The Central Bank may soon order commercial banks to increase the minimum amount of capital they hold, to boost their resilience in the face of an economic downturn or financial market difficulties.
Speaking at Maynooth University today, the Deputy Governor of the Central Bank, Sharon Donnery, said the case for the Central Bank to raise the Countercyclical Capital Buffer (CCB) was now "compelling".
The Central Bank believes increasing the capital buffer would be unlikely to lead to a reduction in the amount of lending to consumers and businesses.
But it could have an impact on banks plans to pay dividends to their shareholders.
Shares in Bank of Ireland closed 4.1% lower in Dublin trade following the comments, while shares in AIB were down 2.8%.
Sharon Donnery said that "given the stage of the economic and financial cycle and the uncertainty surrounding the outlook for the macro-financial environment, it is timely for us to consider wider aspects of the macroprudential policy toolkit, so we can most effectively promote resilience in the financial system".
"In particular, it is appropriate to consider capital-based instruments that can complement the mortgage measures in achieving the overall objective of macroprudential policy, and mitigate the impact of cyclical systemic risk," she said.
"One such instrument available to the Central Bank, and which has been activated in a number of countries already, is the Countercyclical Capital Buffer," she added.
Central Bank may tell Irish banks to increase their capital levels pic.twitter.com/mVhzd7oEam
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Introduced in 2016 by the European Systemic Risk Board (ESRB), the CCB is an instrument central banks can use to force banks to put money aside during periods of strong growth.
It can be released during a downturn, helping banks to avoid the "cliff edge" style halt to lending many European banks suffered in 2008 - 2010.
It can also be used to reduce the amount of credit flowing into an overheating economy.
The buffer applies to all bank lending, not just mortgage lending, and as such the CCB is an extra control level the Central Bank can use, on top of the loan to value and loan to income ratios.
However, it appears that it is the rapid growth in property prices - rather than excessive credit growth - that is pushing the Central Bank in the direction of triggering the CCB.
Because the buffer phases in over a 12 month period, central banks have to take an "educated guess" as to when best to raise the Countercyclical buffer in order to have an effect.
The buffer is set in a range of 0% to 2.5%, and has been set at 0% here since its introduction.
The Central Bank reviews the criteria for the Counter-cyclical Capital Buffer every three months, with the last review taking place in March. Now the bank has indicated it is thinking of raising the buffer for the first time.
If it does so, the commercial banks will have 12 months to phase in the additional capital.
As Irish banks already have a high level of capital it is unlikely to result in a restriction on the amount of money they lend out.
But the introduction of an additional capital requirement may alter plans by banks to pay out dividends, or return capital to overseas parent companies (in the cases of Ulster Bank and KBC).
The idea is to ensure that if banks require additional lending firepower, the cupboard will not be bare in the event of a downturn.
The countercyclical buffer is used when the economy and associated lending growth is strong, but is released when the economy goes into a downturn, helping banks to avoid a sudden shutdown in credit supply to the economy.
Most countries subject to the ESRB (which includes non-EU members such as Iceland and Norway) have not lifted the CCB above 0%, but a few countries - including the UK - have been active in adjusting the CCB for their banks.
The British first lifted the buffer to 0.5% in March 2016, but reverted to 0% three months later, in the immediate aftermath of the Brexit referendum.
However, with little turbulence in financial markets after the vote, the Bank of England raised the CCB to 1% last summer.
As is the case with all countries, the banks have 12 months to build their capital reserve up to the required level.
Slovakia and the Czech Republic have a 0.5% requirement, a level that Denmark has adopted in March.
Norway and Sweden operate 2% buffers, while Iceland currently has a 1.25% buffer, but is in the process of phasing in a 1.75% rate.
An important question for the Central Bank here will be how big a buffer it should set - whether it should start small and work up over a series of steps, or have a large - ie bigger than 1% - rise right at the start to signal intent and have a significant amount of capital set aside.
Also next month there are three significant events that could delay or impact on the central banks' timing of any announcement - the situation in Italy and its spillovers to financial markets, the June EU summit and its decisions (or not) on Brexit, and the June monetary policy meeting of the ECB governing council.
In a paper published in 2016, the Central Bank described the indicators it would use when making its quarterly assessment of the CCB rate.
The key indicator is the "credit gap" - the deviation of the credit-to-GDP ratio from its long run trend. It it has been applied in the past decade, the credit gap would have resulted in a maximum CCB being applied to Irish banks between 2003 and 2010.
However, aggregate credit growth in Ireland is at best "subdued". But the Central Bank uses a range of other indicators, including property prices, the private sector debt burden and bank balance sheet strength.
Meanwhile in Athens, the Central Bank's head of Economics and Statistics said there was now a general policy in Ireland of taking active measures to avoid boom-bust cycles and their negative effects.
Mark Cassidy said "there is currently a clear policy stance, with widespread political and public buy in, to mitigate cyclical economic risks by building resilience into fiscal policy and avoiding potential overheating in the economy.
"Prudential supervision and macroprudential policy tools are much better equipped to both monitor the build-up of systemic risk and build resilience among both borrowers and lenders," Mark Cassidy said.
The Countercyclical Capital Buffer is one of these macroprudential tools.
