ANNUAL REPORT 2008 - Polymer Bank Notes of the World

eflected discretionary deleveraging of riskweightedassets by individual banks, awidespread raising of capital despite challengingbusiness conditions and, to some degree, theimpact of both the implementation of theBasel II Framework and prudential filters.The prospects for profitability to return to preturmoillevels do not look very promising in theshort term. Significant further declines in thevalues of other structured finance products –including US consumer asset-backed securitiesand euro area residential mortgage-backedsecurities – cannot be ruled out. Lower growthrates for loans to households and firms, a virtualstandstill in securitisation activities, and reducedincome from fees and commissions as well astrading are likely to pose challenges to the financialperformance of banks in 2009. In response, bankshave tightened their lending standards and cutcosts. Against this background, significant policyactions were taken by the Eurosystem and byeuro area governments to bolster market liquidity,confidence and capital buffers.The financial performance of large euro areainsurers deteriorated in the first half of 2008,with most insurers witnessing reductions inpremiums compared with the same periodof 2007. A significant reason for this was afall in demand for life insurance productsfollowing the equity and credit market turmoil.The financial market turbulence and knockoneffects for the real economy will continueto pose further challenges for many insurancefirms. In addition, insurers which offer bankingservices or are part of a financial conglomeratecontinue to be affected by the challenges facingthe banking sector.Global hedge fund returns were strongly negativeacross almost all investment strategies by theend of September 2008. Volatile asset pricereversals, forced deleveraging and margin calls,sudden bans on short sales by public authoritiesand investor redemptions contributed to thisweak performance. While the hedge fund sectoris known to have deleveraged considerably sincethe start of the market turmoil, thereby reducingits vulnerability to further margin calls orunexpected cuts in bank credit lines, hedge funds’vulnerability to the risk of investor redemptionsappears to have grown during 2008 as investorredemptions tend to be sensitive to hedge funds’performance. Looking ahead, if hedge fundsincreasingly fail to retain their investors, thepossibility of further sizeable asset sales by thesector may represent a non-negligible threat tothe stability of the financial markets.STRUCTURAL DEVELOPMENTSThe major structural trends in the EU bankingsystem are in line with those observed inprevious years. 2 Consolidation continued, despiteshowing signs of a moderate slowdown. Trendsvaried across the 15 older EU Member States,while the number of credit institutions in thecountries that have joined the EU since 2004remained broadly unchanged, with Cyprus beinga notable exception owing to the ongoingconsolidation in the cooperative banking sector.Altogether, the number of credit institutions inthe EU declined by 166 in 2007 (from 8,514 to8,348), while the corresponding figure in theprevious year was 175.At the same time, the EU banking landscapecontinued to be dominated by domestic creditinstitutions (which had a 71.3% market share),with the remainder equally divided betweenbranches and subsidiaries of foreign institutions.It should be highlighted, however, that there aresignificant differences among countries, withthe newer Member States characterised by theprominence of foreign entities, especially thosewith a parent company in one of the older EUcountries. It is noteworthy that, in contrast to thesituation in 2006, branches of foreign institutionsin the EU showed an increase in terms of marketshare of total assets. This was particularly true inthe countries that have joined the EU since 2004,where the market share of foreign branchesincreased by approximately 1 percentage point,while that of foreign subsidiaries saw a declineof approximately 4 percentage points.2 The data in this section are taken from the ECB’s report entitled“EU banking structures”, which only contains data up to 2007.ECBAnnual Report2008151