Against the background of the gradual economic recovery, financial market participants have also become more optimistic concerning corporate earnings prospects. That said, the high leverage of euro area non-financial corporations, coupled with low profitability in 2008 and 2009, has translated into high default rates for non-financial firms. Chart 3 on slide 7 shows patterns of default rates for euro area firms of all size categories, indicating that, in 2009, bankruptcies reached historically high levels. There is a large degree of cross-country heterogeneity within the euro area with some countries having endured annual increases in bankruptcies of more than 70% in 2009. When considering the outlook, it is instructive to examine past correlation patterns between bankruptcies and real GDP growth. As Chart 3 shows, insolvencies in the euro area remained at very high levels after the last downturn (2002–03), even after GDP already picked up. Hence, notwithstanding a recovery in economic activity, it might still take some time before a normalisation of bankruptcies would be observed. The fourth risk identified outside the euro area financial system is the possibility of greaterthan-expected household sector credit losses if unemployment rises by more than expected. Over the past six months, the condition of euro area household sector balance sheets has changed little with only a slight increase in new ECB estimates for write-downs on residential mortgages and consumer loans up to end–2010. That said, considerable increases in the rate of unemployment in most countries are expected between the fourth quarter of 2009 and the fourth quarter of 2010.

Moreover, in view of the considerable near-term funding needs of euro area governments, a particular concern is the risk of bank bond issuance being crowded out, making it challenging to roll-over a sizeable amount of maturing bonds by the end of 2012. In addition, the vulnerabilities of financial institutions associated with concentrations of lending exposures to commercial property markets and to Central and Eastern European countries remain. There are also risks of heightened financial market volatility, if macroeconomic outcomes fail to live up to expectations. A key concern is that many of the vulnerabilities highlighted in my presentation today could be unearthed by a scenario involving weaker-than-expected growth. I will now conclude with five policy messages stressed in the Review (slide 17). First, the measures taken by the ECB to stabilise markets and restore their functioning, as well as the establishment of the European Financial Stabilisation Mechanism, have lowered tail and contagion risks. Second, sizeable fiscal imbalances remain and the responsibility rests on governments to frontload and accelerate fiscal consolidation, so as to ensure the sustainability of public finances, not least to avoid the risk of a crowding out of private investment, while establishing conditions conducive to durable economic growth. Third, with pressure on governments to consolidate their balance sheets, disengagement from financial sector intervention means that banks will need to be especially mindful of the  BIS Review 75/2010  5  risks that lie ahead.