Irish Banks Face Wake-Up Call with Rising Interest Rates

Irish banks are urged to stay vigilant and prepared as rising interest rates pose financial risks. Learn more about the challenges they face in this wake-up call.

In the face of fluctuating interest rates that are affecting economies worldwide, Irish banks have received a stern warning from the national regulator to not be complacent. Recognizing the potential financial risks inherent in such unpredictable economic situations, the regulator has urged banks to remain proactive, vigilant, and adequately prepared for the challenges that may arise due to increasing interest rates.

Research conducted by the Central Bank has shed light on a slower response from banks in adjusting European Central Bank (ECB) policy rate changes to new mortgage rates and household deposits. The strength of monetary policy transmission is being observed by analyzing the extent to which changes in bank interest rates affect various loan and deposit products in the euro area, including Ireland. As economies grapple with an extraordinary episode of inflation, monetary policy measures are being implemented to bring inflation back in line with the 2% target set by the Eurosystem. Since July 2022, key ECB interest rates have experienced a rise of 425 basis points. One channel through which monetary policy is transmitted to the economy, and subsequently to inflation, is the interest rates set by banks on loans and deposits. This channel is expected to strengthen in the coming months.

While retail interest rates for both firms and households have seen increases corresponding to changes in key ECB policy rates, there are variations across loan and deposit products as well as among different countries within the euro area. In the case of Ireland, the pass-through of interest rates to household deposits and new mortgages has been weaker compared to the euro area as a whole. Several factors contribute to this, including the relatively abundant deposit base of the Irish retail banking system and the competitive dynamics within the banking services market. The effective transmission of ECB monetary policy to the domestic economy through the banking system is vital in combating inflation, and it is expected that this channel will strengthen in the months ahead.

As inflation exerts considerable pressure on the global economy, the Irish financial system faces increased risks. Despite these challenges, the Irish economy has demonstrated resilience. The financial services regulator has affirmed the resilience of the Irish banking system amidst recent turbulence and its ability to absorb potential future shocks. However, certain segments of the non-bank financial intermediation sector may be more vulnerable. In response, the Central Bank has announced an increase in the countercyclical capital buffer (CCyB) to 1.5 percent. This time-varying capital requirement aims to enhance the resilience of the banking system to cyclical risks and ensure sustainable credit provision to the economy.

While many households and businesses are grappling with the cost of living crisis, they have shown resilience thus far in the face of inflationary shocks. Nevertheless, some borrowers may encounter difficulties, and it is likely that banks will continue to experience higher levels of profitability. On average, Irish households have significantly reduced their debt levels over the past decade. However, specific groups, such as lower-income households, may face increased financial strains. Despite signs of resilience in the domestic economy and a particularly tight labor market, the Irish economy remains vulnerable to the risks of persistent inflation and an economic slowdown, which may expose vulnerabilities. Therefore, Irish banks are strongly urged to remain vigilant and proactive, keeping in mind the potential risks and challenges that may arise as a result of rising interest rates.

In conclusion, Irish banks are being cautioned against complacency in the face of rising interest rates and the associated risks. The Central Bank has emphasized the need for vigilance, proactivity, and preparation to tackle the challenges that may arise. Ensuring the effective transmission of ECB monetary policy through the banking system is crucial in addressing inflationary pressures. While the Irish financial system has exhibited resilience, certain sectors may face vulnerabilities, necessitating strategic measures to mitigate risks. As households and businesses navigate the cost of living crisis, potential difficulties may arise, and banks should be mindful of these challenges. By remaining attentive and proactive, Irish banks can navigate the impact of rising interest rates effectively.