Main risks identified outside the euro area financial system  A main risk to the euro area financial stability is the possibility that concerns about the sustainability of the public finances persist, or even increase, with an associated crowding out of private investment (slide 5). The progressive intensification of market concerns about sovereign credit risks among industrialised economies in the early months of 2010 opened up a number of hazardous contagion channels and adverse feedback loops between financial systems and public finances, in particular in the euro area. The main reason for the severe deterioration of public finances was the activation of automatic stabilisers as a result of the marked contraction of economic activity which followed the collapse of Lehman Brothers. At the same time, because the structural fiscal deficits of a number of euro area countries were sizeable before the financial crisis erupted, fiscal deficits in those countries rose to very high levels. Added to this were the discretionary fiscal measures taken by many countries to stimulate their economies, following the adoption in December 2008 of the European Economic Recovery Plan. By early May this year, adverse market dynamics had taken hold across a range of asset markets in an environment of diminishing market liquidity. Ultimately, the functioning of some markets, such as the government bond markets in countries with a very negative fiscal outlook, became impaired, thereby triggering a significant widening of government bond yield spreads in these countries, as shown on Chart 1 on slide 5.
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.