This box attempts to quantify these aspects: it measures the tightness of co-movement across euro area sovereign credit spreads and sets out to gauge the relevance of common driving forces versus idiosyncratic influences. In assessing sovereign debt sustainability, government holdings of financial assets, and not only gross government liabilities, should also be taken into account. An indicator of net government debt provides useful complementary information to gross government debt levels, in particular when an increase in government liabilities is accompanied by a simultaneous increase in government financial assets. Euro area residential property prices have exhibited pronounced volatility over the last decade, not dissimilar to the dynamic in other advanced economies. A legacy of the substantial appreciation in house prices in most euro area countries over the decade leading up to 2005, as well as the strong expansion of economic activity related to housing, has been an accumulation of imbalances in this sector that continue to affect the economic and financial outlook. This box reviews the recent evolution of some measures for detecting residential property price misalignments from fundamentals in selected euro area countries for which relatively long time series for house prices and the ancillary fundamental variables are available from national and international sources. Risk-neutral densities (RNDs) provide an estimate of the probability that market participants attach to future price developments. They are derived from the option prices of a given asset, and under certain assumptions can provide a distribution of outcomes on the basis of which a quantitative risk assessment can be made. In the case of exchange rates, they are an important tool in assessing the likelihood of sharp movements – a key risk for financial stability – and the evolution of this likelihood over time. This box introduces RND estimates for the euro/dollar exchange rate, briefly describes how they are constructed, explains how they can be interpreted and discusses the information they provide at the current juncture. Global current account and financial imbalances have narrowed markedly during the financial crisis. From a policy perspective, it is important to determine to what extent this narrowing constitutes a structural feature of the global economy, and to what extent it is cyclical, which would imply a renewed widening of imbalances, thereby putting the global recovery at risk. As well as macroeconomic risks associated with global growth, the re-emergence of widening global imbalances may have negative effects on euro area financial stability through increased market and liquidity risks. In particular, should investor concerns focus on the sustainability of public debt, countries with large deficits may experience funding pressures owing to heightened risk aversion and a concomitant rise in bond yields. This may also have an impact on the term structure of international interest rates and lead to volatility in foreign exchange markets, which could spill over to other market segments. Moreover, if global imbalances were to widen and concerns relating to the condition of countries with large external deficits or surpluses were to arise, the risk of disorderly exchange rate adjustments may emerge. Aside from financial stability considerations, this question is also central to international policy discussions, particularly in the context of the G20 Framework for Strong, Sustainable and Balanced Growth, which aims to ensure a durable reduction in global imbalances, together with a sustained global recovery. This special feature describes the recent wave of private capital flows to emerging market economies (EMEs), analyses the drivers of the flows and discusses the impact of portfolio flows on domestic macro-financial conditions. Currently, private capital flows to emerging markets are characterised by a surge in portfolio inflows which have reached similar levels to those prevailing prior to the onset of the financial crisis in 2007. The prospect of sudden stops and reversals sometimes associated with strong portfolio inflows can complicate the management of domestic macro-financial conditions in EMEs with potential negative financial stability implications. One of the key risks over the medium term linked to such flows is a boom/bust cycle in one or more systemically important emerging economies, along with the unwinding of imbalances and possible contagion. A bust could create severe disruptions in global financial markets and affect the euro area through a rise in global risk aversion, as well as through direct real economy and financial market linkages. During the recent financial crisis, euro area firms, and especially small and medium-sized enterprises (SMEs), reported severe problems gaining access to finance. Using new survey data for a sample of more than 5,000 firms in the euro area, this special feature presents the results as a means of tracking the financing obstacles faced by non-financial corporations, as well as a structural analysis of this issue during the recent crisis. After disentangling the impact of various factors, it is shown that firm age and size are key determinants of whether a company experiences problems accessing financing. As SMEs are often unable to switch from bank credit to other sources of finance, experiencing major financing obstacles can be a considerable challenge and can endanger economic growth. Looking forward, expanding access to finance while ensuring financial sector stability through responsible practices and an appropriate evaluation of risks appears essential for a sustained economic recovery. The financial crisis has illustrated the importance of timely and effective measures of systemic risk. The ECB and other policy-making institutions are currently devoting much time and effort to developing tools and models which can be used to monitor, identify and assess potential threats to the stability of the financial system. This special feature presents three such models recently developed at the ECB, each focusing on a different aspect of systemic risk. The first model uses a framework of multivariate regression quantiles to assess the contribution of individual financial institutions to systemic risk. The second model aims to capture financial institutions’ shared exposure to common observed and unobserved drivers of financial distress using macro and credit risk data, and combines the estimated risk factors into coincident and early warning indicators. The third model relies on standard portfolio theory to aggregate individual financial stress measures into a coincident indicator of systemic stress. Fundamental reforms of regulation and supervision are currently under way – both at international and European level – to address the deficiencies exposed by the financial crisis. In this context, a range of policy approaches have been developed, aimed at mitigating the burden on taxpayers and minimising future reliance on public funds to bail out financial institutions. This special feature examines the recent initiatives undertaken by several EU Member States to implement bank levies and resolution funds, in some cases exploiting synergies with deposit guarantee schemes (DGSs). These financing mechanisms are fully supported by the European Commission in the context of the proposed EU framework for bank recovery and resolution. Valuation losses in the trading books constituted the first wave of losses suffered by euro area LCBGs in the current crisis, triggered by the collapse of the US sub-prime market. More recently, estimating potential losses from banks’ government bond portfolios formed an important part of the EU-wide stress-testing exercise carried out in July 2010. The important role played by trading-book holdings for the profit and loss accounts of many LCBGs has intensified the need for monitoring, stress testing and possibly also forecasting the valuations of banks’ trading books for financial stability purposes. An important impediment to this work is the limited availability of data from public sources which consist mainly of quarterly or annual observations from banks’ published financial reports. This box focuses on the statistical revaluations data collected under Regulation (EC) No 25/2009 of the ECB of 19 December 2008 concerning the balance sheet of the monetary financial institutions sector (recast) (ECB/2008/32) and discusses its usefulness in providing information for the analysis of changes in trading and banking-book valuations at the aggregate banking sector level. The customer funding gap is an indicator that is defined as net loans (i.e. gross lending to the nonfinancial sector minus provisions for non-performing loans) minus customer deposits. It shows whether banks have enough deposits to cover the expansion of their lending activities or whether they have to tap the money and capital markets to finance these activities. A customer funding gap can lead to funding risks in case liquidity unexpectedly ceases to be available, conditions experienced in autumn 2008 as well as the first half of 2010. This box looks at the development of the aggregated liabilities and at the evolution of the funding gap of the set of euro area banks that participated in the EU-wide stress-test exercise. The customer funding gap for this sample has increased in both absolute and relative (i.e. as a percentage of total assets) terms since 2005, although it declined in 2009. The EU-wide stress-testing exercise that was carried out in July 2010 involved, among other features, the disclosure of the exposures of all 91 participating banks to 30 European sovereigns. The reason for this extensive disclosure was to provide a harmonised source of information to market participants and, thereby, to help them in assessing the scope of potential losses by individual institutions that would arise from fluctuations in the value of sovereign debt. The exercise provided evidence that the EU banks’ trading-book holdings of foreign sovereign debt securities are unlikely to be large enough to create a direct channel for the propagation of systemic risk, which is somewhat contrary to the views held by some market participants prior to the disclosure. Net interest income generated by retail customer activities, such as, in particular, the collection of deposits and the granting of loans, is one of the main sources of income for euro area banks. At the current juncture, with short-term interest rates hovering at historical lows and many banks experiencing protracted difficulties in accessing both retail and wholesale funding, banks’ deposit margins have been squeezed significantly. Similarly, in euro area countries where the majority of loans carry a rate of interest that is either floating or has a short period of fixation, lending margins have also come under pressure in light of the sharp decline of short-term market rates over the past two years.