Irish financial system

Short-term risks to the Irish financial system remain high. The international financial environment has experienced tighter credit, rising forbearance, capital flight from some vulnerable euro area countries and, especially for these countries, a diminishing pool of unencumbered assets to draw from for collateralised borrowing. Monetary policy has been eased aggressively by many central banks and unconventional policies are being pursued. This has reduced tail risks and volatility in financial markets, but investor sentiment, banking-sector resilience, and access to market funding all remain fragile.
Financial market uncertainty fell during the second half of 2012 but options-implied stock-market volatility in the euro area remains relatively high compared with US levels (Chart 25).

Notes: Chart shows weekly observations for the S&P 500 volatility index
(VIX), Euro Stoxx 50 volatility index (VSTOXX). Each volatility index is a
measure of expectations of stock-market volatility (over the next 30
days) derived from stock-index option prices.

Concerns about euro area sovereign indebtedness continue to dominate regional and, to a large extent, international market sentiment. Large scale conventional and unconventional monetary policy measures have alleviated some market stresses including redenomination risk.

Notes: Chart shows the probability that the Danish krone will strengthen
outside its present exchange-rate band against the euro in one year's
time. This risk neutral probability reflects in part market assessments of
a sharp depreciation in the value of the euro and-or redenomination.
The probability is estimated using euro-Danish krone forward rates and
implied volatility estimates derived from options markets.

 Irish banks remain without access to senior unsecured term debt markets due in part to concerns over domestic loan portfolios. The ability of euro area banks to raise funds more generally
remains impaired due to concerns surrounding loan portfolios and regional economic weakness. Turnover of unsecured debt in the euro area fell to its lowest level on record in the second quarter of 2012 according to survey data compiled by the ECB. In the absence of unsecured funds, euro area banks have resorted to secured funding. As banks pledge more of their assets to creditors in these deals, however, they are left with fewer free assets ("asset encumbrance"), heightening concerns about their ability to repay other debts.
Demand for low-credit-risk assets has increased while creditrating downgrades of formerly triple-A rated countries has reduced the supply of these assets. This, combined with central bank policy measures, has compressed yields on US and German sovereign bonds, traditional safe-haven assets, to record lows in July. Record high corporatebond returns and increased flows into international high-yield bond funds suggest risk appetite is rising and requires close monitoring.