Consolidation in the banking sector and the centralisation of European equity markets may leave the Republic without an indigenous financial industry, the governor of the Central Bank, Mr Maurice O'Connell, warned yesterday.

Welcoming the Irish Stock Exchange's decision to adopt the Deutsche Borse electronic trading system, Mr O'Connell said centralisation was not inevitable. He warned, however, that it would happen if no measures were taken to counteract it.

"There is a distinct possibility that small markets could wither and fade away as investors move to the centres of greater liquidity. This is probably the greatest threat to the Irish financial services industry," he said.

Mr O'Connell said he hoped a "vibrant indigenous sector" could face the challenge of new competition in banking. "Despite the advent of the single currency, it does matter that we continue to have an Irish financial industry where the major decisions are taken here," said Mr O'Connell.

"The merger of Deutsche Bank and Dresdner Bank is a reminder of the forces at work that may leave us without an indigenous financial industry," he said.

Addressing a UCD conference organised by the monthly publication Finance Dublin, Mr O'Connell said the IFSC had reached the point of critical mass. This meant the centre would grow of its own accord "as long as the environment is right".

"If, at any time in the future, the environment is not right, if there are better opportunities elsewhere, the centre will suffer," he said.

"The banking sector has been through a torrid time, with the ongoing inquiries into taxation abuses. These issues, however, belong in the past and I believe that today we have a very compliant financial industry generally."

Mr O'Connell confirmed that the Central Bank had initiated "stress testing" at mortgage lending banks and building societies. "It helps to alert the lending institutions to the potential consequences of a shock to the economy," he said.

While stress testing had attracted "exaggerated comment", this was an integral part of regulation and was not intended as a "panic button" measure.

Mr O'Connell said the International Monetary Fund (IMF) had undertaken a "large scale" assessment of the Central Bank's control systems, at the bank's invitation. "It was essentially a pilot exercise, as the IMF seeks to extend its role as the guardian of financial stability," he said.

Mr O'Connell said he was unable to disclose the IMF's findings, but declared the Central Bank "very satisfied" with them.