Only a small number of hate crime perpetrators received prison sentences, Criminal Justice Inspection Northern Ireland said.
More than eight incidents were reported to police every day last year.
Some cases were not prosecuted due to failure to meet the evidential standard to obtain a conviction, a report by chief inspector Barry McGuigan found.
Mr McGuigan said: "This report concludes that the level of hate crimes occurring in Northern Ireland remains stubbornly high, despite the progress that has been made by the criminal justice agencies.
"And when under reporting is considered alongside those incidents which fall below the threshold for prosecution, the situation becomes more glaring."
Violence motivated by racism was responsible for the greatest number of offences, statistics published by the inspectorate showed.
There were 3,108 incidents and 573 files sent to prosecutors across all categories in 2015/16.
A total of 270 convictions were obtained.
Mr McGuigan's report added: "Published statistics illustrated the small numbers of alleged perpetrators of hate crime receiving prison sentences or being placed on probation compared with the overall number of incidents recorded by the PSNI."
It said the PSNI recorded crime as hate-motivated using a "perception-based" system while the Public Prosecution Service took an evidence-based approach.
The inspectorate's report said: "Even taking into account the effects of the perception versus evidential tests and the fact that more than one prosecutorial decision may be recorded against any individual within a case, the numbers of convictions over the past two years compared with total incidents, files forwarded and decisions issued indicated a high attrition rate."
Mr McGuigan said the lack of a consistent approach by "first responders" who engaged with victims was also unacceptable to victims and should be addressed.
He said it would be aided by a review of existing legislation and the consideration of statutory offences similar to those already existing in England and Wales.
The watchdog added: "Every hate crime is a failure for our society."