income in net operating income rose significantly in 2006. for some lcbgs with sizeable capital market operations, the share of trading income accounted for nearly half of net operating income in 2006 and corresponded to more than 45 % of their tier 1 capital, as shown in the chart on the right of slide 10. special feature article a looks at the relationship between bank income diversity and systemic risk. it finds that a measure of systemic risk is positively correlated with bank size and the share of trading income, while it is negatively correlated with revenues from ( traditional ) interest income sources. euro area insurance sector in the euro area insurance sector, there was a broad - based improvement in profitability in 2006 ( see the chart on the left of slide 11 ). the positive assessment is further supported by the fact that the profitability of the weaker performers in 2005 also improved in 2006. underlying this improvement was a strengthening of investment income, mainly owing to buoyant stock markets and higher interest rates. moreover, favourable developments in the financial conditions of primary insurers and reinsurers in 2006, together with a greater focus on risk management and risk - adjusted prices, support a positive outlook for the euro area insurance sector as a whole. these positive developments continued to be priced into expected default frequencies ( as shown in the chart on the right of slide 11 ). however, risks and challenges for the sector remain, as greater financial market risks could pose a challenge to the life insurance and non - life insurance sectors. 5. triggering factors for the materialisation of risks and the exposure of vulnerabilities i will now consider some possible factors that could trigger the materialisation of certain risks and the exposure of identified vulnerabilities. an important issue highlighted in the fsr relates to the existing ample financial market liquidity and the prevailing very low risk premia. one possibility is that an abrupt and sharp increase in risk aversion and a loss of confidence could lead to a substantial reduction in financial market liquidity which, as stressed, is currently abundant. such a decline could expose several underlying vulnerabilities and trigger an adverse scenario which could involve : • funding liquidity challenges for highly leveraged financial institutions ; • unwinding of carry trades and possible unwinding of global imbalances ; • increasing credit spreads across the credit quality spectrum ; • increased asset price volatility in financial markets more generally ; and • reduced bank profitability as a result of lower trading revenues. a second adverse scenario could

concludes that there is some concern that the deteriorating performance of sub - prime rmbs could affect the broader market for structured credit instruments, due to the fact that the concentration of sub - prime mortgage loans as collateral for collateralised debt obligations ( cdos ) is very high. it cannot be ruled out that further poor performance of this type of collateral could trigger rating downgrades of cdo tranches themselves and lead to a reassessment of risk in other segments of structured credit markets. financial market liquidity an overarching theme, pertaining to several sources of risk and vulnerability in the financial markets, is the abundant liquidity characterising global markets. indeed, there appears to be a consensus among market participants that market liquidity has reached unprecedented levels. financial market liquidity is a measure of the ability of market participants to undertake securities transactions without triggering large changes in their prices. the concept of financial market liquidity is distinct from the concept of monetary liquidity, but there can be links between the two. although the measurement of market liquidity is rather complex, symptoms of the abundance of liquidity include high leverage, low yields, low market volatility, narrow credit spreads, and high market turnover. overall, abundant liquidity seems to be intertwined with the “ search for yield ” which has been discussed in past issues of the fsr and it appears to be dependent on confidence remaining in the smooth functioning of the market. the chart on the left of slide 6 introduces a composite indicator of financial market liquidity in the euro area equity, bond, foreign exchange and credit markets. it is constructed to gauge three different dimensions of market liquidity. the first dimension is tightness, that is the magnitude of risk premiums required by market - makers for holding inventories of securities, and it is measured by the bid - ask spread. the second dimension is depth and resiliency, that is the degree to which the volume of transactions impacts on asset prices, and it is measured by using ratios of asset price movements to transactions. the third dimension relates to liquidity risk premia, that is, the compensation required by investors for the risk that attempts to unwind positions could be challenged by uncertain market conditions in the future. this is measured using yield spreads between securities which are known to have varying degrees of liquidity. the evolution of this indicator over time confirms that financial market liquidity has increased significantly since 2001. it rose sharply in 2003 and 2004 and markets have remained very liquid since then