Brexit could have a "material" impact on the profitability of Irish financial firms, with the UK accounting for about 20 per cent of total revenues of Irish banks, according to the Central Bank.

The bank said it had been engaging with firms across the financial sector, particularly those with the largest UK exposures, to ensure they are prepared for the risks associated with a potential Brexit.

It noted the Bank of Ireland and AIB had sizeable property-related exposures to the UK while an increasing share of new lending was now going to the UK as it had a more buoyant mortgage market.

“The effect will depend on their exposure to UK markets and the nature of the ‘new relationship’ agreed between the UK and EU,” deputy governor Sharon Donnery said.

In its latest half-year review, the Central Bank said the risks to Ireland’s hard-won recovery were clearly “weighted to the downside” because of the uncertain external environment, which was currently dominated by unease over Brexit.

Its report concludes that a vote to Leave on June 23rd would have pronounced short-term effect in the form of volatility in the euro/sterling exchange rate, which, it said, would pose significant challenges for exporters.

The Central Bank said it had been involved in extensive contingency planning ahead of next week’s vote, but declined to reveal how steep a fall in sterling was being provisioned for.

“The nature and scale of the macroeconomic effect of a Brexit would be influenced by the extent of any change to the free movement of goods, services, capital, and labour, currently facilitated through the operation of the EU single market,” it said.

Reflecting market nervousness ahead of the British vote, the yield on Germany’s safe haven 10-year bonds fell below zero on Tuesday morning for the first time. Sterling was also trading near a two-month low against the euro, after a string of opinion polls showed growing support for the Leave camp.

In its report, the Central Bank also warned that household debt, while declining, remained high, leaving many households vulnerable to adverse movements in income or interest rates.

Despite the uncertain international backdrop, it said domestic economic conditions remained positive with consumption and investment continuing to support stronger growth.

As a result, it upped its growth forecasts for the economy to 5.1 per cent this year and 4.2 per cent in 2017.

“Accommodative monetary policy, an improving fiscal situation, and continuing positive business and consumer sentiment underpin the macroeconomic outlook,” it said.

The bank also noted the pace of house price inflation had moderated “markedly” following the introduction of mortgage lending curbs in early 2015.

It plans to review these restrictions on annual basis with the outcome of the first review due in November. As part of the process, it has launched a public consultation process to inform the review

The bank said a scarcity of housing units for sale or rent was a feature of the residential property market of late, and while construction activity pointed to an increase in housing supply, “it is unlikely to be sufficient to address the current housing shortfall.”

Returning to Irish banks, the regulator noted that while the sector returned profit in 2014, following €34 billion of total losses over the previous five years, earnings remain weak and vary across individual lenders.

In aggregate, most of the profit growth across banks last year was a result of lenders freeing up provisions previously set aside for bad loans, as their loan books continue to shrink, it said.

“Core profitability remains weak due to low income growth,” the Central Bank said. “Domestic banks are not alone in this regard. The outlook across the European banking sectors is a challenging one. Sustainable and robust internal profit and capital generation remains key to domestic banks’ long-term recovery and viability.”

While domestic banks have been reducing their soured loans in recent years, with the value of non-performing loans having fallen by more than half their 2013 to €27.8 billion, or just over 15 per cent of their portfolios, progress on resolving long-term mortgage arrears “remains slow,” the report said.