The risk of large-scale instability in the Irish financial system is higher now than it was a year ago, according to a new report by the Central Bank.
The capacity of the Irish financial system to absorb major shocks is "robust" and the exposure of Irish banks to the US subprime crisis is "negligible", the financial stability report finds.
But the turbulence in international money markets since August has more than cancelled out an easing in the main domestic risks, such as spiralling house prices, strong credit growth and soaring rates of personal debt, that were threatening to destabilise the Irish banking this time last year.
Sharp falls in the share prices of Irish banks yesterday pushed the value of the Iseq index to its lowest point in 17 months, as Bank of Ireland said a less favourable global economic backdrop and ongoing volatility in financial markets would lead to more moderate earnings growth.
Although Irish banks have little or no exposure to the subprime crisis, either directly or through "conduit" investment funds, the growing likelihood is that the subprime crisis will result in a significant slowdown in the US economy - and that could drag down economic activity in the Republic.
The decline in housing activity and a deterioration in competitiveness relative to our trading partners also pose risks to the Irish economy, the bank said.
Central Bank governor John Hurley welcomed the slowdown in house prices and said the underlying fundamentals of the residential market continued to be "reasonably strong".
Levels of indebtedness in the Republic continue to be high by international standards, but the annual rate of growth in private-sector credit and mortgage credit has almost halved since early 2006.
Mr Hurley also welcomed the recent easing in the pace of capital appreciation in the commercial property market. The bank had been concerned that capital values were moving out of line with rents, giving rise to unprecedented low yields.
In times of financial stress, it is exposure to the volatile commercial property that leads to the greatest credit losses for the banking sector.
Based on the usual measures of financial health such as asset quality, profitability solvency, liquidity and credit ratings, Irish banks are well-placed to withstand adverse economic and banking sector developments in the short to medium term, the financial stability report concludes.
But Mr Hurley said that he expected the current difficulties in credit markets would continue into next year.
Activity in the interbank (or wholesale funding) market remains well below normal and is likely to revert to earlier levels only when a greater degree of confidence returns to the market.
"It may take some time before such confidence returns," Mr Hurley said.
Since 2003, Irish banks have become steadily less reliant on interbank money to fund the loans they give to customers and have instead increased the proportion of funding sourced from debt securities, which tend to have longer maturities.
Traditional banking activities have been "highly profitable" for Irish banks in recent years, meaning they have not needed to chase profit through hedge funds or the subprime sector to the same extent as their international counterparts, according to Central Bank economist Gavin Doheny.
