financial system has been favourable. credit quality in the euro area remains high, and it should be further underpinned by the positive economic outlook. although there are some pockets of vulnerability in the euro area household and corporate sectors that have most likely increased, on average financial positions continue to be sound. moreover, financial institutions, including banks and insurance companies, have shown improving financial results and market participants expect profitability to remain strong in the foreseeable future. in late february and early march this year, the shock - absorbing capacity of the global and euro area financial system was tested by the third significant burst of market volatility in the past two years. this had been weathered comfortably. improvements in the risk management practices of financial firms have contributed to ensuring that higher financial market volatility did not prevent the capital markets from facilitating the intermediation of capital. nevertheless, the fact that the global and euro area financial systems have so far proven resilient to a series of adverse disturbances, while comforting, does not provide any ground for complacency. the few episodes of sharply rising market volatility endured in the past two years were triggered by relatively small and transitory disturbances in an environment of strong macroeconomic fundamentals and abundant financial market liquidity. therefore, it is unlikely that these episodes can provide sufficient guidance on how the financial system would perform in the event of larger shocks that could trigger a more material reappraisal of risks, or a change in risk appetite, at a less favourable stage of the credit cycle. moreover, previously identified sources of risk and vulnerability to financial system stability remain. and some of these vulnerabilities could be quickly exposed if financial market liquidity were to abruptly and sharply decline, for example as a result of a sudden decrease in investors ’ risk appetite. there are several interesting and policy - relevant issues pertaining to the existing abundance of financial market liquidity. they relate to its nature, causes, symptoms and consequences. it is essential to emphasise that financial market liquidity is a concept distinct from monetary liquidity, although there can be links between the two. financial market liquidity can be defined as the ability of market participants to undertake securities transactions without triggering large changes in asset prices. the measurement of financial market liquidity is not straightforward, but the symptoms of abundant market liquidity are visible and include high leverage, low bond yields, low volatility, narrow credit spreads, and high market turnover. we have constructed a composite indicator of financial

and it has been affected by a number of factors. first, the flattening of the euro area yield curve in recent months has encouraged substitution into shorter - term monetary assets from longer - term instruments outside m3. second, the growth of the “ other financial intermediaries ” ( ofi ) sector may accentuate this development, since institutional investors such as ofis, which have become increasingly important over recent years, may be more sensitive to such yield differentials than households. third, the shift in international investor sentiment in favour of the euro area economy has led to capital inflows, which – as foreigners purchase euro - denominated securities from domestic residents – have also contributed to the acceleration of m3 growth. such phenomena suggest some caution in interpreting the latest annual growth rates. nevertheless, they should not lead to the conclusion that the strong recent dynamism of m3 can be discounted. the fact remains that the underlying rate of monetary expansion continues to be strong. higher policy rates and short - term interest rates are starting to influence monetary and credit dynamics, although, as yet, they have not significantly dampened their overall strength. the growth of credit to the private sector has moderated somewhat, though it seems to have stabilised at double - digit rates. borrowing for financial transactions – notably in the context of securitisation activities, private equity transactions and leveraged buyouts ( lbos ) – has supported strong rates of credit expansion. credit extended for such purposes may not have the same immediate implications for aggregate demand as lending to finance investment or consumption spending. nonetheless, such borrowing contributes to the accumulation of monetary liquidity in the euro area, as bank balance sheets expand. given the vigorous monetary and credit growth in an environment of already ample liquidity, a crosscheck of the outcome of the economic analysis with that of the monetary analysis supports the assessment that upside risks to price stability prevail over the medium to longer term. accordingly, as stressed by the governing council already last month, strong vigilance is of the essence in order to ensure that risks to price stability over the medium term do not materialise. this will support the solid anchoring of medium to longer - term inflation expectations in the euro area at levels consistent with price stability. iii. the euro area financial system let me now conclude with a brief assessment of the prospects for financial stability in the euro area. as i mentioned at the beginning of my presentation, the external macro - financial environment of the euro area