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GFSR
Global Financial Stability Report (GFSR)

Navigating Monetary Policy Challenges and Managing Risks

April 2015


Global financial stability risks have risen since October. Chapter 1 finds that these risks have also been pivoting away from banks to shadow banks, from solvency to market liquidity risks, and from advanced economies to emerging markets. In advanced economies, the key challenge is to enhance the traction of accommodative monetary policies, ensure a smooth normalization of monetary policy in the United States, and manage the undesirable side effects of low interest rates. Emerging markets must address their own domestic financial vulnerabilities from weaker growth, lower commodity prices, and a stronger dollar, while strengthening their resilience to the changing global environment.

Chapters 2 and 3 examine developments in international banking and the potential risks stemming from the financial management industry. Analyzing developments since the global financial crisis, Chapter 2 highlights a shift from direct cross-border lending to local lending by foreign banks’ affiliates. The decline in cross-border lending can be explained by a combination of regulatory changes, weaknesses in bank balance sheets, and macroeconomic factors. This change can positively affect the financial stability of host countries. Cross-border lending tends to compound adverse domestic and global shocks; in contrast, foreign-owned subsidiaries behave less procyclically than domestic banks during domestic crises. Chapter 3 shifts the focus to the asset management industry, particularly “plain-vanilla” products, such as mutual funds. Even these vehicles may pose financial stability risks due to incentive problems between portfolio managers and end investors (which may lead to herding) and due to run risk stemming from liquidity mismatches. The empirical analysis finds evidence for many of these risk-creating mechanisms, although their importance varies across markets. Oversight of the industry should be strengthened.


Contents

Front Matter

Chapter 1: Enhancing Policy Traction And Reducing Risks
Chapter 1 concludes that global financial stability risks have risen since October. They have also been rotating: away from banks to shadow banks, from solvency to market liquidity risks, and from advanced economies to emerging markets. In advanced economies, the key challenge is to enhance the traction of accommodative monetary policies, ensure a smooth normalization of monetary policy in the United States, and manage the undesirable side effects of low interest rates. Emerging markets must address their own domestic financial vulnerabilities from weaker growth, lower commodity prices, and a stronger dollar, while strengthening their resilience to the changing global environment.

Boxes
Chart 1.1     The Oil Price Fallout—Spillovers and Implications for the Financial Sector
Chart
Chart
Chart
1.2    Russia’s Financial Risks and Potential Spillovers
Tables
Data 1.1   Household Debt in the Euro Area, Japan, the United Kingdom, and the United States
Data 1.2   Corporate Debt in the Euro Area, Japan, the United Kingdom, and the United States
1.3   Reallocating Assets: Stylized Investment Choices
Data 1.4   Energy’s Impact on Two Barclays Corporate Credit Indices
Data 1.5   Summary of Sovereign, Corporate, and Banking Indicators
Figures
Chart Data 1.1   Global Financial Stability Map: Risks and Conditions
Chart Data 1.2   Global Financial Stability Map: Components of Risks and Conditions
Chart Data 1.3   Global Disinflationary Forces
Chart Data 1.4   Asset Valuation and Volatility Heat Maps
Chart 1.5   Quantitative Easing Impact Channels
Chart Data 1.6   Private Nonfinancial Sector Gross Debt
Chart Data 1.7   Episodes of Private Sector Deleveraging in Selected Advanced Economies
Chart Data 1.8   Insolvency Frameworks and Macroeconomic Deleveraging
Chart 1.9   Quantitative Easing and Financial Markets
Chart Data 1.10   Illustrative “Baseline” QE Portfolio Rebalancing Scenarios in Japan and the Euro Area
Chart Data 1.11   Bank Lending and Constraints
Chart
Chart
Data 1.12   Bank Nonperforming Loans and Lending Conditions
Chart Data 1.13   Life Insurance Industry Characteristics
Chart Data 1.14   United States: Nonfinancial Corporations
Chart Data 1.15   U.S. Credit Spreads, Firm Leverage, and Interest Coverage
Chart Data 1.16   U.S. High-Yield Energy Markets
Chart Data 1.17   U.S. Interest Rates and Term Premiums
Chart 1.18   Global Interest-Rate Developments
Chart 1.19   The October 15 Flash Rally in U.S. Treasuries
Chart Data 1.20   Asset CoMovements and Correlation Spillovers
Chart Data 1.21   Wide Range in the Inflation Outlook of Emerging Market Economies
Chart Data 1.22   China: Real Estate and Interest Rate Developments
Chart Data 1.23   Emerging Market Nonfinancial Corporate Investment Continues to Shrink
Chart Data 1.24   Dependence of Emerging Market Sovereigns on Commodities, and Market Reaction
Chart Data 1.25   Energy Corporate Sector Metrics
Chart Data 1.26   Large Increase in Emerging Market Debt
Chart Data 1.27   Firms in Countries with Large Currency Selloffs Also Had High Equity Volatility
Chart Data 1.28   Financial Stability of Emerging Market Banks
Annex Tables
Data 1.2.1   Potential Portfolio Outflows by Euro Area Investors, 2015
Data 1.2.2   Japan: A Potential Portfolio Rebalancing Scenario under QQE2, 2015–17
Data 1.2.3   Potential Portfolio Outflows by Japanese Institutional Investors, 2015–17
Annex Figure
Chart Data 1.2.1   Euro Area Negative-Yielding European Government Bonds and Baseline Portfolio Rebalancing

Chapter 2: International Banking After the Crisis: Increasingly Local and Safer?
Chapter 2 analyzes developments in international banking since the global financial crisis. It highlights a shift from direct cross-border lending to local lending by foreign banks’ affiliates. The decline in cross-border lending can be explained by a combination of regulatory changes, weaknesses in bank balance sheets, and macroeconomic factors. This change can positively affect the financial stability of host countries. Cross-border lending tends to compound adverse domestic and global shocks; in contrast, foreign-owned subsidiaries behave less procyclically than domestic banks during domestic crises. More international cooperation is needed to maximize the benefits of international banking while mitigating the risks.

Boxes
Chart
Chart
Chart
Data 2.1   The International Expansion of Chinese and Japanese Banks
Chart
Chart
Data 2.2   The Expansion of Pan-African Banks: Opportunities and Challenges
Chart Data 2.3   Banking Union in Europe
2.4   Global Banks: Regulatory and Supervisory Areas in Need of Attention
Tables
2.1   Effects of International Banking Linkages on the Incidence of Crises
2.2   Main Findings of the Analysis of the Effects of International Banking Linkages on Domestic Credit Growth
Figures
Chart Data 2.1   Developments in Foreign Banking Claims
Chart 2.2   Types of Claims in Bank for International Settlements Consolidated Statistics
Chart Data 2.3   Number of Branches and Subsidiaries of Foreign Banks in 2008 and 2013, by Region
Chart Data 2.4   Banking Regionalization from Asia
Chart Data 2.5   Trends in Latin America and Europe
Chart 2.6   PreCrisis and PostCrisis Geographic Correlation Networks from Banks’ Stock Returns
Chart Data 2.7   Changes in Corporate Borrowing
Chart Data 2.8   Share of Countries that Changed Regulations on International Banking Operations between 2006 and 2014
Chart Data 2.9   Share of Countries that Tightened Regulations on International Banking Operations between 2006 and 2014, by Region
Chart 2.10   Effects of Regulations and Other Factors on International Banking Linkages
Chart Data 2.11    Changes in Capital Flows
Chart 2.12   Effect of International Banking Linkages on Domestic Credit Growth
Chart 2.13   Lending Growth by Domestic and Foreign-Owned Banks during Crises
Chart 2.14   Effect of Parent and Subsidiary Characteristics on Subsidiary Lending Growth

Chapter 3: The Asset Management Industry and Financial Stability
Chapter 3 examines potential risks stemming from the asset management industry, focusing on “plain-vanilla” products, such as mutual funds. Even these vehicles may pose financial stability risks due to incentive problems between portfolio managers and end investors (which may lead to herding) and due to run risk stemming from liquidity mismatches. The empirical analysis finds evidence for many of these risk-creating mechanisms, although their importance varies across markets. Oversight of the industry should be strengthened, with a better microprudential supervision of risks and by adopting a more-encompassing (macroprudential) approach.

Boxes
3.1   Possible Incentive Problems Created by Delegated Management
Chart
Chart
Data 3.2   Fund Share Pricing Rules and First-Mover Advantage
Tables
3.1   Summary Characteristics and Risk Profiles of Major Investment Vehicles
3.2   Mutual Fund Flows and Asset Returns
3.3   Selected Regulations for Publicly Offered Funds
3.4   Summary of Analysis and Policy Implications for Mutual Funds and ETFs
Figures
Chart Data 3.1   Financial Intermediation by the Asset Management Industry Worldwide
Chart Data 3.2   Products Offered by Asset Managers and Their Recent Growth
Chart Data 3.3   Key Domiciles of Mutual Funds
Chart 3.4   Unleveraged Open-End Funds and Systemic Risk
Chart 3.5   Liquidity Mismatches
Chart Data 3.6   Growth in Bond Funds by Investment Focus
Chart Data 3.7   Bond Ownership Concentration and Its Effects on Credit Spreads
Chart Data 3.8   Drivers of Fund Flows from End Investors
Chart 3.9   Convexity of Fund Flow-Performance Relationship
Chart Data 3.10   Liquidity Risk and Fund Structures
Chart 3.11   Brand Name Effects
Chart 3.12   Funds’ Liquidity Risk Management
Chart 3.13   Herding among U.S. Mutual Funds
Chart Data 3.14   Ownership Structure of the 25 Largest Global Asset Management Companies
Chart Data 3.15   Bank Financing by Mutual Funds and Money Market Funds
Chart 3.16   Contribution to Systemic Risk by Mutual Funds
Annex Figures
Chart
Chart
Data 3.1.1   Investment Vehicles by Size, Domicile, and Investment Focus
Chart 3.1.2   Operation of a Fund
Chart 3.2.1   Drivers of Changes in Credit Spreads during Distress Episodes

Statistical Appendix

Figures
Data 1.   Major Net Exporters and Importers of Capital, 2013
2.   Sovereign Credit Default Swap Spreads
3.   Selected Credit Default Swap Spreads
4.   Selected Spreads
5.   Implied Volatility Indices
Data 6.   U.S. Corporate Bond Market
Data 7.   Euro Area Corporate Bond Market
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: Equities
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.

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.