James Reilly (Dublin North, Fine Gael)
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Question 119: To ask the Minister for Finance the amount that the price of houses would have to fall in order for the financial system to be at risk, according to the stress tests undertaken for the financial stability report in 2004; and if he will make a statement on the matter. [18898/10]

Brian Lenihan Jnr (Dublin West, Fianna Fail)
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Results on the two stress-testing exercised relating to the impact of house price decline on the banking system were reported in the Central Bank and Financial Services Authority of Ireland's (CBFSAI) Financial Stability Report 2004. The stress-testing exercise contained in the signed article in section 3 of the report examined how Irish banks would perform as a result of simultaneous moves in a number of risks relating to the Irish economy. The stress-testing exercise involved the CBFSAI presenting a range of economic indicators to the banks and asking them to interpret what effect these would have on their performance. In relation to house prices it was assumed that under the stress scenario that house prices growth would amount to 12 per cent in 2003 before declining by 2 per cent and 8 per cent in 2004 and 2005, respectively. The decline in house prices coupled with the other economic variables produced the broad findings that, at that point in 2004, the banks involved could weather the hypothetical scenarios.

Secondly the results of the stress test testing exercise formed the basis of an analysis of the first-round effects on the banking system of falling house prices which was contained in Box D in page 31-23 in section 1 of the Report. This looked at the issue of house prices in isolation. Using loan to value data collected as part of the stress testing exercise, banks' exposure to hypothetical house price falls was estimated. This involved making assumptions about potential defaults rates and declines in house prices. Based on the amount by which the mortgage book had been amortised relative to nominal house prices at the end of 2003, it was the assessment at the time that it would take a 40 per cent decline in house prices coupled with 50 per cent default rate to erode the stock of provisions. In terms of profits it would require the combination of house prices declining by 55 per cent and a default rate of 50 per cent before the banks involved in the stress test would record a loss.

The Deputy may wish to note that, as set out in the Financial Stability Report, there were important limitations inherent in the stress testing exercise. The exercise referred to in the Deputy's question contributed to the CBFSAI's analysis of financial stability at that time, which included a detailed examination of the health of the banking system and as highlighted in the Governor's statement in the report, the CBFSAI's central expectation, based on the CBFSAI's assessment of the risks facing both the household and non-financial corporate sectors, as well as the shock absorption capacity of the banking system, was that the banking system's state of good health would not be compromised over the medium term horizon.