The recent slowdown in house prices has been welcomed by the Central Bank but the rate of credit growth, much of it property-related, remains a concern.
In its Financial Stability Report published today, the bank found that the Irish banking system is currently "fundamentally sound" despite the slowdown in economic growth.
However, the report is inconclusive on the question of whether or not house prices are overvalued. According to the Central Bank Governor, Mr John Hurley, the analysis has given mixed results. He warned that "an absence of overvaluation would not mean that there is no cause for concern from a financial stability viewpoint.
"However, what is more certain is that if house prices were to continue to increase in double-digit figures, the risk of a sharp correction would be more pronounced," he said.
"In this context, the present tentative indications of a gradual slowdown in house price inflation are to be welcomed. This development is consistent with the large increase in supply and the decline in rental income that has been evident for some time," Mr Hurley added.
The Governor repeated that the rate of credit growth, which is largely for property-related purposes, remains a concern with current growth rates outstripping that of other countries.
Personal debt has doubled in the last ten years to almost 95 per cent of personal disposable income in early 2004, the IFSRA report said. The growth of personal-sector credit reflected the growth in residential mortgages, which account for approximately 80 per cent of personal-sector credit, the report added.
While not forecasting economic shocks, the report examined potential risks such as global imbalances, commodity price pressures and expectations of monetary tightening globally.
The report concluded that the banking system is strong enough to absorb the knock-on effects of a global recession such as a property crash.
Mr Hurley pointed out that the bank's focus is on the medium- to long-term where that increasing indebtedness increases the vulnerability of borrowers to income and employment shocks in future years.
Mr Hurley said that there is a danger that some property buyers may have been lulled into a false sense of security by the prolonged period of low interst rates but since most new mortgages are for periods in excess of 20 years, borrowers must take a long-term view of lending rates.
The bank concluded that the stress-tests carried out on the banking system show that the financial position of the banking system, and each individual credit institution included in the test, proved very resilient.