Central Bank Report sets out its key risks and supervisory priorities

On 29 February 2024, the Central Bank of Ireland (the Central Bank) published its Regulatory & Supervisory Outlook 2024 (the Report), against what the Central Bank describes as “the backdrop of an increasingly fast-changing and uncertain world”.

The Report gives the Central Bank’s perspective on the key risks facing the entities it regulates and the investors whose interests it seeks to protect and sets out the Central Bank’s regulatory and supervisory priorities for the next two years.

The Report also provides a sector by sector view of trends, risks and vulnerabilities and chapters covering two topics of particular note at the present time, namely

• artificial intelligence (AI), which the Central Bank regards as “one of the technologies with the greatest transformative potential for the entities the Central Bank supervises and for the Central Bank itself as regulator” and

• financial crime, which the Central Bank sees as increasingly prevalent across the whole financial system and society.

On the global macroeconomic side, the outlook is one of economic and financial market uncertainty, geopolitical tensions and regional conflicts and it continues to be shaped by the adjustment of the global economy to higher interest rates, with tighter financial conditions leaving financial markets and asset prices vulnerable to disorderly corrections.

Structural forces, such as climate change and technological innovations, are bringing fundamental changes to our world, as well as its financial system.

Risk Areas

The Central Bank covers a wide range of sectors, each with their own dynamic but subject to a common global and domestic risk landscape.

The Report focuses on eleven key Risk Areas, within three broad, but interconnected, thematic headings.

These are:

Risk Theme A

Risks predominantly driven by the macroeconomic and geopolitical environment

1. Interest rate and inflation risks
   Regulated entities and consumers continue to be impacted by the adjustment to higher interest rates and more volatile inflation, with financial resilience being tested in some sectors.

2. Asset valuation and market risks
   The uncertain economic outlook increases the risk of further volatility of financial markets and valuation adjustments across asset classes, including commercial real estate and other illiquid assets.

3. Liquidity and leverage risks
   The balance between demand for, and supply of, liquidity can change very quickly which can lead to consequences that cascade across regulated firms, investment funds and the wider financial system. Recent stress episodes have shown how excessive leverage and inadequate liquidity preparedness can amplify stress in the wider financial system.

4. Credit and counterparty risks
   Some participants in the commercial real estate market have been under particular pressure, with higher borrowing costs compounding post-pandemic structural market changes. A failure to properly measure, monitor and mitigate counterparty risk could lead to significant losses as a result of preventable counterparty default.

Risk Theme B

Risks predominantly driven by how regulated entities operate and respond to the evolution of their marketplace and the changing world

5. Consumer and investor detriment risks
   Inappropriate practices that do not serve investors’ interests, combined with low levels of financial literacy and increasing fraud, elevate the risks of harm.

6. Operational risks and resilience
   Digitalisation and more complex business models are increasing the risk of operational disruption as a result of external cyber-attacks or system/process breakdowns within firms or their critical service providers.

7. Risk management practices and risk transfer
   The increasing complexity and interconnectedness of risks and the volatile global environment contributes to the quantification of risk exposure and risk assessment becoming more challenging.

8. Data deficiencies and modelling risks
   A greater reliance on data and models – especially AI - in decision making raises the risk that a foundational aspect of the financial system may be deficient or prone to errors.

Risk Theme C

Risks driven by longer term structural forces

9. Climate and other environmental-related risks
   The risks associated with climate change reflect present day realities rather than emerging risks, as evidenced by the increasing frequency and severity of extreme weather-driven events. Such events will become more unpredictable and impactful through time, accentuating other risks.

10. Financial crime risks
    The financial system is showing signs of more online fraud and other financial crimes, associated with technology advances. This undermines the financial system’s integrity and reputation and can, in extreme conditions, threaten wider financial stability.

11. Strategic risks
    A consistent risk mitigant across all the above risk themes is that a regulated entity has a culture and approach that supports the management of its operation in a prudent, proper, forward looking way. This requires having the expertise, experience, infrastructure and governance structures in place to run it well. Problems generally occur when external shocks or major change coincide with poor risk management and oversight.

Supervisory priorities

The Report also highlights six supervisory priorities, which reflect the outcomes the Central Bank seeks in order to meet its statutory mandate and its domestic and international responsibilities.

These priorities apply across all of the sectors within the Central Bank’s remit and frame the more detailed supervisory strategies for each.

Priority 1 - Proactive risk management and consumer-centric leadership of firms
Leaders of regulated entities should adopt a more proactive approach to managing the risks which their organisations and their customers face. This includes evolving their approaches in line with the scale and complexity of their business models and the changing operating environment, while always actively considering their customers’ interests.

Priority 2 – Firms’ resilience to the challenging macro environment
Regulated entities should be resilient and well-prepared in the face of risks in the macro environment. The Central Bank expects firms to prepare for the impact of shocks that could arise in an environment of greater uncertainty and heightened risk and to be mindful of the consequences for their customers (and provide adequate support to them).

Priority 3 - Firms address operating framework deficiencies
Regulated entities should address any deficiencies identified in their governance, risk management and control frameworks so they are, and remain, effective. This ranges from considering financial and operational resilience holistically to ensuring that their AML and CFT controls are sufficiently robust.

Priority 4 - Firms manage change effectively
Regulated entities should keep pace with changes in the financial system and consumer needs through the well-managed evolution of their business strategies. Firms will need to invest in, and focus on, cyber security, data security and the maintenance of customer trust.

Priority 5 - Climate change and Net Zero transition are addressed
Regulated entities should improve their response to climate change and enhance their role in the transition to a Net Zero economy. The Central Bank will be “undertaking specific initiatives related to understanding the materiality of the flood protection gap in Ireland” and scrutinising and mitigating the risk of greenwashing in the promotion of financial products and their sale to investors.

Priority 6 - The Central Bank enhances how it regulates and supervises
The Central Bank will continue to enhance its authorisation processes and develop a proportionate and responsive regulatory framework. It will also continue to invest in its supervisory approach so that this is more data-driven, agile and scalable.