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Global Financial Stability Report

Risk Taking, Liquidity, and Shadow Banking: Curbing Excess While Promoting Growth

October 2014

Disclaimer: As used in this volume the term “country” does not in all cases refer to a territorial entity that is a state as understood by international law and practice. As used here, the term also covers some territorial entities that are not states but for which statistical data are maintained on a separate and independent basis.

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Global Financial Stability Report

Risk Taking, Liquidity, and Shadow Banking: Curbing Excess While Promoting Growth

October 2014

The October 2014 Global Financial Stability Report (GFSR) finds that six years after the start of the crisis, the global economic recovery continues to rely heavily on accommodative monetary policies in advanced economies. Monetary accommodation remains critical in supporting the economy by encouraging economic risk taking in the form of increased real spending by households and greater willingness to invest and hire by businesses. However, prolonged monetary ease may also encourage excessive financial risk taking.

Front Matter

Chapter 1: Improving the Balance Between Financial and Economic Risk Taking
Chapter 1 concludes that although economic benefits of monetary ease are becoming more evident in some economies, market and liquidity risks have increased to levels that could compromise financial stability if left unaddressed. The best way to safeguard financial stability and improve the balance between economic and financial risk taking is to put in place policies that enhance the transmission of monetary policy to the real economy—thus promoting economic risk taking—and address financial excesses through well-designed macroprudential measures.

Tables
		1.1 Corporate and Banking Sector Fundamentals
		1.2 Changes in Business Models and Strategic Direction
		1.3 Major Bond Index Sensitivities
		1.4 Key Macroprudential Policy Recommendations and Recent Country Examples
		1.5 Capital Investment Regressions
		1.6 Summary of Capital Structure of Sample Firms
		1.7 Major Recent Regulatory Measures and Potential Impacts on Select Bank Business Lines
		1.8 Results of Tests for Independence between Assets’ Volatility and the Volatility of the U.S. Treasury Total Return Index when the Latter Acts as an Originator of Shocks
Figures
Chart	Data	1.1 Global Financial Stability Map
Chart	Data	1.2 Global Financial Stability Map: Risks and Conditions
Chart	Data	1.3 United States: How Far Along the Exit Process?
Chart	Data	1.4 Emerging Market Developments
Chart	Data	1.5 Financial Markets Are Buoyant, Despite Economic Disappointments
Chart	Data	1.6 Global Heat Maps
Chart	Data	1.7 Indebtedness and Leverage in Selected Advanced Economies
Chart	Data	1.8 United States: Capital Expenditure Developments in Nonfinancial Firms
Chart	Data	1.9 Euro Area Nonfinancial Firms: Capital Expenditure Developments
Chart	Data	1.10 Financial Risk Taking and Volatility
Chart	Data	1.11 United States: Nonfinancial Corporations’ Credit Fundamentals
Chart	Data	1.12 United States: Equity Market Fundamentals
Chart	Data	1.13 Emerging Market Corporate Debt and Fundamentals
Chart	Data	1.14 China Corporate Indicators
Chart	Data	1.15 China’s Shadow Banking and Real Estate Markets
Chart	Data	1.16 Bank Capitalization
Chart Chart	Data	1.17 Bank Balance Sheets and Profitability
Chart	Data	1.18 Where Are Banks in Their Transition to New Business Models?
Chart	Data	1.19 Bank Lending and Nonbank Sources of Credit
Chart	Data	1.20 Market Liquidity: Rising Flow but Deteriorating Depth
Chart		1.21 Feedback Loop between Performance, Flow, and Illiquidity
Chart		1.22 Asset Management Industry Impact on Liquidity
Chart	Data	1.23 Liquidity Risk Ampliﬁers
Chart	Data	1.24 Evolution and Concentration of Asset Allocations to Emerging Markets
Chart	Data	1.25 Volatility Developments
Chart	Data	1.26 Monetary Policy Normalization
Chart	Data	1.27 Stretched Valuations across Asset Classes
Chart	Data	1.28 Cross-Country Distribution
Chart		1.29 Analysis of Selected European Spreads
Chart		1.30 Volatility Multiples between High and Low States

Chapter 2: Shadow Banking Around the Globe: How Large, and How Risky?
Chapter 2 examines the growth of shadow banking around the globe, assessing risks and discussing regulatory responses. Although shadow banking takes vastly different forms within and across countries, some of its key drivers tend to be common to all: search for yield, regulatory circumvention, and demand by institutional investors. The contribution of shadow banks to systemic risks in the financial system is much larger in the United States than in Europe. The chapter calls for a more encompassing (macroprudential) approach to regulation and for enhanced data provision.

Boxes
Chart Chart		2.1 The Run on the Shadow Banking System and Bank Losses during the Financial Crisis
Chart	Data	2.2 New Shadow Banking Developments
Chart		2.3 China: Bank Characteristics and Wealth Management Product Issuance
Tables
		2.1 Comparison of Shadow Banking Measures
		2.2 Summary of Panel Regression on Shadow Banking Growth
		2.3 List of Economies Included in the Empirical Studies
		2.4 List of Variables Used in Regression Analysis
		2.5 Panel Regression of Shadow Banking Growth: Flow of Funds Sample, 1990−2013
		2.6 Panel Regression of Shadow Banking Growth: Financial Stability Board Sample, 2002-2012
		2.7 Snapshot of the New International Regulatory Initiatives
Figures
Chart		2.1 Broad Shadow Banking Measures
Chart	Data	2.2 Lending by Shadow Banks
Chart		2.3 Traditional versus Shadow Banking Intermediation
Chart		2.4 Alternative Measures of Shadow Banking Size
Chart		2.5 Shadow Banking Subsectors
Chart	Data	2.6 Size of the Shadow Banking Markets
Chart		2.7 Drivers of Shadow Banking
Chart		2.8 Sensitivity Analysis by Subsector
Chart		2.9 Brazil: Investment Funds, Insurance Companies and Pension Funds, and the Interest Rate
Chart		2.10 Shadow Banking Risks in the Euro Area, the United States, and Japan
Chart	Data	2.11 Systemic Risk and Interdependence of Financial Intermediaries
Chart	Data	2.12 U.S. Intermediaries' Contribution to Distress Vulnerability of the Euro Area Banking Sector
Chart		2.13 Effective Shadow Banking Regulation Must Cover Activities and Entities
Chart		2.14 Policy Framework to Mitigate Shadow Banking Risks
Chart		2.15 Different Definitions of Shadow Banking
Chart		2.16 Components of Broad and Narrow Measures of Noncore Liabilities

Chapter 3: Risk Taking By Banks: The Role of Governance and Executive Pay
Chapter 3 discusses how conflicts of interest between bank managers, shareholders, and debt holders can lead to excessive bank risk taking from society’s point of view. It finds that banks with boards of directors independent from management take less risk. There is no clear relation between bank risk and the level of executive compensation, but a better alignment of bankers’ pay with long-term outcomes is associated with less risk.

Boxes
Chart		3.1 Types of Executive Compensation
		3.2 Trends in the Regulation of Bankers’ Pay
		3.3 Adjusting Compensation for Bank Managers: Advantages and Pitfalls
Chart	Data	3.4 Integrity in Financial Institutions
		3.5 Regulation and Risk-Taking Incentives: Basel I to III
Tables
		3.1 Equity Payoffs with Various Distances to Default
		3.2 Reform Initiatives in Various Jurisdictions
		3.3 Governance Characteristics Used as Explanatory Variables in the Empirical Analysis
		3.4 Summary of the Empirical Literature
		3.5 Measures of Risk Used in the Empirical Analysis
		3.6 Summary Results of the Empirical Analysis
		3.7 Number of Banks by Country in Samples for Various Regressions
		3.8 Robustness in Subsamples
		3.9 Gambling for Resurrection
Figures
Chart	Data	3.1 Corporate Complexity and Opacity: Dispersion of Earnings-per-Share Forecasts by Sector
Chart	Data	3.2 Trends in Compensation Practices in Banks
Chart	Data	3.3 Summary Statistics of Boards and Risk Management in Banks
Chart		3.4 Bank Governance and Risk Taking
Chart		3.5 Bank Governance and Risk Taking during the Global Financial Crisis
Chart		3.6 Size-Adjusted Compensation and Risk Taking
Chart		3.7 Summary of Main Findings: Impact on Risk Taking
Chart		3.8 Economic Significance of Bank Governance Variables

Statistical Appendix

Full Text

Figures
Chart	Data	1. Major Net Exporters and Importers of Capital, 2013
Chart		2. Sovereign Credit Default Swap Spreads
Chart		3. Selected Credit Default Swap Spreads
Chart		4. Selected Spreads
Chart		5. Implied Volatility Indices
Chart	Data	6. U.S. Corporate Bond Market
Chart	Data	7. Euro Area Corporate Bond Market
Chart	Data	8. U.S. Commercial Paper Market
Tables
	Data	1. Capital Market Size: Selected Indicators, 2013
	Data	2. MSCI Equity Market Indices
	Data	3. Emerging Markets Bond Index: EMBI Global Sovereign Yield Spreads
	Data	4. Emerging Market Private External Financing: Total Bonds, Equities, and Loans
	Data	5. Emerging Market Private External Financing: Bonds
	Data	6. Emerging Market Private External Financing: Equity
	Data	7. Emerging Market Private External Financing: Loans
	Data	8. Equity Valuation Measures: Dividend-Yield Ratios
	Data	9. Equity Valuation Measures: Price/Earnings Ratios
	Data	10. Emerging Markets: Mutual Funds

(*)Please note that effective with the April 2011 issue, the IMF’s Statistics Department has assumed responsibility for compiling the Financial Soundness Indicators tables and they are no longer part of this appendix. However, these tables will continue to be linked to the GFSR Statistical Appendix on the IMF’s public website.

The following symbols have been used throughout this appendix:

. . . to indicate that data are not available;

—— to indicate that the figure is zero or less than half the final digit shown, or that the item does not exist;

- between years and months (for example, 2008–09 or January–June) to indicate the years or months covered, including the beginning and ending years or months;

/ between years (for example, 2008/09) to indicate a fiscal or financial year.

“Billion” means a thousand million; “trillion” means a thousand billion.

“Basis points” refer to hundredths of 1 percentage point (for example, 25 basis points are equivalent to ¼ of 1 percentage point).

“n.a.” means not applicable.

Minor discrepancies between constituent figures and totals are due to rounding.

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Front Matter

Chapter 1: Improving the Balance Between Financial and Economic Risk Taking
Chapter 1 concludes that although economic benefits of monetary ease are becoming more evident in some economies, market and liquidity risks have increased to levels that could compromise financial stability if left unaddressed. The best way to safeguard financial stability and improve the balance between economic and financial risk taking is to put in place policies that enhance the transmission of monetary policy to the real economy—thus promoting economic risk taking—and address financial excesses through well-designed macroprudential measures.

Tables
		1.1 Corporate and Banking Sector Fundamentals
		1.2 Changes in Business Models and Strategic Direction
		1.3 Major Bond Index Sensitivities
		1.4 Key Macroprudential Policy Recommendations and Recent Country Examples
		1.5 Capital Investment Regressions
		1.6 Summary of Capital Structure of Sample Firms
		1.7 Major Recent Regulatory Measures and Potential Impacts on Select Bank Business Lines
		1.8 Results of Tests for Independence between Assets’ Volatility and the Volatility of the U.S. Treasury Total Return Index when the Latter Acts as an Originator of Shocks
Figures
Chart	Data	1.1 Global Financial Stability Map
Chart	Data	1.2 Global Financial Stability Map: Risks and Conditions
Chart	Data	1.3 United States: How Far Along the Exit Process?
Chart	Data	1.4 Emerging Market Developments
Chart	Data	1.5 Financial Markets Are Buoyant, Despite Economic Disappointments
Chart	Data	1.6 Global Heat Maps
Chart	Data	1.7 Indebtedness and Leverage in Selected Advanced Economies
Chart	Data	1.8 United States: Capital Expenditure Developments in Nonfinancial Firms
Chart	Data	1.9 Euro Area Nonfinancial Firms: Capital Expenditure Developments
Chart	Data	1.10 Financial Risk Taking and Volatility
Chart	Data	1.11 United States: Nonfinancial Corporations’ Credit Fundamentals
Chart	Data	1.12 United States: Equity Market Fundamentals
Chart	Data	1.13 Emerging Market Corporate Debt and Fundamentals
Chart	Data	1.14 China Corporate Indicators
Chart	Data	1.15 China’s Shadow Banking and Real Estate Markets
Chart	Data	1.16 Bank Capitalization
Chart Chart	Data	1.17 Bank Balance Sheets and Profitability
Chart	Data	1.18 Where Are Banks in Their Transition to New Business Models?
Chart	Data	1.19 Bank Lending and Nonbank Sources of Credit
Chart	Data	1.20 Market Liquidity: Rising Flow but Deteriorating Depth
Chart		1.21 Feedback Loop between Performance, Flow, and Illiquidity
Chart		1.22 Asset Management Industry Impact on Liquidity
Chart	Data	1.23 Liquidity Risk Ampliﬁers
Chart	Data	1.24 Evolution and Concentration of Asset Allocations to Emerging Markets
Chart	Data	1.25 Volatility Developments
Chart	Data	1.26 Monetary Policy Normalization
Chart	Data	1.27 Stretched Valuations across Asset Classes
Chart	Data	1.28 Cross-Country Distribution
Chart		1.29 Analysis of Selected European Spreads
Chart		1.30 Volatility Multiples between High and Low States

Chapter 2: Shadow Banking Around the Globe: How Large, and How Risky?
Chapter 2 examines the growth of shadow banking around the globe, assessing risks and discussing regulatory responses. Although shadow banking takes vastly different forms within and across countries, some of its key drivers tend to be common to all: search for yield, regulatory circumvention, and demand by institutional investors. The contribution of shadow banks to systemic risks in the financial system is much larger in the United States than in Europe. The chapter calls for a more encompassing (macroprudential) approach to regulation and for enhanced data provision.

Boxes
Chart Chart		2.1 The Run on the Shadow Banking System and Bank Losses during the Financial Crisis
Chart	Data	2.2 New Shadow Banking Developments
Chart		2.3 China: Bank Characteristics and Wealth Management Product Issuance
Tables
		2.1 Comparison of Shadow Banking Measures
		2.2 Summary of Panel Regression on Shadow Banking Growth
		2.3 List of Economies Included in the Empirical Studies
		2.4 List of Variables Used in Regression Analysis
		2.5 Panel Regression of Shadow Banking Growth: Flow of Funds Sample, 1990−2013
		2.6 Panel Regression of Shadow Banking Growth: Financial Stability Board Sample, 2002-2012
		2.7 Snapshot of the New International Regulatory Initiatives
Figures
Chart		2.1 Broad Shadow Banking Measures
Chart	Data	2.2 Lending by Shadow Banks
Chart		2.3 Traditional versus Shadow Banking Intermediation
Chart		2.4 Alternative Measures of Shadow Banking Size
Chart		2.5 Shadow Banking Subsectors
Chart	Data	2.6 Size of the Shadow Banking Markets
Chart		2.7 Drivers of Shadow Banking
Chart		2.8 Sensitivity Analysis by Subsector
Chart		2.9 Brazil: Investment Funds, Insurance Companies and Pension Funds, and the Interest Rate
Chart		2.10 Shadow Banking Risks in the Euro Area, the United States, and Japan
Chart	Data	2.11 Systemic Risk and Interdependence of Financial Intermediaries
Chart	Data	2.12 U.S. Intermediaries' Contribution to Distress Vulnerability of the Euro Area Banking Sector
Chart		2.13 Effective Shadow Banking Regulation Must Cover Activities and Entities
Chart		2.14 Policy Framework to Mitigate Shadow Banking Risks
Chart		2.15 Different Definitions of Shadow Banking
Chart		2.16 Components of Broad and Narrow Measures of Noncore Liabilities

Chapter 3: Risk Taking By Banks: The Role of Governance and Executive Pay
Chapter 3 discusses how conflicts of interest between bank managers, shareholders, and debt holders can lead to excessive bank risk taking from society’s point of view. It finds that banks with boards of directors independent from management take less risk. There is no clear relation between bank risk and the level of executive compensation, but a better alignment of bankers’ pay with long-term outcomes is associated with less risk.

Boxes
Chart		3.1 Types of Executive Compensation
		3.2 Trends in the Regulation of Bankers’ Pay
		3.3 Adjusting Compensation for Bank Managers: Advantages and Pitfalls
Chart	Data	3.4 Integrity in Financial Institutions
		3.5 Regulation and Risk-Taking Incentives: Basel I to III
Tables
		3.1 Equity Payoffs with Various Distances to Default
		3.2 Reform Initiatives in Various Jurisdictions
		3.3 Governance Characteristics Used as Explanatory Variables in the Empirical Analysis
		3.4 Summary of the Empirical Literature
		3.5 Measures of Risk Used in the Empirical Analysis
		3.6 Summary Results of the Empirical Analysis
		3.7 Number of Banks by Country in Samples for Various Regressions
		3.8 Robustness in Subsamples
		3.9 Gambling for Resurrection
Figures
Chart	Data	3.1 Corporate Complexity and Opacity: Dispersion of Earnings-per-Share Forecasts by Sector
Chart	Data	3.2 Trends in Compensation Practices in Banks
Chart	Data	3.3 Summary Statistics of Boards and Risk Management in Banks
Chart		3.4 Bank Governance and Risk Taking
Chart		3.5 Bank Governance and Risk Taking during the Global Financial Crisis
Chart		3.6 Size-Adjusted Compensation and Risk Taking
Chart		3.7 Summary of Main Findings: Impact on Risk Taking
Chart		3.8 Economic Significance of Bank Governance Variables

Statistical Appendix

Full Text

Figures
Chart	Data	1. Major Net Exporters and Importers of Capital, 2013
Chart		2. Sovereign Credit Default Swap Spreads
Chart		3. Selected Credit Default Swap Spreads
Chart		4. Selected Spreads
Chart		5. Implied Volatility Indices
Chart	Data	6. U.S. Corporate Bond Market
Chart	Data	7. Euro Area Corporate Bond Market
Chart	Data	8. U.S. Commercial Paper Market
Tables
	Data	1. Capital Market Size: Selected Indicators, 2013
	Data	2. MSCI Equity Market Indices
	Data	3. Emerging Markets Bond Index: EMBI Global Sovereign Yield Spreads
	Data	4. Emerging Market Private External Financing: Total Bonds, Equities, and Loans
	Data	5. Emerging Market Private External Financing: Bonds
	Data	6. Emerging Market Private External Financing: Equity
	Data	7. Emerging Market Private External Financing: Loans
	Data	8. Equity Valuation Measures: Dividend-Yield Ratios
	Data	9. Equity Valuation Measures: Price/Earnings Ratios
	Data	10. Emerging Markets: Mutual Funds

The following symbols have been used throughout this appendix:

. . . to indicate that data are not available;

—— to indicate that the figure is zero or less than half the final digit shown, or that the item does not exist;

- between years and months (for example, 2008–09 or January–June) to indicate the years or months covered, including the beginning and ending years or months;

/ between years (for example, 2008/09) to indicate a fiscal or financial year.

“Billion” means a thousand million; “trillion” means a thousand billion.

“Basis points” refer to hundredths of 1 percentage point (for example, 25 basis points are equivalent to ¼ of 1 percentage point).

“n.a.” means not applicable.

Minor discrepancies between constituent figures and totals are due to rounding.

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Global Financial Stability Report

Global Financial Stability Report

Risk Taking, Liquidity, and Shadow Banking: Curbing Excess While Promoting Growth

Reports and Related Links:

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IMF’s Work

RESOURCES

TOPICS

Flagship Publications

Other Publications

IMF reports and publications by country

Regional Offices

All News

See Also

For Journalists

Press Center

RESOURCES

FLAGSHIPS

KEY SERIES

IMF NOTES

Related Articles

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Global Financial Stability Report

Risk Taking, Liquidity, and Shadow Banking: Curbing Excess While Promoting Growth

Reports and Related Links:

Contents

Front Matter

Statistical Appendix

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Contents

Front Matter

Statistical Appendix