The Central Bank has directed lenders in the Republic to hold additional capital from next year in order to protect them from a sudden downturn.
The regulator said that banks must hold the equivalent of 1 per cent of risk-weighted assets as a so-called countercyclical capital buffer (CCyB) from July 2019, though it noted that the sector currently has enough surplus capital to absorb the increase.
The buffer applies not only to domestic banks, but the Irish loan portfolios of European-regulated institutions.
"As a small, open economy vulnerable to a range of external risks, the CCyB is an important tool to promote a more stable financial system that is less prone to boom-bust cycles," said Central Bank governor Philip Lane, adding that the measure complements other "macroprudential measures", such as mortgage limit rules introduced in 2015.
Central banks and regulators across the EU have been obliged since the start of 2016 to make lenders ringfence funds as a CCyB when they judge that credit growth is becoming excessive. The buffers are in addition to normal capital reserve demands, and are part of a raft of new rules designed to avoid a future crisis.
For example, Sweden has told its banks to set aside a capital buffer of 2 per cent of risk-weighted assets since March, and the UK is targeting a rate of 1 per cent by the end of this year.
While the State's largest lenders, Bank of Ireland and AIB, have only this year begun to see their underlying loan books start to grow again following massive contraction following the 2008 financial crash, the Central Bank said that academic research supports the case for moving early in the economy cycle to ensure that a buffer is available for future downturns.
“While aggregate credit growth is close to zero, continued deleveraging in the SME and buy-to-let sectors obscured positive growth in home loans, consumer lending and loans to large enterprises,” the Central Bank said.
The bank said that the high level of Irish householders and overhang of nonperforming loans on the balance sheets of banks increases the vulnerability of the Irish financial system to shocks.
It also noted that Irish home prices are now “roughly in line with economic fundamentals,” after rebounding by 76 per cent from their lows in 2013. “Accordingly, the cyclical risk of house prices moving ahead of fundamental values is now more elevated than in recent years,” it said.
