## EXECUTIVE SUMMARY

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### Near-term outlook and systemic trends
- The global financial system continues to strengthen due to extraordinary policy support, regulatory enhancements, and the cyclical upturn in growth.  
- The upswing in global economic activity has boosted market confidence and reduced near-term threats to financial stability.  
- However, continuing monetary accommodation is producing rising asset valuations and higher leverage, shifting financial stability risks from the banking system toward nonbank and market sectors.  
- Too much money chasing too few yielding assets: less than 5 percent ($1.8 trillion) of the current stock of global investment-grade fixed-income assets yields over 4 percent, compared with 80 percent ($15.8 trillion) before the crisis.  
- Leverage in the nonfinancial sector is now higher than before the global financial crisis in the Group of Twenty economies as a whole.  
- Rising private sector debt service ratios in several major economies are stretching debt servicing capacity for weaker borrowers in some countries and sectors. Countries highlighted with already high private nonfinancial sector debt servicing pressures and debt levels include Australia, Canada, China, Korea.

### The two sides of monetary policy normalization
- Baseline expects gradual normalization of monetary policies over several years as inflation recovers only slowly; too fast a pace would remove needed support for recovery and core inflation.  
- Unconventional policies and quantitative easing have prompted substantial portfolio adjustments, making market adjustment less predictable and increasing the risk that abrupt or ill-timed shifts could cause turbulence across borders and markets.  
- Prolonged monetary support may further build financial excesses as the search for yield intensifies and vulnerabilities migrate to the nonbank sector.  
- Downside scenario: a repricing of risks leads to sharp increases in credit costs, falling asset prices, and a pullback from emerging markets. Estimated impacts:
  - Global output would fall 1.7 percent relative to the WEO baseline.
  - The economic impact would be about one-third as severe as the global financial crisis and more broad-based.
  - Monetary normalization would reverse in the United States and stall elsewhere.
  - Estimated $100 billion reduction in portfolio flows to emerging market economies over four quarters.
  - Bank capital would take the biggest hit where leverage is highest and where banks are most exposed to the housing and corporate sectors.

### Deleveraging in China
- China growth and recent financial policy tightening have eased near-term slowdown concerns, but China’s financial system remains large, complex, and growing rapidly with elevated risks.  
- Banking sector assets rose to 310 percent of GDP from 240 percent of GDP at the end of 2012.  
- Growing use of short-term wholesale funding and “shadow credit” has increased bank vulnerabilities.  
- Reducing shadow credit growth even modestly would weigh on profitability and credit provision by small and medium-sized banks.  
- Authorities must balance tightening financial policies against slowing growth; targeting balance sheet vulnerabilities at weak banks and sustaining corporate leverage reduction remain priorities.

### Global banks and insurers
- Global systemically important banks (GSIBs) have stronger balance sheets because of improved capital and liquidity buffers, tighter regulation, and greater market scrutiny.  
- Considerable progress on legacy issues and restructuring, but several banks continue to face legacy and business model challenges.  
- Banks representing about $17 trillion in assets, or about one-third of the GSIB total, may continue to generate unsustainable returns, even in 2019.  
- Supervisory focus should remain on business model risks and sustainable profitability.  
- Life insurers have reduced legacy exposures, steered product mixes away from high guaranteed returns, and sought higher yields; supervisors should monitor rising exposure to market and credit risks.

### Policy recommendations and priority actions
- Fully address crisis legacy problems and require banks and insurance companies to strengthen balance sheets in advanced economies, including:
  - Putting a resolution framework for international banks into operation.
  - Focusing on risks from weak bank business models to ensure sustainable profitability.
  - Finalizing Basel III.
  - Enhancing regulatory frameworks for life insurers to increase reporting transparency and incentives to build resilience.
  - A global and coordinated policy response for cyberattack resilience is needed.
- Major central banks should ensure smooth normalization with well-communicated plans on unwinding securities holdings and guidance on prospective changes to policy frameworks to anchor expectations and avoid market dislocations.  
- Deploy macroprudential measures and consider extending their boundary to curb rising leverage; examples:
  - Introduce and/or tighten borrower-based measures to slow fast-growing overvalued segments.
  - Bank stress tests must assume more stressed asset valuations.
  - Increase capital requirements for banks more exposed to vulnerable borrowers.  
- Strengthen regulation of the nonbank financial sector to limit risk migration and excessive capital market financing:
  - Accelerate transition to risk-based supervision.
  - Introduce harmonized regulation of insurance companies with emphasis on capital.
  - Implement tighter microprudential requirements in highly leveraged segments.
- Address debt overhangs, especially among largest borrowers, by discouraging further debt buildup and encouraging business investment over debt financing.  
- Emerging market economies should use supportive external conditions to enhance resilience, including strengthening external positions and reducing corporate leverage where high; frontier and low-income countries should build institutional capacity for marketable securities issuance and medium-term debt management.  
- In China, continue policies to improve risk management and transparency, reduce maturity and liquidity transformation risks in shadow credit activities, and prioritize reducing corporate leverage.  
- Complete and implement postcrisis reform measures to minimize the likelihood of another disruptive crisis and enable comprehensive evaluation of reform impacts.  
- Implement structural reforms and supportive fiscal policies to lift global growth and generate positive spillovers, reinforcing financial policy efforts.

### Household debt and growth (Chapter 2 findings)
- Household debt-to-GDP ratios increased across countries with a moderated but not reversed trend after the global financial crisis.  
- Advanced economies: household debt to GDP rose from 35 percent in 1980 to about 65 percent in 2016 and has kept growing since the global financial crisis, albeit more slowly.  
- Emerging market economies: household debt to GDP rose from 5 percent in 1995 to about 20 percent in 2016 and has largely continued rising in recent years.  
- There is a trade-off: higher household debt gives a short-term boost to growth but raises medium-term risks to macroeconomic and financial stability (lower growth, consumption, employment, and higher banking crisis risk).  
- The trade-off is stronger when household debt is higher and can be attenuated by appropriate macroprudential and financial sector policies, better financial supervision, less dependence on external financing, flexible exchange rates, and lower income inequality.

### Financial conditions as predictors of growth (Chapter 3 findings)
- Financial conditions provide valuable information about risks to future growth and support targeted preemptive action.  
- The chapter develops a macroeconomic measure linking financial conditions to the probability distribution of future GDP growth across 21 major advanced and emerging market economies.  
- Changes in financial conditions shift the whole distribution of future GDP growth. Wider risk spreads, rising asset price volatility, and waning global risk appetite are significant predictors of increased near-term downside risks; higher leverage and credit growth signal medium-term risks.  
- Current low funding costs and financial market volatility support a sanguine near-term risk view, but rising leverage signals future risks; a rapid decompression in spreads and volatility could significantly worsen the global growth risk outlook.  
- A real-time retrospective analysis shows forecasting models augmented with financial conditions would have assigned a considerably higher likelihood to the economic contraction that followed the global financial crisis than models based on recent growth alone.

*International Monetary Fund | October 2017*

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_Source: https://www.imf.org/-/media/files/publications/gfsr/2017/october/chapter-1/documents/exec-summary.pdf_