Indeed, while the risks of investing in different types of banks do not differ substantially under low volatility conditions, such as the one that prevailed until recently, the risks from investing in large euro area banks increase considerably when market volatility goes up. Overall, however, forward-looking market indicators provide a positive assessment of the outlook for the euro area banking sector, although the uncertainty surrounding this assessment has increased since the publication of the December 2005 Review. The chart on the right on slide 11 depicts the broadly based contraction of a standard measure of credit risk – the expected default frequency –  4  BIS Review 50/2006  across banks with different levels of risk. Notable in this regard is the substantial improvement in this indicator for the most risky banks. 5.3  Other euro area financial institutions – insurance companies and hedge funds  Allow me now to turn to non-bank financial institutions, focusing on insurance companies and hedge funds, two sectors that have been at the centre of attention during the past year. Despite significant losses incurred by the reinsurance sector following the damage caused by natural catastrophes, the financial performance of the euro area insurance sector as a whole improved in 2005, owing to stronger investment income, improving underwriting income and rising equity prices. Market-based indicators suggest that the outlook for the sector remains favourable in the immediate future. However, there are a number of risks facing the industry in the period ahead.
And despite the good starting point, there are some quiet signals of the need to be alert in the UK. The level of debt relative to corporate profits has started slowly rising again. The evolution of corporate debt levels will bear close scrutiny in this market environment. 4. Is the banking system exposed to an adjustment of asset prices? The answer here is given by our stress test last year: Britain’s major banks are resilient to an economic and market stress more severe than the global financial crisis. The 2017 stress test subjected the banks to simultaneous UK and global recessions, a deep market shock and stressed estimates of conduct redress fines. The test included a sharp adjustment in corporate credit markets and commercial property markets. Sterling investment grade corporate bond yields were assumed to snap up almost 800bps as long-term gilt yields rose by over 500bps and credit spreads blew out. Commercial property prices were assumed to fall by 40%. 10  These are typically syndicated loans to large companies which have either high levels of indebtedness, a non-investment grade credit rating, or are owned by a private equity sponsor. For more information, see pages 30-31 of the November Financial Stability Report. 11 As a percentage of institutional leveraged loan issuance. 9  All speeches are available online at www.bankofengland.co.uk/speeches  9  More than 5% of UK and global business loans would have been impaired over the first two years of the test period.