Chart 5  Chart 6  Changes in international equity indices since trough(a)  European corporate bond spreads  Interest rates Expected earnings  Implied risk premium Total  Per cent 100  Basis points (log scale) Illiquidity premium (a) 10,000 Compensation for credit risk (b) Great Depression (c) Current (d)  80 60 40  1,000  20+ 0 20  100  EuroStoxx  S&P500  FTSE 100  40  Current  March  Current  March  Current  March  Current  March  Current  BIS Review 10/2010  March  Sources: Bloomberg, IBES, Thomson Datastream and Bank calculations. (a) Based on a three-stage dividend discount model. See Panigirtzoglou, N. and Scammell, R. (2002), 'Analysts' earnings forecasts and equity valuations', Bank of England Quarterly Bulletin (Spring), pages 59-66. (b) Taken as 9 March 2009. 10  Sources: Citigroup, Moody's Investors Service, UBS Delta and Bank calculations. (a) Spread of iBoxx € corporate bond index over iTraxx Europe credit default swap index. (b) iTraxx Europe five-year credit default swap index. (c) Credit risk premium for realised default rates on US corporate bonds issued in 1931. (d) Credit risk premium for Moody's current default probability forecast for European corporates.
A normalisation of long-term interest rates would increase UK companies’ debt servicing costs from 17% of profits currently to around 33%. 6  Reinhart, C M and K Rogoff (2009), This Time is Different – Eight Centuries of Financial Folly, Princeton University Press. 7  Data are not available for all ten countries, so period averages are based on slightly different samples. 8  Bank of England Financial Stability Report, December 2009. 4  BIS Review 10/2010  That is significantly below the levels reached in the early 1990s, when debt servicing peaked at 58% of profits. But the distribution of debt across companies again paints a less promising picture. In 2007, around 25% of UK firms made insufficient profits to cover their interest payments (Chart 11). This is a long tail. For sovereigns, debt servicing costs among the G7 economies are currently low, at around 3% of GDP. But were medium-term interest rates to normalise, against a backdrop of rising debt ratios, the combined effect would be significant. Over the medium term, debt servicing relative to GDP in the G7 economies would double. Finally, banks’ refinancing burden in the next few years has grown as a result of a shortening of debt maturities during the crisis. The average maturity of US banks’ rated debt is estimated by Moody’s to have fallen from 6.7 years to 3.2 years since 2005. Among UK banks, it has fallen from 6.8 years to 4.3 years.