The European banking sector is particularly affected, as investors fear losses from write-downs on government bonds. The ensuing loss of confidence in the banking system is resulting once again in a sharp fall in activity on the interbank market, which in turn is leading to higher refinancing costs and liquidity bottlenecks. Meanwhile, the European banks themselves are holding back economic activity with their restrictive lending practices. Weak economic activity is further hampering efforts by the affected nations to restructure their budgets. All of these developments have caused a steep rise in credit risk premia in financial markets. In response to this serious situation, euro area countries have adopted additional measures to strengthen fiscal discipline in a sustainable way and to restore confidence in the European banking sector and the financial markets. The actual implementation of these measures is essential if the financial markets are to be convinced in the long term. On the whole, we expect that the international environment will probably remain fraught with considerable uncertainty for some time to come; the risks to financial stability will remain correspondingly high. Situation of Swiss big banks The deterioration in the global economic environment has not left the Swiss big banks unscathed. In the second half of 2011, their profitability suffered from the volatile financial market situation as well as from low customer activity levels. Against this backdrop and given the enhanced regulatory requirements, UBS and Credit Suisse have announced that they will be significantly reducing their risk exposure for the next few years.
I have developed a few simple rules for selecting variables to keep an eye on:  2  BIS central bankers’ speeches  Over time, governments cannot run an increasing deficit. To prevent the debt level from exploding, the deficit must be kept in line with nominal GDP growth. That figure is around 4 per cent annually, for most Western countries. A fiscal balance can hide important imbalances. If one sector in the economy is far too large, the taxes from this sector can contribute significantly to the fiscal budget. An example is the construction sector in some European countries in the years leading up to the crisis. In normal times, this sector is around 3–5 per cent of GDP in most countries. In Spain, housing construction was 9 per cent in 2006. In Ireland, the contribution was 11 per cent. When problems arose, construction activity decreased and tax income was reduced significantly. Therefore, one should also look at the current account. Inflation above 4 per cent might indicate that price stability is not firmly anchored. If unemployment is above 4 per cent of the labour force, it might signal a labour market out of order. Finally, the risk of running into a crisis seems to increase if the total assets of the banking sector constitute more than 4 times GDP. This table illustrates the 4 per cent rule. Many countries had negative fiscal balances through the last decade despite moderate to high economic growth.