Net interest income has been an important driver of the improved bank performance, on account of the steeper yield curve and wider operating margins. The tightening of credit standards, the gradual pass-through of lower policy rates to lending rates and declining competitive pressures in the credit market have all contributed to higher revenues from core banking business. Trading income has increased even more strongly as the financial markets  4  BIS Review 168/2009  recovered after the first quarter of 2009 and has been the main contributor, on average, to the increase in revenues as a percentage of assets. With regard to bank capital positions and loan-loss provisions, I would like to highlight the following points. The recovery in major banks’ earnings, the slowdown in the growth rate of both risk-weighted and total assets and increases in capital have contributed to a slight increase in the regulatory capital ratios of the median institutions. Even those institutions with the lowest regulatory capital ratios comfortably exceed at present the minimum requirements (see the left side of Chart 11). Provisions on impaired assets had been a serious drag on euro area LCBGs’ incomes in 2007 and 2008. To a large extent these provisions still related to securitised loans, although the share of loan impairments had started to grow. Most institutions have reported sharply higher provisions for loan losses (see the right side of Chart 11). Moreover, expressed as a percentage of total loans, loan-loss provisions were the highest in the third quarter compared to the five preceding years.
The turnaround has been underpinned by government-provided downside protection of financial institutions’ balance sheets, which has reduced tail risk, improving macroeconomic news and better than expected earnings, especially by financial institutions. Against this background, the equity markets have rebounded, led by financial stocks. At the same time, historically low levels of money market interest rates have induced a hunt for yield among investors, triggering outflows from bank deposits and money market funds into riskier assets, including corporate bonds issued by lower-rated borrowers. Euro area bond and equity markets Over the past six months, euro area long-term bond yields have declined. However, in late November 2009, the slope of the euro area yield curve remained steeper than at any point in time since the launch of the euro, due to the past declines in short-term market rates (See Chart 8). Intra-euro area sovereign spreads, as well as euro area sovereign CDS spreads, have narrowed further, in some cases to pre-Lehman levels, until very recently, when a few have widened again. Looking ahead, the prospects for euro area government bonds continue to be surrounded by persistent uncertainty about future macro-financial developments. Upward risks to yields could stem from a further unwinding of flight-to-safety and flight-to-liquidity flows. In addition, slower than expected growth might increase the financing needs of euro area governments and bond markets might face difficulties in absorbing higher government bond issuance.