The Financial Stability Review is an important analytical lever for the BCL in carrying out its mission in terms of financial stability and/or the assessment of structural and cyclical risks likely to affect the resilience of the main components of the Luxembourg financial sector. It also provides the BCL with substantial information enabling it to contribute both to the conduct of macroprudential policy in Luxembourg, through its participation at national level in the Systemic Risk Board (CoRS) and at European level, in particular as a member of the European Systemic Risk Board (ESRB).

The Review deals with all the financial stability issues for Luxembourg through three chapters that are supplemented by ad hoc boxes. In addition, the annex proposes two analyses dedicated to themes specific to financial stability in Luxembourg.

The first chapter traces the main macroeconomic developments that have affected the world economy, the euro area and Luxembourg in the recent period. The underlying of the economic recovery and the acceleration of inflation in a tense geopolitical context are analysed and put into perspective with recent monetary policy decisions. In addition, this chapter offers a detailed analysis of the evolution of the residential real estate market in Luxembourg. In this context, three new analytical boxes are introduced whose objective is to further explore the dynamics of residential real estate prices.

The second chapter describes recent developments on the financial markets and their impact on the Luxembourg financial sector. Capital markets recorded strong growth in 2021 thanks to the global economic recovery. The gradual rise in nominal interest rates in the face of accelerating inflation in a context of major geopolitical tensions, in this case Russia's aggression against Ukraine, has already had a significant impact on the yields of certain asset classes, notably bonds and equities, in the first half of 2022. In addition, the analysis of risk aversion shows that the increase in risk perception in the first half of 2022 reflects a growing pessimism in investor expectations driven by both the slowdown in economic growth, the severity of the supply shock, the worsening of tensions in the energy market and the rise in the price of goods and services.

The third chapter presents recent developments in the domestic financial sector. Luxembourg's banking sector has remained resilient during the COVID-19 pandemic and has sufficient additional shock absorption reserves. The vigorous measures taken by the Governing Council of the ECB prior to and during the emergence of the health crisis (PEPP, tiering, possibility of borrowing at negative rates up to -1% in the context of TLTRO3, etc.) have made it possible, first of all, to stabilise the financial markets and thereby to serve as a powerful liquidity support for financial sector players, including investment funds domiciled in Luxembourg; and then to strengthen the European banking sector, including Luxembourg, in consolidating its profitability and resilience during this recessionary period. For the year 2022, although the gradual exit from the low interest rate environment makes it possible to consolidate banking profitability, the war in Ukraine has fuelled the increase in credit risk for a few resident banks. Based on a central macroeconomic scenario of the ECB last June, however, our forecasts remain positive and suggest that the return on equity at the aggregate level should reach 6.2% at the end of 2022, despite the revision of growth projections in the euro area.

The Luxembourg investment fund sector is not subject to any particular vulnerabilities. Nevertheless, the gradual normalization of monetary policies and the increase in volatility in global markets could negatively affect its performance in 2022.

Finally, and as every year, the Financial Stability Review proposes two specific studies as an appendix.

The first analysis examines the determinants of bankruptcies of non-financial corporations in Luxembourg during the COVID-19 pandemic. It can be seen that the decrease in the number of bankruptcies since 2020 is not linked to macroeconomic conditions in Luxembourg but to the implementation of exceptional public support measures.

The second study proposes a set of measures of systemic risk in order to assess potential vulnerabilities in the Luxembourg investment fund sector. These measures make it possible to understand the contagion effects during extreme market events.

The Financial Stability Review 2022 is available on request, while stocks last, from the BCL (info@bcl.lu) and can also be downloaded from the BCL website (www.bcl.lu).