign controlled versus indigenous entities to better understand linkages to the domestic economy. (¶22)	CBI, CSO	MT	M
2.	Deepen understanding of the risks and vulnerabilities associated with loans between SPEs and NFCs and from SPEs to SMEs and households. (¶30)	CBI, CSO	ST	H
3.	Intensify the collaboration between the CBI, the CSO, and international regulators on the nature of the OFI residual linkages to the domestic economy. (¶33)	CBI, CSO	MT	M
4.	Conduct risk analysis of the OFI residual at a granular balance sheet level. (¶34)	CBI, CSO	MT	M
5.	Conduct more deep-dives to further enhance the monitoring of risks of sub-segments of the funds sector. (¶50)	CBI	ST	H
6.	Conduct further in-depth analyses of the indirect linkages of the funds sector to the domestic economy, with a focus on funds’ claims on the SPEs and OFI residual sectors. (¶63)	CBI	ST	H
7.	Ensure sufficient resources at the CBI MBF unit to allow it to monitor developments and conduct the analyses recommended in this technical note. (¶64)	CBI	MT	M
8.	Reduce the remaining data gaps in the non-bank lending and cross-border financing to the CRE sector. (¶72)	CBI	MT	M

^*C = Continuous; I = Immediate (within one year); ST = Short Term (within 1-3 years); MT = Medium Term (within 3-5 years).

^**H = High; M = Medium; L = Low.

View Table

Table 1.

Ireland: Main Recommendations on Interconnectedness of Market-Based Finance

#	Recommendations	Addressee	Timing*	Priority**
1.	Disaggregate the OFI residual into foreign controlled versus indigenous entities to better understand linkages to the domestic economy. (¶22)	CBI, CSO	MT	M
2.	Deepen understanding of the risks and vulnerabilities associated with loans between SPEs and NFCs and from SPEs to SMEs and households. (¶30)	CBI, CSO	ST	H
3.	Intensify the collaboration between the CBI, the CSO, and international regulators on the nature of the OFI residual linkages to the domestic economy. (¶33)	CBI, CSO	MT	M
4.	Conduct risk analysis of the OFI residual at a granular balance sheet level. (¶34)	CBI, CSO	MT	M
5.	Conduct more deep-dives to further enhance the monitoring of risks of sub-segments of the funds sector. (¶50)	CBI	ST	H
6.	Conduct further in-depth analyses of the indirect linkages of the funds sector to the domestic economy, with a focus on funds’ claims on the SPEs and OFI residual sectors. (¶63)	CBI	ST	H
7.	Ensure sufficient resources at the CBI MBF unit to allow it to monitor developments and conduct the analyses recommended in this technical note. (¶64)	CBI	MT	M
8.	Reduce the remaining data gaps in the non-bank lending and cross-border financing to the CRE sector. (¶72)	CBI	MT	M

^*C = Continuous; I = Immediate (within one year); ST = Short Term (within 1-3 years); MT = Medium Term (within 3-5 years).

^**H = High; M = Medium; L = Low.