IRISH FINANCIAL institutions remain robust and capable of absorbing shocks, the governor of the Central Bank said yesterday.
Results of regular stress-testing of the banking sector indicate that the sector has the capacity to weather a significant slowdown, John Hurley said.
Addressing the Institute of Internal Auditors, Mr Hurley said one of the points that had emerged from analysis of the international crisis was that firms that had rigorous internal processes for the valuation of complex or potentially illiquid products had performed better during the recent turmoil.
He said Irish banks had been insulated from the global trends that have led to the current international banking crisis by the recent exceptional performance of the Irish economy.
Irish banks' liquidity arrangements were good and they were well positioned to access central bank funding, he said.
Low interest rates internationally have created a downward pressure on profit margins in traditional banking activities, he said, prompting banks to invest in new products without taking on board the risks inherent in them. These new products included assets that consisted of pools of US subprime mortgages, Mr Hurley said.
There was also a move towards the use of more volatile wholesale funding sources.
"Irish banks shared the experience of their international peers in that margins on traditional business had fallen over the longer term. However, because of the high level of demand in Ireland, profitability was maintained without recourse to investing in structured products or conduits.
"The re-pricing of risk in international financial markets and the associated turmoil was triggered in mid-2007 when international investors became nervous about the underlying value of their investments in assets that consisted of pools of US subprime mortgages."
The problem in time spilled over into the interbank market. "Term premia are expected to remain elevated for some time because of wider problems in the financial system such as uncertainties regarding the valuation of complex products, counterparty mistrust and continuing uncertainty about the ultimate location of mounting losses on assets linked to the US subprime residential mortgage sector."
The difficulties in the US have spilled over into the global economy. Many observers, he said, are of the view that the US economy "may experience little or no growth for some time".
While euro zone economic growth is expected to continue to expand "the risks to this outlook would appear to be on the downside". Food and energy price increases have impacted on inflation, with the harmonised euro zone rate now well above 3 per cent. "The headline rate is expected to moderate gradually over the course of the year, but the risks to the outlook are clearly on the upside," he said.
