yves mersch : financial sector luxembourg - recent developments and financial stability introductory speech by mr yves mersch, governor of the central bank of luxembourg, at the alfi 2003 spring conference, luxembourg, 11 march 2003. * * * chairman, ladies and gentlemen, it is an honor and a pleasure for me to be invited to join the 2003 spring conference of the luxembourg investment fund association and to hold its introductory speech. my presentation comprises two main sections. the first section is devoted to recent developments in the financial sector, with a specific focus on luxembourg. the second section relates to financial stability issues. 1. recent developments in the financial sector the year 2002 has been, as you all know, a difficult year for the financial industry as a whole. weak economic and financial market conditions have translated into a deterioration in the profitability of the european banks. this deterioration appears to be the consequence of a combination of two major adverse developments in their operating environment. - first, the deterioration in the economic cycle and in the borrowers ’ credit quality, resulting in increased loan loss provisions. - second, the plunge in global and in particular in european stock markets, coupled with increased risk aversion and uncertainty in other financial markets, entailing reduced commissions and trading income from capital - market related businesses. the luxembourg financial sector, characterized by its high degree of openness, has not escaped from the impact of the depressed general environment. in the year 2002, the luxembourg banking sector has seen its net results deteriorating on an aggregated basis by 6 %, although the evolution is unequally spread among the individual financial institutions. while interest margins and commissions, which are their key sources of profitability, have declined in total by 7 % and 6 % respectively, a compensation of this negative trend has partly been achieved at the level of certain individual institutions through an increase in their one - off exceptional revenues and / or a release of previously created general provisions. the one - off exceptional revenues increased in total by 525 million euros, or 132 %, and are related for the major part to capital gains income through the sell - off of the stock - holdings by several banks in cedel, this in the context of the total acquisition of the luxembourg based embedded payment and securities settlement system by deutsche boerse ag. the level of provisions on a net aggregated basis has increased by 595 million euros, or 84 % compared to 2001. a closer look at the figures highlights that within this general increase, which is related in particular

##em has conducted ( or plans to conduct ) more than 800 activities accounting for around 19. 000 working days in the accession countries. let me now say a word about the criteria. the criteria accession countries have to comply with are often thought to be constricted to the maastricht criteria, which are nominal criteria, but we ought not to forget that there is another second set of copenhagen criteria, by the number of three, which have been set up in 1993 already : 1. the first is a political criterion. it encompasses the stability of institutions guaranteeing democracy, the rule of law, human rights and, what is important in some of the new accession countries, the respect for protection of minorities as well. 2. the second copenhagen criterion is of economic nature. accession countries should demonstrate the existence of a functioning market economy as well as the capacity to cope with competitive pressure and market forces which are the key rules in the european union. 3. finally, the third copenhagen criterion relates to the acquis communautaire. we must be convinced that it can be implemented, that means the ability to take on the existing obligations of membership including adherence to the aims of political, economic and monetary union. let me now elaborate on three issues that i consider of importance : convergence, currency regimes as well as policy mix. 1. convergence • nominal convergence is necessary but not sufficient. thus, real convergence has to be pursued in parallel. why also real convergence? because the maastricht treaty very clearly spells out that the criteria must be fulfilled in a sustainable way and not result from a point lending at one day in the year ; • real convergence is also the translation of the second copenhagen criteria, which very clearly says that you have to demonstrate your capacity to cope with competitive pressure and market forces. that is why real convergence is also important and has to be pursued in parallel. this process will allow a closing of the gap between accession and euro zone countries as it is stated in the objectives of the union as defined in article 2 of the treaty of the union and article 2 of the community treaty. the recent economic policies have shown that this parallel convergence is possible and has been pursued and achieved in many existing european union countries. on the nominal side, convergence to the bottom has occurred in long - term interest rates already in most accession countries, showing that financial markets pay some credibility to the current policy frameworks and consider the announced accession timetable as being credible. real convergence is proceeding further but