## Global Financial Stability Report — October 2018: Preface, Executive Summary, and Chapter 1 Excerpts

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### Global assessment, near-term outlook, and key statistics
- Global expansion remains strong but "has lost some momentum" and "growth may have plateaued in some major economies."
- Diverging prospects across countries due to "tighter financial conditions, rising trade barriers, higher oil prices, and increased geopolitical tensions."
- GFSR reflects information available as of September 14, 2018.
- Tail-risk statistical facts:
  - With a 5 percent probability, emerging market economies (excluding China) could face debt portfolio outflows in the medium term of "$100 billion or more over a period of four quarters (or 0.6 percent of their combined GDP)."
  - The ratio of total non-financial sector debt to GDP in jurisdictions with systemically important financial sectors stands at an all-time high of 250 percent.
  - Total nonfinancial sector debt in jurisdictions with systemically important financial sectors has grown from $113 trillion (more than 200 percent of their combined GDP) in 2008 to $167 trillion (close to 250 percent) by the time of the report.
- Growth projections and revisions:
  - GDP growth in emerging market and developing economies is set to remain at 4.7 percent in 2018–19.
  - The growth outlook was revised down by about 0.3 percentage points in 2018 and roughly 0.4 percentage points in 2019 versus the April 2018 WEO.
- Near-term risks have "recently shifted to the downside and some have partially materialized."

### Financial stability outlook, vulnerabilities, and market conditions
- Near-term risks to financial stability have "increased"; medium-term risks "remain elevated."
- Key vulnerabilities:
  - "High and rising public and corporate debt."
  - "Stretched asset valuations in some major markets."
  - Deteriorating underwriting standards in many segments of market-based finance.
  - Uncertain resilience of market liquidity provision in the new institutional environment.
- Market and regional signals:
  - U.S.: "The Federal Reserve has raised its policy rate 25 basis points since April, marking the seventh hike in the tightening cycle."
  - U.S. equity valuations: cyclically adjusted price-to-earnings ratios are elevated well beyond precrisis levels.
  - Term premiums historically low but largely explained by fundamentals.
  - High-yield corporate bond spreads close to historically low levels; leveraged loan spreads narrowed and covenant quality may be underpriced.
- Market liquidity and new structure:
  - Market liquidity may be more segmented and dependent on high-frequency trading firms and benchmark-driven investors.
  - No clear evidence of broad-based deterioration in major capital market liquidity to date, though flash events have occurred.

### Emerging markets — conditions, flows, and vulnerabilities
- Financial conditions in most emerging market economies tightened since mid-April 2018 due to higher external financing costs, rising idiosyncratic risks, and escalating trade tensions.
- Portfolio flow facts:
  - Emerging market stock and bond funds saw about $35 billion of outflows during the recent sell-off.
  - Historical comparators: taper tantrum (2013) and China devaluation (2015) fund outflows were closer to $60 billion peak to trough.
- External and foreign-currency vulnerabilities:
  - Countries where external debt is too high relative to exports account for roughly 40 percent of aggregate GDP of emerging markets (excluding China).
  - The share of countries with high public debt in aggregate EM GDP (excluding China) has more than doubled since 2008.
  - As of August 2018, over 45 percent of low-income countries were at high risk of, or already in, debt distress (compared with one-third in 2016 and one-quarter in 2013).
- Capital flows-at-risk and tail scenarios:
  - Under a severely adverse scenario (5th percentile), medium-term debt outflows could reach 0.6 percent of combined GDP of emerging market economies (excluding China) over a four-quarter period.
  - A broad-based rise in risk aversion scenario (U.S. corporate spreads +100 basis points, U.S. 10-year yields −30 basis points, U.S. dollar +5 percent) would move near-term capital flows at risk from less than −0.1 percent of GDP to −0.7 percent of GDP.

### Balance-sheet vulnerabilities by sector and region
- Indicators tracked include: corporate net debt to EBITDA; household debt-to-GDP; gross public debt to GDP; bank Tier 1 capital ratios; external debt to GDP; insurance assets to equity; asset manager leverage metrics.
- Sector and regional highlights:
  - United States:
    - Public sector debt continues to climb; federal deficit expansion anticipated to exacerbate debt dynamics.
    - Household debt ratios have declined; corporate leverage moderated since 2015–16 but highly levered and speculative-grade firms account for a growing share of new debt issuance.
    - Non-bank financial entities have increased leverage, including through derivatives.
  - Euro area:
    - Corporate and sovereign leverage remain elevated; nonperforming loans still elevated in some banks.
  - Other advanced economies:
    - Household leverage on an upward trajectory in Australia, Canada, and the Nordic countries.
  - China:
    - Nonfinancial corporate leverage rising and above global historical benchmarks; household debt growth rapid and at the high end for emerging markets.
    - Largest Chinese banks appear better capitalized; vulnerabilities high at small and medium-sized banks.
    - Regulatory tightening led to less favorable credit conditions for weaker borrowers; authorities eased monetary policy to cushion the economy.

### Banking sector resilience, stress testing, and remaining weaknesses
- Postcrisis improvements:
  - Implementation of Basel III capital and liquidity accords; global median common-equity-to-asset ratio increased by more than 2 percentage points since 2010.
  - Widespread adoption of stress testing and stronger supervisory intensity for large banks.
  - Liquidity buffers and LCR reporting generally above 100 percent.
- Remaining bank-sector concerns:
  - Market aggregate price-to-book ratios less than one in the euro area, China, Japan, and the United Kingdom.
  - Simulated stress finds institutions representing 7 percent of sample bank assets have a simulated stress capital need in 2018 (most in the euro area).
  - Level 2 and Level 3 assets remain significant multiples of capital for some G-SIBs; a decline of less than 5 percent in value could reduce leverage ratios by 100 basis points for some.
  - Sovereign–bank nexus persists as banks’ holdings of government bonds remain large.

### Market infrastructure, CCPs, fintech, and cyber risk
- CCPs concentrated credit risk from centrally cleared derivatives; margin calls and haircuts procyclical as cycles worsen.
- Fintech growth rapid but still relatively small; regulatory challenge to support innovation while safeguarding stability.
- Cyber threats are an evolving financial stability concern; many supervisors lack dedicated cyber units and skills.

### Policy recommendations and priorities
- Complete and implement the global regulatory reform agenda; "resist the call to roll back reforms."
- Macro- and microprudential policies:
  - Develop and deploy macro- and microprudential measures as warranted.
  - "More active use of countercyclical capital buffers may have merit at this juncture."
  - Deploy broad-based macroprudential tools timely to address rising debt levels, loosening underwriting standards, and stretched housing valuations.
  - Develop new macroprudential tools for vulnerabilities outside the banking sector, including for asset managers and insurers.
- Bank-specific and supervisory actions:
  - Monitor bank lending to highly indebted private and sovereign borrowers and exposures to opaque or illiquid assets.
  - Develop currency-specific liquidity risk frameworks and monitor liquidity at individual entity levels within banking groups.
  - Continue to intensify supervision, including onsite work for systemic institutions.
- Emerging market policies to manage external risks:
  - Tackle vulnerabilities and enhance resilience with appropriate mix of fiscal, monetary, exchange rate, and prudential policies.
  - Maintain credible policy frameworks, strengthen governance, and build buffers (foreign exchange reserves, fiscal buffers).
  - Capital flow management measures may be appropriate only in crisis or near-crisis situations; they should be transparent, temporary, and nondiscriminatory and not substitute for macroeconomic adjustment.
  - Develop local bond markets and a stable local investor base to reduce reliance on foreign investors and currency mismatches.
- Cross-border and multilateral cooperation:
  - Strengthen home-host collaboration, regulatory coordination, and enhanced resolution planning and information sharing.
  - Preserve multilateral policy coordination; avoid regulatory fragmentation and regulatory arbitrage.
  - Central bank swap lines and coordinated liquidity support remain important crisis tools.
- Addressing data and perimeter gaps:
  - Improve data availability (DGI and SDDS Plus progress) and fill sectoral and cross-border data gaps, especially for shadow banking and nonbank interconnections.
  - Expand macroprudential frameworks and tools beyond banks, including for insurers and asset managers.

### Scenarios, stress tests, and GaR findings
- Growth-at-Risk (GaR) approach:
  - Focuses on the 5th percentile (5 percent probability) of forecasted growth distributions.
  - Near-term risks to global financial stability have increased modestly over the past six months; medium-term risks remain elevated.
  - Box 1.1 GaR exercise: an extreme escalation of trade tensions modeled as a roughly 100 basis point widening of U.S. credit spreads and a 12 percent drop in U.S. equity prices shifts the lower 5th percentile of the growth distribution leftward by about 1.5 percentage points near term.
- Key risk triggers identified:
  - Further escalation of trade tensions.
  - A sudden deterioration in risk sentiment from geopolitical or policy uncertainty.
  - Faster-than-anticipated monetary policy normalization in major economies causing sudden tightening of global financial conditions.
  - Political events (for example, no-deal Brexit or fiscal concerns in highly indebted euro area countries) could spike risk aversion.

*Prepared by IMF staff; Executive Board discussion concluded on September 20, 2018. Source: Global Financial Stability Report, October 2018 — "A DECADE AFTER THE GLOBAL FINANCIAL CRISIS: ARE WE SAFER?"*

### Preface                                                                                                                 

### Preface

### Overview
- Ten years since the failure of Lehman Brothers, the global economy continues to grow and "progress toward a safer global financial system is undeniable."
- New supervisory and regulatory standards, tools, and practices have been developed and implemented globally.
- Many shadow-banking activities that contributed to the global financial crisis have been "curtailed or transformed into safer market-based finance."
- Nevertheless, "is the financial system safe enough?"—clouds appear on the horizon, including uneven recovery, rising inequality, inward-looking policies, increased policy uncertainty, and emerging trade tensions.

### Key statistics and trends
- The GFSR reflects information available as of September 14, 2018.
- With a 5 percent probability, emerging market economies (excluding China) could face debt portfolio outflows in the medium term of "$100 billion or more over a period of four quarters (or 0.6 percent of their combined GDP)."
- "The ratio of total non-financial sector debt to GDP in jurisdictions with systemically important financial sectors stands at an all-time high of 250 percent."
- "Total nonfinancial sector debt in jurisdictions with systemically important financial sectors has grown from $113 trillion (more than 200 percent of their combined GDP) in 2008 to $167 trillion (close to 250" [text continues in source].

### Near-term conditions and vulnerabilities
- Global financial markets have remained buoyant and appear complacent about the risk of a sudden, sharp tightening in financial conditions.
- A combination of rising U.S. interest rates, a stronger dollar, and intensifying trade tensions have already led to market pressures and capital outflows in some emerging market economies.
- Market pressures have to date been largely idiosyncratic among emerging markets, with "little evidence of broader spillovers to the asset class at this point."
- Robust global risk appetite has masked the challenges emerging markets could face should global financial conditions suddenly tighten sharply.

### Medium-term risks
- Medium-term risks remain elevated as easy financial conditions contribute to further buildup of financial vulnerabilities.
- Key vulnerabilities cited include:
  - High and rising leverage levels in the nonfinancial sector.
  - Stretched asset valuations across several sectors and regions.
  - Deteriorating underwriting standards, including in many segments of market-based finance.
  - Uncertain resilience of market liquidity provision in the new institutional environment.

### Emerging markets: recent developments
- Financial conditions in advanced economies remain accommodative, particularly in the United States, with "interest rates still low by historical standards, risk appetite robust, and asset valuations rising in major markets."
- Financial conditions have remained broadly stable in China, where authorities have eased monetary policy to offset external pressures and the impact of tighter financial regulations.
- Financial conditions in most emerging market economies have tightened since mid-April, driven by higher external financing costs, rising idiosyncratic risks, and escalating trade tensions.

### Scenario and stress considerations
- Near-term risks to global financial stability—assessed using the growth-at-risk (GaR) approach—have increased somewhat over the past six months.
- A much sharper tightening of financial conditions in advanced economies would significantly increase short-term risks.
- An intensification of concerns about resilience and policy credibility in emerging markets may lead to further capital outflows and rising global risk aversion.
- A broader escalation of trade actions may undermine investor confidence and harm the economic expansion.
- Political and policy uncertainty (for example, in the event of a no-deal Brexit or reemerging fiscal concerns in some highly indebted euro area countries) could adversely affect market sentiment and lead to a spike in risk aversion.
- With inflation firming, "central banks may step up the pace of monetary policy normalization, which could lead to a sudden tightening of global financial conditions."

### Policy recommendations and priorities
- Countries should "complete and implement the global regulatory reform agenda and ... resist the call to roll back reforms."
- To counteract rising vulnerabilities, "macro- and microprudential policies should be developed and deployed, as warranted."
- Example policy action: "more active use of countercyclical capital buffers may have merit at this juncture."
- Prudential regulation and supervision should remain attentive to, and lean against, emerging risks, including those related to cyberthreats, new technologies, and other risky activities outside the regulatory perimeter.
- International cooperation is crucial for maintaining global financial stability and fostering sustainable economic growth.
- The IMF "remains a key player for promoting cooperative financial policies."

### Conventions and editorial notes (selected)
- Symbols used in the report:
  - . . . to indicate that data are not available or not applicable;
  - — to indicate that the figure is zero or less than half the final digit shown or that the item does not exist;
  - – between years or months (for example, 2017–18 or January–June) to indicate the years or months covered, including the beginning and ending years or months;
  - / between years or months (for example, 2017/18) to indicate a fiscal or financial year.
- Definitions:
  - "Billion" means a thousand million.
  - "Trillion" means a thousand billion.
  - "Basis points" refers to hundredths of 1 percentage point (for example, 25 basis points are equivalent to ¼ of 1 percentage point).
- If no source is listed on tables and figures, data are based on IMF staff estimates or calculations.
- Minor discrepancies between sums of constituent figures and totals shown reflect rounding.

*Preface, Global Financial Stability Report, October 2018 (text provided).*

### EXECUTIVE SUMMARY

### EXECUTIVE SUMMARY

### Global assessment and near-term outlook
- The global expansion remains strong but "has lost some momentum" and "growth may have plateaued in some major economies."
- Prospects increasingly diverge among countries due to differences in policy stances and the combined impact of "tighter financial conditions, rising trade barriers, higher oil prices, and increased geopolitical tensions."
- Beyond 2019, growth in most advanced economies is expected to be held back by "slow labor force growth and weak labor productivity."
- In emerging market and developing economies, growth is projected to remain relatively robust, though income convergence toward advanced economy levels would be less favorable for countries undergoing substantial fiscal adjustment, economic transformation, or conflicts.
- Near-term risks to the global outlook have "recently shifted to the downside and some have partially materialized," including:
  - Rising trade barriers with adverse consequences for investment and growth.
  - Tightening of financial conditions in most emerging market and developing countries since mid-April 2018.
  - Declines in capital flows to some countries reflecting "weak fundamentals, higher political risks, and/or U.S. monetary policy normalization."
- Advanced-economy financial conditions remain broadly accommodative; an inflation surprise could trigger "an abrupt tightening of monetary policy and an intensification of market pressures."

### Financial stability outlook and vulnerabilities
- Near-term risks to financial stability have "increased" while medium-term risks "remain elevated."
- Key vulnerabilities include:
  - "High and rising public and corporate debt."
  - "Stretched asset valuations in some major markets."
  - Banks remain exposed to "highly indebted companies, households, and sovereigns; to their holdings of opaque and illiquid assets; or to their use of foreign currency funding."
  - Continued rise of external borrowing in most emerging market economies, posing challenges where countries "lack adequate reserve buffers or strong domestic investor bases."
- Since mid-April 2018, "rising U.S. interest rates and a stronger U.S. dollar—coupled with intensified trade tensions—have triggered a reversal in portfolio flows, an increase in borrowing costs, and a weakening in local currencies in some emerging markets."
- Country-specific episodes cited:
  - "In some emerging markets, notably Turkey and Argentina, external vulnerabilities and country-specific risks have led to outsized currency depreciations" with intensified concerns about domestic banks and spillovers.
  - "Increased balance of payments pressures in Argentina prompted the request for external assistance."
  - "In advanced Europe, Italian government bond spreads have widened and risky asset prices have fallen," and Brexit concerns remain high.

### Regulatory reforms and financial system resilience
- The broad international regulatory agenda has "helped strengthen the global banking system."
- Some forms of shadow banking have been "curtailed."
- "Most countries now have a macroprudential authority and some tools" to oversee and contain systemic risks.
- Emerging frictions and fragmentation risks:
  - Regulators are increasingly focusing on "the liquidity of individual entities within international banking groups," which can aid resolution but may "fragment liquidity in international banking groups."
  - Market liquidity appears more segmented across trading platforms; while no broad-based deterioration is evident, "careful monitoring of liquidity conditions is warranted."
- The report emphasizes completing the regulatory reform agenda and avoiding "a rollback of reforms."

### Policy recommendations and priorities
- Use financial regulation and supervision more proactively to address systemic risks.
- Deploy broad-based macroprudential tools, including "countercyclical capital buffers," more actively where financial conditions remain accommodative and vulnerabilities are high.
- Develop new macroprudential tools for vulnerabilities outside the banking sector.
- Regulators and supervisors must remain attentive to new risks, notably from "cybersecurity, financial technology, and other institutions or activities outside the perimeter of prudential regulation."
- As monetary policy normalizes in advanced economies, emerging market and developing economies should prepare for "tighter financial conditions and higher volatility" by:
  - Tackling vulnerabilities and enhancing resilience with an appropriate mix of fiscal, monetary, exchange rate, and prudential policies.
  - Recognizing that "capital flow management measures may be appropriate but not as a substitute for macroeconomic adjustment."
  - Maintaining credible policy and institutional frameworks, strengthening governance, and improving human and physical capital.
- For low-income developing countries:
  - Prioritize "building resilience, lifting potential growth, improving inclusiveness, and making progress toward the 2030 Sustainable Development Goals."
  - Commodity exporters should prioritize "economic diversification."
  - Create room for development expenditure by "broadening the tax base, improving revenue administration, and prioritizing spending on health, education, and infrastructure, while cutting wasteful subsidies."
  - Urgent action is needed to "contain debt vulnerabilities," and both debtors and creditors "share a responsibility for ensuring sustainable financing practices and enhancing debt transparency."
- Public sector balance sheet analysis is useful to reveal public assets alongside debt and nondebt liabilities, helping to identify risks and manage assets and liabilities; limitations include "data quality and differences in accounting practices."

### Financial conditions and monetary policy dynamics
- Financial conditions have diverged: "Financial conditions in advanced economies have remained accommodative, while conditions have tightened in emerging markets."
- United States:
  - "The Federal Reserve has raised its policy rate 25 basis points since April, marking the seventh hike in the tightening cycle."
  - "Near-term market-implied interest rate expectations have drifted higher, but still lag the median policy rate expectations of the Federal Open Market Committee."
  - Despite monetary policy tightening, U.S. financial conditions have "eased further as a result of continued strong risk appetite and rising asset valuations."
- Globally:
  - "The monetary policy normalization by a number of major central banks has advanced since the last GFSR."
  - Nonetheless, "global interest rates continue to be low by historical standards."
  - Continued withdrawal of monetary accommodation is expected to tighten financial conditions and potentially reveal accumulated financial vulnerabilities.

### Key scenarios and risks highlighted
- A further escalation of trade tensions, rising geopolitical risks, or heightened policy uncertainty in major economies could:
  - Lead to "a sudden deterioration in risk sentiment."
  - Trigger "a broad-based correction in global capital markets and a sharp tightening of global financial conditions."
- Specific risks requiring vigilance:
  - Liquidity conditions, especially within international banking groups and capital markets.
  - New and evolving risks from cybersecurity and financial technology.
  - Vulnerabilities outside the perimeter of prudential regulation.

*Prepared by IMF staff; Executive Board discussion concluded on September 20, 2018. Source: Global Financial Stability Report, October 2018 — "A DECADE AFTER THE GLOBAL FINANCIAL CRISIS: ARE WE SAFER?"*

### 3. Financial Conditions Index: United States

### 3. Financial Conditions Index: United States

### FOMC projections and market-implied policy rates; U.S. financial conditions
- Market expectations of U.S. rates have drifted higher but remain below the Federal Reserve’s dot plot.
- The slope of the U.S. Treasury yield curve has flattened to its lowest level since before the global financial crisis.
- U.S. stocks have experienced the longest rally in recent history following strong growth and tax reform.

### Financial conditions across major regions and China
- Euro area and other major advanced economies:
  - Financial conditions have remained relatively easy, driven by still-accommodative monetary policies and strong global risk appetite.
  - The ECB announced its intention to end its bond purchase program by the end of 2018 and said it would keep interest rates on hold at least through summer 2019, subject to incoming data.
  - Investors have pushed out the expected timing of the first ECB policy rate hike; German long-term yields have fallen since April 2018.
- United Kingdom:
  - Market concerns about a no-deal Brexit have increased, driving sterling volatility to a five-month high and suppressing corporate valuations.
- Japan:
  - The Bank of Japan signaled it would maintain current extremely low interest rates for an extended period and allow for a wider band around its long-term target for 10-year government bond yields.
- China:
  - Financial conditions broadly stable; easing in monetary policy largely offset the impact of external pressures.
  - China’s equity markets have weakened on rising trade tensions.
  - Tighter liquidity from earlier regulatory de-risking and deleveraging led to pockets of stress in corporate bond markets, prompting authorities to ease monetary policy.
  - The central bank injected liquidity via cuts to the required reserve ratio and through lending facilities.
  - The exchange rate weakened further, down 7 percent against the U.S. dollar (and down 5 percent compared with a basket of 24 currencies) since mid-June, prompting authorities to reintroduce a 20 percent reserve requirement for foreign exchange forwards.
- Other systemically important emerging market economies:
  - Combination of country-specific political or policy uncertainties and worsening external financing conditions led to a significant tightening of financial conditions in more vulnerable economies.
  - On aggregate, financial conditions remain broadly accommodative relative to historical levels.
  - Most emerging markets have responded to market turbulence and the U.S. dollar rally by hiking policy rates or effectively ending monetary easing; some have intervened in foreign exchange markets while others have allowed exchange rates to absorb shocks.

### Near-term risks to global financial stability (Growth-at-Risk findings)
- Overall global financial conditions have tightened a notch relative to six to twelve months earlier, despite notable easing in U.S. financial conditions.
- Application of the GaR (growth-at-risk) approach:
  - Suggests near-term risks to global financial stability have increased modestly compared with the last GFSR, while medium-term risks remain elevated.
  - The GaR approach focuses on the 5th percentile of the forecasted growth distribution (the GaR threshold), representing growth outcomes that occur with 5 percent probability.
  - The impact of tightening global financial conditions over the past six months on the estimated distribution of global growth outcomes one year ahead implies a modest increase in near-term risks versus April 2018.
  - Relative to historical norms, near-term risks are still fairly subdued, while medium-term risks continue to be elevated.

### Scenarios and key near-term risk triggers
- A sharp tightening of global financial conditions could be triggered by:
  - Further escalation of trade tensions.
  - A sudden shift in risk sentiment from rising geopolitical risks or policy uncertainty in major economies.
- Specific vulnerabilities in such scenarios:
  - Countries with high external debt, substantial financing or rollover needs, limited policy space, and weak reserve buffers would be particularly vulnerable to capital outflows and rising global risk aversion.
  - Escalation of trade tensions to systemic levels could tighten financial conditions significantly and increase tail risk to global growth and financial stability.
  - A rise in political and policy uncertainty (for example, fiscal uncertainty in highly indebted euro area countries or a breakdown in Brexit negotiations) could damage market confidence and create contractual and operational uncertainties.
  - Faster-than-anticipated monetary policy normalization in advanced economies (for instance, due to firmer-than-expected inflation in the United States) could lead to sudden tightening of global financial conditions and spillovers to emerging markets.

### Financial vulnerabilities and debt dynamics
- Total nonfinancial sector debt in countries with systemically important financial sectors:
  - Now stands at $167 trillion, or over 250 percent of aggregate GDP, compared with $113 trillion (210 percent of GDP) in 2008.
- Higher debt has increased nonfinancial sector sensitivity to interest rate changes.
- Sectoral and regional vulnerabilities:
  - United States:
    - Risks continue to build in the public sector; public sector debt has continued to climb, with anticipated federal deficit expansion exacerbating already-unsustainable debt dynamics.
    - Household debt ratios have declined, and corporate sector leverage moderated since 2015–16 due to improved profitability.
    - The share of highly levered and speculative-grade firms in new debt issuance has grown; highly leveraged deals account for a growing share of new leveraged loan issuance and have surpassed precrisis highs.
    - Bank balance sheets have strengthened, but non-bank financial entities have increased leverage, including through derivatives.
  - Euro area:
    - Leverage in corporate and sovereign sectors remains elevated.
    - The share of lower-rated companies has increased; public sector debt remains elevated in several economies.
    - Bank capital positions have improved, but weaknesses remain, including tight sovereign-bank links and still-elevated nonperforming loans in some banks.
    - Market participants have become concerned about cross-border exposures of euro area banks to vulnerable emerging market borrowers.
  - Other advanced economies:
    - Leverage remains moderate to high across several sectors.
    - Household leverage is a key concern, with household debt to GDP on an upward trajectory in a number of countries—notably Australia, Canada, and the Nordic countries.
  - Japan:
    - Household and corporate balance sheets appear sound, but low profitability has created potential financial sector vulnerabilities, including foreign currency funding positions.

### Indicators highlighted in figures and charts (as presented)
- Growth-at-Risk (GaR) concept focuses on the 5th percentile (5 percent probability) of forecasted growth distributions.
- Financial conditions and GaR indicators are tracked by:
  - Global Financial Conditions Index (standard deviations).
  - Near- and medium-term GaR forecast percentile ranks.
  - Distribution shifts in one-year-ahead and three-year-ahead growth forecasts conditional on current financial conditions and vulnerabilities.
- Balance sheet vulnerability metrics include:
  - Total nonfinancial sector debt (trillions of U.S. dollars; percent of GDP).
  - Households: Debt to GDP by region (percent).
  - U.S. and European leveraged loan issuance by leverage multiple (percent of issuance).
  - Quality breakdown of investment-grade index (percent of index with BBB ratings).
  - Banking system capital ratios by region (percent).
  - Banks’ gross nonperforming loans by region (percent).

*Source: IMF staff estimates and analysis as presented in the chapter.*

### CHAPTER 1 A DECADE AFTER ThE GLOBAL FINANCIAL CRISIS: ARE WE SAFER?

### CHAPTER 1 A DECADE AFTER ThE GLOBAL FINANCIAL CRISIS: ARE WE SAFER?

### Leverage and Balance-Sheet Vulnerabilities by Sector and Region
- Indicators covered (as measured in the chapter and Figure 1.7):
  - Corporate sector: net debt to EBITDA, EBITDA to assets, interest coverage ratios, corporate debt to GDP.
  - Households: household debt-to-GDP and debt-service ratios (nonfinancial sector for emerging market economies).
  - Sovereigns: gross public debt to GDP.
  - Banks: equity to assets and Tier 1 capital ratio.
  - External sector: external debt to GDP.
  - Insurance: assets to equity, credit to assets, portfolio fraction of bonds rated BBB or lower, default probabilities within the next three years.
  - Asset managers and other nonbank financial sectors: assets to equity, credit to assets, incurred debt to assets, loans to assets.
- Regional aggregation and samples:
  - Red shading indicates a value in the top 20 percent of pooled samples of advanced or emerging market economies for nonfinancial corporations, households, and the external sector, and of all countries for remaining sectors from 2000 through 2018 (or longest sample available).
  - Other systemically important advanced economies include Australia, Canada, Denmark, Hong Kong SAR, Japan, Korea, Norway, Singapore, Sweden, Switzerland, and the United Kingdom.
  - Other systemically important emerging economies include Brazil, India, Mexico, Poland, Russia, and Turkey.

### China: Deleveraging, De-risking, and Emerging Vulnerabilities
- Key findings:
  - Nonfinancial corporate sector leverage in China has been rising and is currently well above global historical benchmarks (Figure 1.7).
  - Household debt growth in China has been rapid and is now at the high end for emerging markets, despite low loan-to-value ratios.
  - Largest Chinese banks appear better capitalized; vulnerabilities at small and medium-sized banks are high.
  - Strong demand for high-yielding investment products spurred rapid growth in complex investment vehicles; authorities introduced new asset management rules to curb these developments.
- Effects of regulatory tightening:
  - Tighter financial regulation aimed at deleveraging and de-risking has led to less favorable credit conditions for weaker borrowers (Figure 1.8).
  - To cushion the impact of regulatory tightening on the economy, authorities have eased monetary policy and softened implementation of proposed new rules.
  - These easing measures may support near-term economic growth but could entail greater risks to financial stability over the medium term if they delay progress in reducing financial vulnerabilities.
- Additional indicators shown (Figure 1.8):
  - Investment products and small-to-medium bank claims on financial institutions (three-month change, trillions of renminbi).
  - Corporate defaults and corporate bond spreads (billions of renminbi, basis points).
  - Leverage at nonfinancial traded companies (top 100 Chinese firms by assets).

### Asset Valuations and Market Pricing Risks
- General assessment:
  - Asset valuations are relatively high in some markets, notably the United States; model results are sensitive to assumptions about corporate earnings, GDP growth, and inflation.
  - Government bond valuations appear broadly consistent with fundamentals, but term premiums are historically low.
- Specific observations:
  - U.S. equity market valuations appear stretched; cyclically adjusted price-to-earnings ratios are elevated well beyond precrisis levels (Figure 1.9, panel 1).
  - U.S. equity prices appear modestly higher than model-based fair values using alternative S&P 500 earnings expectations and proxies for the risk-free rate and equity risk premium (Figure 1.9, panel 2).
  - Market-implied equity volatility is notably below model-based forecasts across most major equity markets and over different horizons (Figure 1.9, panel 3).
  - Term premiums remain at historically low levels but appear largely explained by fundamentals (Figure 1.9, panel 4); they can adjust meaningfully to revisions in expectations for inflation, growth, and monetary policy.
  - High-yield corporate bond spreads remain close to historically low levels in absolute terms and when scaled by leverage; bond spreads appear too low after accounting for expected default rates (Figure 1.9, panel 5).
  - Leveraged loan spreads have narrowed appreciably and markets may be underpricing deterioration in covenant quality (Moody’s 2018).
  - Housing market valuations (price-to-income, price-to-rent, mortgage costs) have risen over the past six years in major advanced economies, with valuations relatively high in Australia, Canada, and the Nordic countries (Figure 1.9, panel 6).

### Market Liquidity and the New Postcrisis Financial Structure
- Structural changes and risks:
  - Market liquidity may have become more segmented across trading platforms and more dependent on high-frequency trading firms, benchmark-driven institutional investors, and less price-sensitive participants (such as central banks).
  - Poor market liquidity could amplify shocks and exacerbate asset price adjustments, raising risks to financial stability.
- Current assessment:
  - So far, there is no clear evidence of a meaningful deterioration of market liquidity in major capital markets, though accommodative monetary conditions could be masking frictions.
  - Liquidity has evaporated briefly during a few specific events (flash crashes); to date such events have had minimal lasting impacts on asset prices and real activity (see Box 1.4 for U.S. equity market events).
- Outlook:
  - A less favorable macroeconomic environment, continued monetary policy normalization, and further financial stress in emerging markets may test these new market structures; liquidity conditions should be closely monitored.

### Fragilities in Emerging and Frontier Markets
- Recent tightening of financial conditions:
  - Financial conditions in emerging markets tightened since mid-April, driven by a stronger dollar, rising idiosyncratic political and policy risks, and escalating trade tensions.
  - Market pressures were more pronounced in countries with larger external imbalances and weaker policy frameworks.
- Portfolio flows and market moves:
  - Nonresident capital flows to emerging markets slowed in recent quarters; portfolio flows reversed starting in mid-April after strong inflows in 2017 and early 2018.
  - Emerging market stock and bond funds saw about $35 billion of outflows (Figure 1.10, panel 1).
  - For context, fund outflows during the taper tantrum episode in 2013 and the China devaluation episode in 2015 were closer to $60 billion from peak to trough.
  - Initially pressures were more pronounced in bond markets; equity outflows accelerated in June amid fears of escalating trade tensions.
  - As trade tensions escalated in June, market pressures shifted to currencies of export-oriented economies (mostly in Asia) and to emerging market equities.
- Central bank and policy responses:
  - Several emerging market central banks responded with interest rate hikes and foreign exchange interventions.
  - Argentina and Turkey raised policy rates sharply.
  - Countries already tightening (including Indonesia, Mexico, and the Philippines) hiked rates by more than markets had expected.
  - Foreign exchange interventions were conducted in the spot market (Argentina, Indonesia) and via derivatives (Argentina, Brazil, India, Turkey).
  - Chinese authorities maintained more accommodative monetary policy via cuts in reserve requirements and guiding short-term rates lower, but also adjusted policies to support the currency as trade tensions rose.
- Growth and outlook:
  - Although aggregate vulnerabilities in emerging markets remain moderate relative to historical levels, external leverage has continued to rise across most countries.
  - The combination of a stronger dollar, higher credit spreads, weaker equity prices, and higher domestic interest rates has tightened financial conditions in emerging markets to a degree comparable, on aggregate, to the taper tantrum episode (see Figure 1.11).
  - The external environment is likely to remain challenging: monetary policy normalization in advanced economies, reduced portfolio flows, and a potential sharp deterioration in global risk sentiment could intensify portfolio outflows from emerging and frontier markets.

*International Monetary Fund | October 2018*

### 1. Emerging Market (Excluding China) Financial Conditions Index

### 1. Emerging Market (Excluding China) Financial Conditions Index

### Growth Outlook and Recent Revisions
- GDP growth in emerging market and developing economies is set to remain at 4.7 percent in 2018–19.
- The growth outlook has been revised down by about 0.3 percentage points in 2018 and roughly 0.4 percentage points in 2019 compared with the April 2018 WEO, reflecting a more subdued outlook for large economies in Latin America (Argentina, Brazil, Mexico) and a sharp slowdown in Turkey.

### Investor Differentiation and Asset Moves
- Investors have continued to differentiate between borrowers based on economic fundamentals and country-specific factors; widening of spreads on hard currency sovereign bonds has been more pronounced in lower-rated issuers.
- Large depreciations in some emerging markets (such as Argentina and Turkey) can be largely explained by idiosyncratic factors; conversely, some currencies benefited from positive country-specific political developments (Mexico, Colombia).
- Emerging market exchange rates have become more correlated since early July, but correlation between their idiosyncratic components remains very low.
- A subset of emerging market currencies has been significantly more volatile than others.
- Spillover indices in emerging currency and equity markets have picked up recently but remain below the highs seen in recent years.

### Bond Issuance and Frontier Market Stress
- First-time and lower-rated international bond issuers were hit hard during the recent sell-off.
- International bond issuance for all emerging market borrowers reached a record monthly pace of about $70 billion between January and April 2018; summer issuance fell below $20 billion per month.
- The slowdown in issuance has been evident for low-income and other frontier market issuers; some have delayed external issuance plans or turned to international financial institutions for support.
- Frontier market borrowers with sizable hard-currency bond redemptions over the next five years compared with their reserve buffers include Ecuador, Pakistan, Sri Lanka, and Zambia.
- For many issuers, the amount of hard currency sovereign bonds maturing is set to rise only marginally in 2019 and remain small until the end of 2021; for some frontier market sovereigns, a sudden tightening of global financial conditions could coincide with large external rollover needs.

### External Environment and Capital Flow Risks
- Emerging markets face headwinds from faster monetary policy normalization in advanced economies, a strong U.S. dollar, rising interest rates, trade tensions, policy uncertainty, and contagion risks associated with high leverage and large external financing needs.
- Retail outflows have been sizable and inflows from institutional investors have slowed considerably.
- Market participants revised upward expectations for the likely path of interest rates, pricing in about 90 basis points of additional interest rate hikes over the next two years.
- The realized upward shift in market pricing for the federal funds rate from October 2017 to August 2018 was about 90 basis points. The October 2017 GFSR baseline assumed market pricing would shift up by about 40 basis points over the first 12 months and another 45 basis points by the end of 2019; the new GFSR baseline assumes an additional upward shift in market expectations for the future federal funds rate of 50 basis points.
- Estimated cumulative impact on portfolio flows: a realized impact so far of an estimated $20 billion, and an additional drag of about $10 billion by the end of 2019.
- Based on estimates, deterioration in external factors could lead to a $50 billion reduction of inflows in 2018, easing modestly to an additional $40 billion reduction in 2019.

### Capital Flows-at-Risk Analysis and Tail Scenarios
- The analysis uses a quantile regression framework to assess capital flows at risk over the near term (current and next two quarters) and the medium term (five to eight quarters ahead). Three main predictive factors for portfolio debt flows are risk appetite, U.S. market interest rates, and the U.S. dollar.
- Current outlook for medium-term portfolio flows is relatively unfavorable: high downside risks driven by elevated U.S. interest rates, a strong dollar, and favorable global risk appetite.
- Under a severely adverse scenario (the 5th percentile of the probability distribution), medium-term debt outflows could reach 0.6 percent of the combined GDP of emerging market economies (excluding China), on par with outflows seen during the global financial crisis (measured over a four-quarter period).
- The estimated outflows under this tail-risk scenario are much higher than in 2011:Q4 (the height of the Euro-area sovereign debt crisis).
- If there is a broad-based rise in risk aversion (scenario where spreads on U.S. corporate bonds rise by 100 basis points, U.S. 10-year yields fall 30 basis points, and the U.S. dollar appreciates by 5 percent), near-term capital flows at risk would drop from less than –0.1 percent of GDP to −0.7 percent of GDP; medium-term risks would abate but remain significant.

### Key Vulnerabilities and Buffers (as presented)
- Buffers and strengths:
  - Sound policy frameworks
  - Foreign exchange reserves
  - Fiscal buffers
  - Deep and liquid local markets
  - Strong local investor base
- Risks and vulnerabilities:
  - Faster monetary policy normalization in advanced economies
  - Strong U.S. dollar
  - Rising interest rates
  - Political risks
  - Trade tensions
  - Policy uncertainty
  - Contagion from high leverage
  - Large external financing needs
  - Short-term foreign currency debt
  - Flighty investors
  - Trade exposures

_International Monetary Fund | October 2018_

### 6. Risk-Aversion Scenario: Medium-Term Debt Portfolio Flows

### 6. Risk-Aversion Scenario: Medium-Term Debt Portfolio Flows

### Forecast densities and portfolio flows
- Portfolio flows to emerging market economies have been under pressure in recent months and are expected to remain subdued given the external backdrop.
- Historical reference points noted: "Before taper tantrum (2013:Q1)", "Year ago (2017:Q2)", "Latest (2018:Q2)".
- Portfolio flows are analyzed in percent of EM GDP (figures shown across time 2013–2018).
- Total flows, institutional flows, and retail flows are distinguished in the analysis.
- Scenario markers and shocks referenced: Renminbi devaluation, U.S. election, EM sell-off, Taper tantrum.
- Probability density plots shown for baseline outlook through 2018:Q3 (estimates through 2018:Q3).

### High levels of external and foreign-currency debt as vulnerabilities
- External debt has increased much faster than exports in many emerging markets.
- Countries where external debt is too high relative to exports now account for roughly 40 percent of aggregate GDP of emerging markets (excluding China).
- Current account imbalances of emerging market economies have decreased since 2013 in aggregate, with examples: China and oil exporters saw surpluses narrow; Brazil, India, Indonesia, Mexico, and South Africa shrank current account deficits.
- Public sector vulnerabilities:
  - The share of countries with high public debt in aggregate GDP of emerging markets (excluding China) has more than doubled since 2008.
  - Roughly one-third of countries exhibit a high share of foreign currency debt.
  - Countries that have both high public sector debt and a high share of foreign currency debt are relatively few, including Lebanon, Tunisia, and Ukraine.
- Low-income country debt distress:
  - As of August 2018, over 45 percent of low-income countries were at high risk of, or already in, debt distress, compared with one-third in 2016 and one-quarter in 2013.

### Corporate sector leverage and firm-level debt risk
- Firm-level data across a sample of 14,000 non-financial firms indicate high leverage has stretched debt-repayment capacity in some economies.
- Metrics cited include average interest coverage ratios and the proportion of debt owed by firms with interest coverage ratios of less than 1 (debt at risk).
- Median debt at risk has declined recently across regions, though challenges persist in some countries in Latin America and in emerging Asia.

### Reserve buffers and potential foreign exchange liquidity drains
- IMF assessment of reserve adequacy (ARA) metric identifies countries with large stocks of external liabilities relative to foreign exchange reserves, including Argentina, South Africa, and Turkey.
- Turkey and Argentina have increased their shares of external foreign-currency debt since 2013, exposing them to foreign exchange mismatch and rollover risks; South Africa has maintained a large share of local currency liabilities.
- Potential drains on reserves include:
  - Large short-term debt liabilities to foreigners or a loss of export income.
  - Contingent liabilities of the central bank or operations in derivatives markets (for example, reserves borrowed through a short-term foreign exchange swap).
- Reserves linked to derivatives transactions or provisions allowing banks to meet reserve requirements in foreign currency may not be available for balance-of-payments purposes during stress periods.
- Reserves and potential FX drains are presented as percent of gross foreign exchange reserves (latest 2018 figures).

### Composition of the investor base and implications for market stress
- The share of foreign nonbank investors in sovereign debt markets has been rising since 2013, increasing susceptibility to capital flow reversals.
- Multisector bond funds:
  - Assets have more than doubled since the global financial crisis to well over $1 trillion (more than 10 percent of the entire bond mutual fund sector globally).
  - Aggregate emerging market investment by multisector bond funds stands at more than $150 billion.
  - These funds can hold highly concentrated positions, currently at historical highs in a few countries.
  - Over two-thirds of the emerging market investment of a sample of 40 large multisector bond funds is managed by funds that have derivatives leverage in the 90 percent to 850 percent range.
- Different nonbank investor types (pension funds, insurance companies, mutual funds) have different risk appetites and mandates; mutual funds and ETFs are noted as potentially increasing volatility due to greater sensitivity to global financial conditions.
- Concentrated positions by large opportunistic global funds can render parts of the domestic yield curve illiquid, potentially impairing monetary policy transmission and exacerbating market pressures.
- In corporate bond markets:
  - Investors tend to be mainly local or regional.
  - Hard-currency corporate bond issuance has grown rapidly and is dominated by Asian and Chinese firms.
  - The investor base in emerging Asia largely consists of local or regional Asian accounts, while global and out-of-region investors play a larger role in Latin America, emerging Europe, and the Middle East and North Africa.
- Local currency corporate bond markets are larger than hard currency markets and are growing fast, especially in Asia; investors remain predominantly domestic.

### Deeper and more liquid domestic markets as buffers, and their limits
- Empirical evidence indicates that large banking sectors, deeper capital markets, and broader domestic institutional investor bases can mitigate the impact of global risk factors on emerging markets.
- Speed limits: deepening too quickly can lead to economic and financial instability; sound institutional and regulatory frameworks are needed to mitigate challenges.
- Risks of domestic concentration:
  - An overreliance on holdings of sovereign debt by domestic banks may increase risks in times of stress if bank solvency is challenged.
  - Lack of a deep local market or local institutional investor base could compound market pressures in times of stress.
- Country examples:
  - South Africa and Malaysia have relatively large domestic investor bases and liquid currency markets (compared with the size of their local bond markets), features that provide some resilience.

*Source: IMF, Global Financial Stability Report — October 2018, Chapter 1 (section 6).*

### CHAPTER 1 A DECADE AFTER ThE GLOBAL FINANCIAL CRISIS: ARE WE SAFER?

### CHAPTER 1 A DECADE AFTER ThE GLOBAL FINANCIAL CRISIS: ARE WE SAFER?

### Market Size and Domestic Investor Base
- Bond markets in many emerging market economies have grown significantly, but overall financial deepening varies across countries.
- In Asia (including China, India, Indonesia), foreign exchange liquidity remains low compared to the size of the economy or of the local debt market; in some cases the size of domestic mutual, insurance, and pension funds is among the lowest.
- A significant foreign investor presence in markets with limited local investor bases can result in higher volatility of capital flows and asset prices, including the exchange rate.
- Central banks in Asia typically aim to maintain a high level of reserves and tend to be more active in foreign exchange interventions as a counterbalancing factor.
- Argentina and Turkey: narrow domestic investor bases; Argentina also has low foreign exchange liquidity and low reserve buffers, making absorption of external shocks more challenging.

### Banks—Stronger, but Not Yet Out of the Woods
- Banks have strengthened balance sheets since the global financial crisis: higher levels of capital and more liquidity in aggregate.
- Weaknesses remain: exposures to borrowers with high debt-service burdens, holdings of government bonds creating sovereign-bank nexus risks, holdings of opaque and illiquid assets, and reliance on foreign currency funding.

### Bank Balance Sheets Are Stronger, but Some Weak Links Remain
- Regulatory, supervisory, and market reforms over the past decade have boosted capital buffers (see Figure 1.20, panel 1 in source).
- Market measures indicate concerns:
  - Bank aggregate price-to-book ratios are less than one in the euro area, China, Japan, and the United Kingdom (Figure 1.20, panel 2).
  - If market valuations are used, a number of banks would have a market-adjusted capitalization of less than 3 percent, the minimum level in the Basel III framework (Figure 1.20, panel 3).
- Simulated stress results:
  - Institutions representing 7 percent of sample bank assets have a simulated stress capital need in 2018; most of these institutions are in the euro area (Figure 1.20, panel 4).
  - Simulations assess capital needs against a common equity Tier 1 ratio of 4.5 percent (plus the capital surcharge for global systemically important banks in the sample) and a leverage ratio of 3 percent.

### Banks Face a Series of Different Vulnerabilities
- Private nonfinancial sector debt-service ratios are already higher than long-term averages in a number of economies, particularly in Belgium, Canada, China, France, Hong Kong SAR, Russia, and Turkey, where the current debt-service ratio is more than 1 percentage point above each country’s long-term average.
- Credit provided by banks in these countries amounts to more than $30 trillion, or about half of total borrowing from banks by the nonfinancial private sector of major economies (Figure 1.21, panel 1).
- Borrowers with stretched debt-service ratios face higher risk of repayment difficulties if interest rates rise or incomes fall, increasing the risk of further rises in nonperforming loans.
- Foreign currency borrowing creates vulnerabilities when sharp currency depreciations occur (example cited: Turkey), affecting local banks and potentially spilling over to foreign banks with exposures.
- Sovereign-bank nexus:
  - Bank holdings of domestically issued government bonds pose risks; regulatory changes have both increased incentives to hold government bonds (Basel III liquidity coverage ratio) and reduced incentives through the leverage ratio.
  - Recent events in Italy: government bond spreads rose sharply in May, inducing a rise in Italian bank credit default swap spreads; renewed market concerns about fiscal policy could reignite sovereign-bank nexus risks and spread tensions to other government bond markets in Europe (Figure 1.21, panels 3–4).

### Bank Exposures to Opaque and Illiquid Assets, Interconnectedness, and Funding
- Level 2 and Level 3 assets:
  - Global systemically important bank (G-SIB) holdings of Level 2 and Level 3 assets have fallen over the past few years, but these assets still represent significant multiples of capital in many G-SIBs (Figure 1.22, panel 1).
  - Estimated impact: for some G-SIBs with large holdings, a decline of less than 5 percent in the value of Level 2 and Level 3 portfolios could reduce their leverage ratio by 100 basis points (Figure 1.22, panel 2).
- Interconnectedness:
  - Equity market prices imply a core set of G-SIBs remain interconnected. Outward spillovers (the percentage of variance in equity returns in one G-SIB explained by variation in other G-SIBs) suggest most G-SIBs are still viewed as interconnected, though a few banks outside a core group appear less interconnected (Figure 1.22, panel 3).
- Funding models and liquidity buffers:
  - Bank liquidity buffers have improved in aggregate since the global financial crisis, but challenges remain and funding models are uneven across jurisdictions (Figure 1.22, panel 4).

*International Monetary Fund | October 2018*

### Chapter 2 finds that average liquidity buffers have

### Chapter 2 finds that average liquidity buffers have

### Liquidity and funding positions
- Average liquidity buffers have grown and reliance on wholesale funding is trending downward, though some banking systems in major jurisdictions still rely significantly on wholesale funding.
- Banks with large foreign currency and wholesale borrowing, and significant foreign currency mismatches, could find it difficult to roll over financing if their local currency has depreciated significantly, as has been seen in some emerging market economies.
- Liquidity problems often strike at individual entities within banking groups; liquidity positions should be assessed at the individual entity level.
- The dollar balance sheets of internationally active banks headquartered outside the United States often have worse liquidity positions than would be suggested by their consolidated balance sheets.
- Institutions that rely on correspondent banking relationships have been under pressure because these relationships have been cut back.

### Key metrics and monitoring
- Figure 1.22, panel 4 uses two metrics to show variation in funding positions: the loan-to-deposit ratio and the proportion of liabilities in foreign currencies.
- In the Basel framework, the liquidity coverage ratio (LCR) is required to be met in the single currency of use; banks and supervisors are suggested to monitor the LCR in all significant currencies.
- A currency is considered “significant” if the aggregate liabilities denominated in that currency amount to 5 percent or more of the bank’s total liabilities.
- Central bank swap lines should be available to provide liquidity in periods of stress.
- Net stable funding ratios could be implemented in more countries.

### Policies to safeguard financial stability — high-level priorities
- Policymakers should step up efforts to boost resilience of financial systems and ensure adequate policy tools for dealing with potential systemic risks and market pressures.
- Global policy coordination is critical to safeguarding global financial stability.
- Advanced economy central banks should continue to gradually withdraw monetary accommodation, where appropriate, and communicate intentions clearly.
- Countries with high public sector debt burdens should aim to improve debt sustainability and enhance fiscal buffers.
- Jurisdictions with high and rising nonfinancial sector leverage should mitigate attendant vulnerabilities through a combination of macroeconomic and prudential policies.

### Microprudential policy recommendations (to increase bank resilience)
- Regulators should continue to monitor bank lending to highly indebted private nonfinancial and sovereign borrowers, as well as exposures to opaque or illiquid assets, and take measures to reduce banks’ excessive risk taking.
- To lessen the risk of funding strains, regulators should develop currency-specific liquidity risk frameworks.
- Asset quality problems should be addressed comprehensively; in the euro area, efforts to tackle legacy nonperforming loans have borne some fruit, yet challenges remain.
- In some emerging markets where nonperforming loans have risen, efforts should start with comprehensive and credible asset quality reviews.

### Macroprudential policy recommendations
- Macroprudential tools should be deployed proactively in conjunction with macroeconomic policies.
- Given rising debt levels, loosening underwriting standards, and stretched housing market valuations, policymakers should deploy macroprudential policy tools in a timely and effective manner.
- More active use of broad-based tools, including countercyclical capital buffers, has merit to reduce exuberance and slow the pace of credit growth while increasing bank resilience ahead of tightening financial conditions.
- Rising foreign currency debt in emerging market economies calls for more active use of tools that mitigate foreign exchange mismatches, such as:
  - limiting borrowers’ access to debt denominated in foreign currency through eligibility criteria or required regulatory approval;
  - limiting lenders’ exposure to nonfinancial sector foreign currency borrowers through additional risk weights;
  - adoption of currency-differentiated liquidity coverage ratios to provide additional foreign currency buffers.

### Addressing vulnerabilities outside the banking sector
- Regulators should improve data availability and develop new tools to address emerging vulnerabilities outside the banking sector.
- Macroprudential frameworks tend to be more developed in advanced economies than in emerging market economies, with more tools available for banks than for other entities.
- Corporate sector vulnerabilities:
  - In most economies, excessive buildup of leverage in nonfinancial sectors is typically addressed indirectly through loan-to-value limits and similar restrictions on debt levels imposed on bank lenders.
  - Tools affecting demand for credit intermediated through capital markets are rare.
  - Emerging market economies need broader instruments to limit foreign currency risk exposures in the corporate sector, including foreign exchange reserve requirements, currency-specific risk weights, and hedging requirements.
- Household sector vulnerabilities:
  - Authorities, especially in jurisdictions experiencing lasting booms in house prices, should consider recalibrating and expanding policy tools limiting households’ access to credit or lenders’ exposures to households.
- Nonbank financial sector:
  - Regulators should aim to improve and harmonize prudential regimes for insurers and asset managers.
  - For insurers, there is a need to establish a global capital standard and to strengthen resolution regimes.
  - There are relatively few macroprudential tools for asset managers; implementing comprehensive and globally consistent standards for asset managers would give regulators data and tools to better identify and mitigate risks related to liquidity mismatches, leverage, and concentration risks.

### Emerging market economies — managing external risks and outflows
- Policymakers in emerging market economies should be prepared to face portfolio flow reversals given continued monetary policy normalization in advanced economies and escalating trade tensions.
- To reduce likelihood and severity of outflows, countries should maintain sound macroeconomic, structural, financial, and macroprudential policies, taking into account cyclical position, balance sheet vulnerabilities, and policy space available.
- During market stress, exchange rate flexibility often serves as a key shock absorber; central bank interventions could be used to prevent disorderly market conditions but require careful consideration of factors including:
  - banks’ and corporations’ balance sheet exposures in foreign currencies;
  - how the exchange rate is valued relative to fundamentals;
  - the level of foreign exchange reserves;
  - potential fiscal and monetary implications of interventions, including through derivatives.
- Build and maintain adequate foreign exchange reserves and use reserves judiciously; consider trade-offs between smoothing volatility today and preserving policy space for larger future outflows.
- Capital flow management measures should be implemented only in crisis or near-crisis situations, should not substitute for needed macroeconomic adjustment, and should be transparent, temporary, and nondiscriminatory.
- To increase resilience to external shocks, policymakers should focus on developing local bond markets and promoting a stable local investor base to reduce reliance on foreign investors and currency mismatches.

### Multilateral policy coordination
- Multilateral policy coordination was key after the global financial crisis; waning multilateralism and regulatory fatigue risk less coordinated financial sector policies.
- Insufficient multilateral coordination would increase policy uncertainty, raise the risk of policy missteps, and provide incentives for regulatory fragmentation and regulatory arbitrage.
- Coordinated policy action—including monetary policy communication—sends a strong signal to markets in times of stress; losing such ability could weaken international responses to future crises.
- Policy actions by individual countries might not account for externalities and spillovers; examples include:
  - unwinding of unconventional monetary policy in advanced economies affecting capital flows to emerging markets;
  - host country subsidiarization and ring-fencing measures fragmenting liquidity in international banking groups;
  - disruption to financial services and market fragmentation during Brexit.
- The international regulatory community must continue cooperative work to tackle future policy challenges, including in the external debt sphere; the IMF will continue to promote cooperative financial policymaking.

### Yield curve, uncertainty, and growth (Box)
- The slope of the U.S. Treasury curve—defined as the spread between longer- and shorter-dated yields—has narrowed meaningfully over the past several quarters, and now stands at less than 30 basis points between 2 and 10 years, near its lowest level since before the global financial crisis.
- Past outright curve inversions (shorter-dated yields exceeding long rates) have typically tended to precede recessions; narrowing of the slope has prompted worries about the longevity of the current recovery.
- Quantile time-series regressions that include the slope show that adding the slope:
  - lowers expected GDP growth;
  - increases the odds of a recession substantially;
  - considerably boosts uncertainty around the conditional forecast;
  - tilts the distribution markedly toward worse outcomes.
- Another potential explanation for the narrow slope is very low term premiums; distant-horizon term premiums across major bond markets have been more closely correlated in recent years, possibly due to global factors related to unconventional monetary policies.

*Source: https://www.imf.org/-/media/files/publications/gfsr/2018/oct/ch1/doc/text.pdf*

### Box 1.1. Implications of the U.S. Yield Curve Slope for the GDP Growth Distribution

### Box 1.1. Implications of the U.S. Yield Curve Slope for the GDP Growth Distribution

### Context and approach
- The analysis complements the October 2018 World Economic Outlook (WEO) “Scenario Box 1—Global Trade Tensions” by focusing on the impact of the financial conditions shock on downside risks to future global growth using the growth-at-risk (GaR) approach.
- GaR incorporates information on a larger set of financial indicators, enabling a more comprehensive assessment of downside risks to growth.
- The recent rise in trade tensions has so far mostly affected sectors directly exposed to the announced trade measures, but further rounds of trade measures and countermeasures could lead to a broader tightening of financial conditions with negative implications for the global economy and financial stability.
- In the WEO, the full scenario—including real, confidence, and financial shocks—can have a marked impact on global growth, with global GDP potentially coming in nearly 0.8 percent less than its current baseline forecast by the end of 2019.

### Shock specification and assumptions
- The financial conditions shock is modeled as a widening of corporate credit spreads reflecting market participants’ expectations of a significant escalation of trade tensions between the United States and China.
- The effects of escalating trade tensions on market valuations are assumed to be persistent, lasting throughout a three-year horizon.
- Specific calibration:
  - Market analysts’ expectations of a decline in U.S. corporate earnings of 15 percent in the event of an extreme escalation of trade tensions.
  - This decline in earnings corresponds to a roughly 100 basis point widening of aggregate U.S. credit spreads and a 12 percent drop of U.S. equity prices.
  - For other Group of Twenty countries, the widening of credit spreads and the decline of equity prices is based on their credit ratings and stock market correlations (betas), respectively.
- WEO assumption for comparison: the WEO analysis assumes that the full impact of the financial shock occurs in 2019, dissipating by half by 2020, and has no impact over the medium term. The GaR exercise here assumes a more persistent financial condition shock.

### Key findings (GaR results)
- Near term (probability density):
  - The financial conditions shock leads to a meaningful increase in the likelihood of severely adverse growth.
  - Compared with the baseline, growth rates in the lower 5th percentile of the distribution shift leftward by about 1.5 percentage points.
- Medium term (probability density):
  - The tightening of financial conditions leads to both a leftward shift in the mode of the growth distribution and greater downside risks (i.e., a fatter left tail).
  - Normally, a near-term tightening of financial conditions in the GaR framework tends to mitigate downside risks to growth over the medium term by curtailing the buildup of vulnerabilities. In this analysis, however, the assumed persistence of the financial condition shock increases downside risk across horizons.
  - The more pronounced downside risk more than offsets the reduction of vulnerabilities.
- Severely adverse outcomes:
  - Overall, the range of severely adverse growth outcomes shifts into negative territory, representing a relatively adverse level compared with the past three decades.

*Prepared by Jeffrey Williams and Sheheryar Malik; figures and estimates are IMF staff estimates as presented in the source.*

### Box 1.4. Jumps and Liquidity in the U.S. Stock Market

### Box 1.4. Jumps and Liquidity in the U.S. Stock Market

### Definitions and methodology
- Jumps: discontinuities in prices; characterized as infinite activity (small jumps) or finite activity (large jumps).
- Interpretation:
  - Large jumps reflect news-related shocks.
  - Small jumps correspond to price moves significant over a period of few seconds, but not necessarily at a lower frequency, and likely reflect insufficient liquidity insofar as markets cannot absorb orders without price impact.
- Detection and classification methods:
  - Significant jumps detected using the methodology developed by Huang and Tauchen (2005) and Andersen, Bollerslev, and Diebold (2006).
  - Finite versus infinite activity categorized using the spectral analysis methodology proposed by Ait-Sahalia and Jacod (2012).
- Note: Both small and large jumps can occur within a day; a news event can generate a large price move followed by small jumps reflecting poor liquidity as prices drift after an announcement.

### Key findings on jumps in the U.S. equity market
- Proportion of daily price variation explained by jumps (either small or large) is currently at a historical low, despite a number of flash crash events in recent years (Figure 1.4.1, panel 1).
- Frequency of significant jump days per month has declined, to about one standard deviation below historical norms (Figure 1.4.1, panel 2).
- Small jumps, which are more likely related to poor liquidity, are less common than news-related large jumps on most days (Figure 1.4.1, panel 3).
- However, during episodes of dramatic volatility spikes—including the VIX Tantrum, Black Monday, and the Flash Crash—small jumps were most prevalent.

### Liquidity implications and interpretation
- Overall findings suggest that liquidity has not materially deteriorated in the U.S. equity market.
- The prevalence of small jumps in high-volatility episodes indicates that liquidity strains can still emerge during stress events, even if aggregate measures show improvement.
- Flash crashes may not be a harbinger of sustained market liquidity strains in U.S. equity markets.

### Sectoral evidence linking liquidity and jumps
- Analysis of sectoral S&P indices indicates that relatively “illiquid” sectors, as measured by trading volume, tend to display a higher share of small jumps (Figure 1.4.1, panel 4).
- This supports an intuitive link between market liquidity and the type of jumps observed.

### Caveats and broader considerations
- Results pertain to the aggregate U.S. equity index; similar analyses in other markets could imply different conclusions.
- Caution warranted: analyses of fixed income, foreign exchange, or global corporate bond markets may imply more worrying inferences for market liquidity.
- Findings are consistent with recent research on high-frequency commodity futures activity (CFTC 2018) and a recent study on the UK equity market (Acquilina, Eyles, Shao, and Ysusi (2018)).

*Source: Box 1.4. Jumps and Liquidity in the U.S. Stock Market (text).*

### 1. Foreign Claims by Domestic Banks and FBOs

### 1. Foreign Claims by Domestic Banks and FBOs

### Balance sheet structures of foreign bank branches and subsidiaries (End-2017)
- Figure shows foreign bank offices operating in selected countries; liquid assets include cash, reserves at the central bank, and holdings of government securities.
- Branches and subsidiaries both lend to customers; branches additionally provide intragroup liquidity.
- Branches rely more on intragroup funding, while subsidiaries have broader deposit bases.
- Asset and funding mix reported across country ISO codes: USA, GBR, DEU, JPN, CAN, HKG, KOR, ZAF, CHL, POL, TUR.

### Trends in liquidity, lending, and intragroup positions (2010–17)
- Liquid assets have risen while either customer credit has fallen or intragroup net claims have declined.
- Simulations assume an increase in holdings of liquid assets that raises the branch’s liquidity ratio, then calculate required changes in loans (or intragroup credit) if intragroup credit (loans) is:
  - unchanged,
  - increases by 10 percentage points of assets, or
  - falls by 10 percentage points of assets.
- Time windows and thresholds cited:
  - Change between 2011 and 2017 (percentage points) shown in panels.
  - Liquidity ratio defined as liquid assets divided by total assets; liquid assets include cash, deposits with central banks, and government securities.
  - Simulated scenarios report loans and intragroup claims as percent of assets under varying liquidity ratio thresholds (percent).

### Drivers and implications of higher branch liquidity
- Possible drivers:
  - Commercial incentives to hold higher-yielding government bonds (for example, foreign banks in the United States) or deposit swap proceeds (foreign banks in Japan).
  - Unconventional monetary policies leading to elevated reserves at central banks.
  - Host regulators’ guidance and pressures encouraging higher holdings of liquid assets.
- Implications:
  - Where liquid assets increased, branches tended to reduce either lending (examples: Japan and Germany), gross intragroup claims, or net lending to group affiliates (example: the United States), fragmenting intragroup activity.
  - Further increases in branch liquidity ratios are likely to result in a significant reduction of loans to customers or intragroup claims.
  - Fragmentation can heighten systemic risks: ring-fencing protects local depositors but weakens foreign banks’ ability to direct liquidity into stressed country offices.
  - Access to central bank liquidity assistance becomes more important if intragroup support is curtailed; eligibility of FBOs for central bank liquidity varies across jurisdictions.

### Regulatory changes and examples
- Structural measures introduced before 2015:
  - United Kingdom: Ring-fencing provisions recommended in ICB (2011) aka The Vickers Report and Liikanen and others (2012).
  - United States: Dodd-Frank Act and Volcker Rule (2010).
- OECD survey of 31 countries:
  - 22 impose local financial requirements on FBO branches.
  - 14 have changed regulation of FBO branch operations.
  - 4 effectively require local entities.
  - Nearly half may require systemic operations to convert to subsidiaries, depending on size, complexity, and other considerations.
- 2015–Present (United States examples):
  - Regulation YY (implemented in 2016) requires FBOs with assets greater than $50 billion to establish intermediate holding companies subject to capital and liquidity rules as well as stress tests.
  - The Intermediate Holding Company framework includes branches within the “responsible officer” governance perimeter.
  - The framework includes a 14-day liquidity buffer for U.S. branch operations and a 30-day liquidity buffer for the U.S. Intermediate Holding Company.
  - In 2018, systemic FBO branches of six non-U.S. global systemically important banks must be explicitly recognized in resolution plans; 2018 guidance requires FBOs to conform to resolution liquidity requirements, including intragroup liquidity tracking.
  - Material branches must identify and map financial and operational interconnections that affect other group entities or the U.S. resolution strategy.
- Emerging and future measures:
  - European Union defining an Intermediate Parent Undertaking framework.
  - United Kingdom updating approach to authorization and supervision of FBO branches, emphasizing a pragmatic balance between safety and openness.

### Risks from fragmentation and market effects
- Collision between structural regulatory tightening and cyclical monetary policy tightening could make a sudden spike in funding costs more likely.
- Banking groups might respond to restrictions on branch networks by increasing cross-border lending, which historically has been a more procyclical supply of credit than lending through branches.
- Local banks may attempt to fill credit gaps left by FBOs but might need to finance expansions with less stable short-term funding.
- Reduced provision of services to multinational corporate clients could push them toward nonbank substitutes whose risks are not fully understood.

### Policy recommendations to manage risks in banking groups (Table 1.SF.3)
- Home-Host Collaboration
  - Where collaboration does not currently take place, regulators should more actively coordinate.
  - Existing home-host collaboration agreements should be assessed and improved where needed (BIS 2017b notes progress but remaining challenges in information sharing).
- Regulatory Coordination
  - Greater coordination needed to ensure country-level measures do not impose significant costs on the global financial system.
  - International standards for regulatory and supervisory regimes applied to large, internationally active banks should be consistently implemented.
  - Subsidiarization and ring-fencing measures should be assessed for incentives that could migrate risk into the less regulated nonbank sector.
- Enhanced Resolution
  - Harmonization of creditor hierarchies would facilitate cross-border resolution.
  - Significant differences in creditor hierarchies, particularly in the treatment of deposits, pose obstacles to cross-border resolution of branches.
  - Better dissemination of information about international bank branches and exposures—through more regular, consistent, and comprehensive use of legal entity identifiers—can improve host authorities’ visibility into branch risks.
- Central Bank Liquidity Support
  - Host central banks may consider providing liquidity assistance to foreign branches if they do not already do so.
  - Home supervisors should facilitate host liquidity support by providing enhanced information about banking group conditions and risks.

*Italic: Source: IMF staff analysis, as presented in the text unit "1. Foreign Claims by Domestic Banks and FBOs".*

### CHAPTER 1 A DECADE AFTER ThE GLOBAL FINANCIAL CRISIS: ARE WE SAFER?

### CHAPTER 1 A DECADE AFTER ThE GLOBAL FINANCIAL CRISIS: ARE WE SAFER?

### Summary
- The global financial crisis prompted a major overhaul of the global financial regulatory architecture, with new standards, tools, and practices developed and implementation launched worldwide; the IMF was an important contributor.
- A decade later, much progress has been made: the global financial rulebook has been reformed, contributing to a more resilient financial system that is less leveraged, more liquid, and better supervised.
- Key successes noted:
  - Implementation of the Basel III capital and liquidity accords.
  - Widespread adoption of stress testing for the banking sector.
  - Curtailment of forms of shadow banking most closely related to the crisis.
  - Most countries now have macroprudential authorities and some macroprudential tools.
  - More intensive bank supervision, especially at large banks.
  - Improved bank resolution regimes and diminished expectation of government bailouts.
- Remaining priorities and concerns:
  - Complete implementation of the leverage ratio.
  - Complete frameworks for cross-border resolution of banks and for insurer solvency.
  - Ensure macroprudential authorities have an adequate toolkit to contain systemic risks.
  - Build on progress in challenging areas such as bank compensation practices and the use of credit rating agencies; consider new thinking where needed.
  - Continue international coordination of financial sector reform; evaluate broader impact of reforms and unintended consequences 10 years after the crisis.
  - Support for a proportionate approach to regulation and supervision based on systemic and global importance.
  - Vigilance regarding fintech, cybersecurity, and the perimeter of prudential regulation (for example, asset management).
  - Recognition that no framework reduces the probability of a crisis to zero; regulators must remain humble and attentive to risk migration.

### Introduction
- The global financial crisis led to rapid, comprehensive, and internationally coordinated public sector responses because of unprecedented dislocation in financial markets and persistent consequences for growth and unemployment.
- Between 2007 and 2008, 24 countries experienced banking crises, with output today remaining below its precrisis trend in 85 percent of these countries (October 2018 World Economic Outlook).
- The G20 regulatory reform agenda of 2009 elevated policy discussions and focused attention on globally consistent rules.
- This chapter:
  - Reviews precrisis failings in financial sector oversight.
  - Assesses progress in implementing the reform agenda.
  - Evaluates whether market structure and risks have shifted toward greater safety.
  - Focuses primarily on advanced and large emerging market economies addressed by the Financial Stability Board (FSB) and the Basel Committee on Banking Supervision (BCBS), while considering adaptation by other advanced or emerging market economies.
  - Does not analyze potential macroeconomic consequences of the reforms (noted as a complex undertaking advanced by the FSB (FSB 2017e)).

### What Went Wrong before the Global Financial Crisis?
- Immediate trigger: correction in U.S. house prices starting in 2006; deeper cause: structural vulnerabilities accumulated during the housing boom.
- Vulnerabilities that accumulated and amplified the crisis:
  - Leverage and capital insufficiency:
    - Leverage rose procyclically during the housing boom; both the quality and quantity of capital were insufficient to absorb large losses.
    - Banks expanded lending without much increase in capital by transferring loans to off-balance-sheet special purpose vehicles (SPVs) that securitized them and sold them to investors.
    - Capital resources appeared strong, but high leverage and collapse of SPVs exposed banks to greater losses; many Tier 2 instruments had poor capacity to absorb losses.
    - Frameworks for stress testing banks were rudimentary; tail risks such as a widespread decline in house prices were underestimated.
    - Banks entered the crisis with relatively low provisions for losses, making capital buffers unreliable.
    - Leverage in the nonbank financial sector rose as securitization expanded market funding while reducing regulatory capital charges.
    - Insurance business models in areas such as monoline insurance changed, calling for new approaches toward risk management and solvency.
  - Liquidity and funding risks:
    - Bank funding shifted toward short-term and uninsured market-based sources, moving away from deposit-based banking and increasing liquidity and maturity transformation.
    - Market funding (provided by other banks and money market funds, among others) was not covered by deposit insurance and often involved interlinked chains of maturity transformation where assets used as collateral passed along multiple intermediaries.
    - Off-balance-sheet vehicles relied almost exclusively on short-term market funding such as asset-backed commercial paper.
    - Use of complex products as collateral raised liquidity risks: availability of market funding relied on perceived quality of mortgage-backed securities and other complex assets; falling house prices reduced the value of these products and opacity impeded market clearing.
    - Banks and intermediaries that relied on market funding faced liquidity pressures (example: Northern Rock); insurers that sold default protection on structured securities faced massive losses and margin calls (example: AIG).
    - Exchange rate risk grew as banks posted U.S. mortgage-related securities as collateral to obtain U.S. dollar funding; some banks used cheap short-term foreign deposits to fund domestic lending; low-cost euro- and Swiss franc–denominated mortgages grew in Central Europe.
    - Hedging relied on continuous availability of short-term funding; currency mismatches of ultimate borrowers made loan portfolios vulnerable.
  - Size, interconnectedness, and opacity of institutions:
    - Large investment and commercial banks with complex global operations were difficult to regulate and supervise for both home- and host-country authorities.
    - Size, interconnectedness, and opaqueness increased the potential for rapid propagation of distress: large complex financial institutions were seen as "too big to fail," strengthening moral hazard and risk-taking incentives.
    - Beyond banking, large insurers and monoline insurers sold default protection under optimistic assumptions, increasing linkages across markets.
  - Supervisory challenges and systemic risk:
    - Wholesale funding markets created vast networks spreading across regulatory perimeters, supervisors, and jurisdictions.
    - Interconnectedness rose through common exposure to mortgage-related securitized products and through OTC derivatives (most common derivative contract was credit default swaps).
    - Ratings agencies were paid by issuers and faced conflicts of interest while highly rating mortgage-backed securities; insurers selling default protection increased linkages.
    - No single macroprudential authority in most countries had a view of risk migration across sectors or powers and tools to contain systemic risks.
    - Systemic risk defined as “the risk of widespread disruption to the provision of financial services that is caused by an impairment of all or parts of the financial system, which can cause serious negative consequences for the real economy” (IMF and others 2016). Macroprudential policy defined as the use of primarily prudential tools to limit systemic risk.
  - Incentives, compensation, and governance:
    - Compensation practices encouraged risk taking and rewarded it when returns were high.
    - Market discipline and self-regulation failed to restrain excessive risk taking.
    - The originate-to-distribute model allowed originators to sell loans for securitization, weakening incentives for prudent underwriting.

### Illustrative Indicators and Examples from the Crisis Period (as reported)
- Between 2007 and 2008: 24 countries experienced banking crises.
- Output remains below precrisis trend in 85 percent of those countries (October 2018 World Economic Outlook).
- Northern Rock grew lending at nearly 20 percent per year from 2000 to 2007 by issuing short-term market debt using mortgage loans as collateral.
- Figures referenced in the chapter illustrate:
  - House price index deflated by CPI and outstanding mortgage debt growth in the United States (Figure 2.1, panel 1).
  - Private label securitization issuance and U.S. ABCP, U.S. MBS, EU ABCP, EU MBS dynamics (Figure 2.1, panel 2).

*International Monetary Fund | October 2018*

### CHAPTER 2 REGuLATORY REFORM 10 YEARS AFTER ThE GLOBAL FINANCIAL CRISIS: LOOkING BACk, LOOkING FORWARD

### CHAPTER 2 REGuLATORY REFORM 10 YEARS AFTER ThE GLOBAL FINANCIAL CRISIS: LOOkING BACk, LOOkING FORWARD

### Causes of the Crisis and Precrisis Regulatory Failures
- Securitization and sale of loans to third-party investors weakened incentives for sound credit underwriting.
- Investors accepted ratings assigned to securitized products without much scrutiny.
- Implicit guarantees eroded market discipline and distorted incentives toward risk taking; examples cited include government-sponsored enterprises in the United States and “too-important-to-fail” institutions.
- Governance at many large financial institutions was insufficient to understand or control risks.
- A preference for relatively light supervision allowed expansion of risk without adequate oversight or buffers.
- The absence of viable resolution frameworks for large complex financial institutions compounded problems: no prior identification of systemically important financial institutions and no special mechanisms for their resolution.
- The failure of Lehman Brothers precipitated panic and forced coordinated policy actions including capital injections and deposit guarantees in several countries.

### International Regulatory Agenda Launched After the Crisis
- At the 2009 G20 summit, the international regulatory community convened to overhaul the regulatory and supervisory framework with goals to:
  - (1) enhance capital buffers and reduce leverage and financial procyclicality,
  - (2) contain funding mismatches and currency risk,
  - (3) enhance the regulation and supervision of large and interconnected institutions,
  - (4) improve the supervision of a complex financial system,
  - (5) align governance and compensation practices of banks with prudent risk taking,
  - (6) overhaul resolution regimes of large financial institutions.
- The IMF supported implementation through multilateral and bilateral surveillance, including the Financial Sector Assessment Program (FSAP), Article IV missions, and Global Financial Stability Reports (GFSRs).

### Enhancing Capital, Reducing Leverage, and Financial Procyclicality
- Basel III aimed to increase the permanence and loss absorption of banks’ capital, focusing on common equity.
- Basel III measures included:
  - Widening the risks covered and constraining capital relief from banks’ internal models.
  - Introducing a non-risk-based leverage ratio calibrated with floors (72.5 percent of the standard calculation).
  - Adding capital cushions: the countercyclical capital buffer (CCyB) and capital conservation buffers.
  - Capital surcharges for systemic banks.
- The BCBS completed a review of the regulatory treatment of sovereign exposures without changes to existing rules (no consensus reached).
- Implementation status as of March 2018:
  - Of 19 RCAP assessments, 15 were compliant.
  - Indonesia, Korea, and the United States were found largely compliant.
  - The European Union was found to be materially noncompliant.
  - All jurisdictions that were home to global systemically important banks (G-SIBs), including the EU, were found compliant with the G-SIB standards for supervision and surcharges for capital and leverage.
- Changes in bank capital and asset composition:
  - The global median common-equity-to-asset ratio increased by more than 2 percentage points since 2010.
  - By 2017, regulatory ratios (Tier 1 and total capital ratios) were significantly higher than before the crisis.
  - Postcrisis increases in regulatory capital ratios were achieved in part through de-risking of bank assets and by moving away from assets with higher regulatory risk weights.
- FSAP findings and implementation gaps:
  - FSAP surveillance highlighted the importance of jurisdictions setting bank-specific capital standards above Basel minima and effective supervisory review.
  - Materially noncompliant jurisdictions host a small but non-negligible fraction of banking assets.
  - Common reasons for noncompliance include political pressures, structural features of economies (for example, widespread presence of small- and medium-sized enterprises in the EU), and time needed to internalize powers and readiness to use them.

### Reducing Procyclicality: Tools and Outcomes
- Countercyclical capital buffer (CCyB):
  - Intended to be activated to lean against systemic risk accumulation and released when the cycle turns.
  - At end-2017, some BCBS jurisdictions had not set the CCyB above zero despite relatively large credit gaps.
  - Many European countries—the Czech Republic, Iceland, Norway, Slovakia, Sweden, and the United Kingdom—had set the CCyB at levels between 0.5 and 2 percent; Hong Kong SAR had set its CCyB at 1.875.
- Other measures to reduce procyclicality:
  - Forward-looking provisioning (expected-loss provisioning) used in countries such as Brazil and Mexico.
  - The IASB’s IFRS 9 for financial instruments was required beginning in January 2018; the FASB does not require this for listed companies until 2020.
  - Capital conservation buffer and leverage ratio under Basel III are designed to limit balance sheet expansion; capital conservation buffer introduced broadly, leverage ratio progress more gradual.
  - Other tools used include caps on credit growth, used primarily in emerging markets, and various sectoral tools targeted at household real estate risks.
- Evidence on reduced procyclicality:
  - A regression measure—the coefficient of real quarterly bank credit growth on real GDP growth, both detrended—showed significant procyclicality in a sample of 61 countries in the precrisis period and a decline to nonsignificance in the postcrisis period.
  - Country-level estimation showed declines in procyclicality of credit in 60 percent of sample countries and in slightly more than half of BCBS countries.
  - Bank-level analysis on a subsample (Canada and the United States) suggested leverage went from slightly procyclical precrisis to slightly countercyclical postcrisis.
- Sectoral and borrower-focused tools:
  - Tools aimed at real estate cyclical risks are common: higher risk weights for high loan-to-value housing loans; loan-to-value caps; debt-service-to-income ratios; caps on loan-to-income and loan-to-value ratios; limits on amortization periods; restrictions on unsecured loans; caps on credit growth to the household sector; household sector capital requirements.
  - Debt-to-income ratios have been used more sparingly despite resilience advantages.

### Stress Testing and Supervisory Practices
- Stress testing became central to bank supervision after the crisis:
  - Microprudential stress testing for solvency and liquidity impact had been developed precrisis, and its use spread widely after programs such as the 2009 U.S. Supervisory Capital Assessment Program.
  - Current frameworks still have room for improvement: resilience often tested to a single scenario and estimated bank losses are generally less than historical experience.
  - Stress testing is now used by almost all supervisors of sophisticated banking systems to assess capital adequacy under potential stress scenarios.
  - Supervisory practices in some jurisdictions (for example, the United Kingdom and the euro area) have been reorganized around Basel implementation and stress-testing frameworks.

### IMF Role and Technical Assistance
- The IMF has played a critical role in facilitating implementation of the regulatory reform agenda through:
  - Multilateral and bilateral surveillance, FSAPs, Article IV missions, and GFSRs.
  - Technical assistance activities that complement and broaden Basel RCAP monitoring, with FSAPs emphasizing stress testing, sectoral standards assessments, and Basel Core Principles assessments.
- FSAP tools highlighted:
  - Stress tests to examine system resilience to shocks and to reveal whether national implementation or deviations from Basel standards could introduce vulnerability.
  - Basel Core Principles assessments that evaluate supervisory practices beyond regulations.

*International Monetary Fund | October 2018*

### 1. Total Credit-to-GDP Gap in BCBS Members and CCyB Rates

### 1. Total Credit-to-GDP Gap in BCBS Members and CCyB Rates

### Liquidity regulation: LCR and NSFR implementation
- Two new regulatory liquidity ratios were introduced: the liquidity coverage ratio (LCR) (implemented beginning in 2015) and the net stable funding ratio (NSFR) (implemented beginning in 2018).
- All Basel member countries have implemented the LCR and undergone Regulatory Consistency Assessment Program assessments, indicating consistency with the agreed-on Basel framework.
- Implementation of the NSFR has proved more demanding because of the discretion needed to ensure its effectiveness in local markets.
- The NSFR was expected to be implemented by January 2018, but some jurisdictions have not issued draft proposals and others have drafts with open deadlines for conclusion.
- Outside BCBS membership there has been interest in adopting Basel III liquidity standards.

### FSAP observations on liquidity risk and stress testing
- FSAP assessments (2012–2018) indicate banking systems in major jurisdictions still rely significantly on wholesale funding.
- Some jurisdictions have introduced liquidity stress testing using horizons beyond the 30-day LCR horizon and highly granular supervisory data.
- FSAP risk analysis identified instances where stress-testing techniques for assessing liquidity risk warranted further development.
- Instances were identified where banking community risk management skills had been slow to develop, in part because benign market conditions shielded practitioners.

### Changes in liquidity buffers and wholesale funding
- Liquidity buffers have, on average, grown since the global financial crisis.
- Banks’ holdings of cash and government securities have increased as a share of total assets.
- Recent reporting of the LCR shows levels well above 100 percent and increasing since data became available in 2014.
- Holdings of government securities have risen in many countries, signaling persistent bank–sovereign links.
- Banks’ reliance on wholesale funding has been trending downward since the crisis.
- Internationally active banks domiciled outside the United States continue to rely on U.S. dollar funding, including through foreign exchange swaps, for their global dollar lending.

### Nonbank liquidity and foreign currency risks
- New valuation guidelines for money market mutual funds have reduced run risks; U.S. institutional money market funds that invest largely in less liquid corporate debt or municipal bonds have moved toward a mark-to-market basis.
- Boards of money market funds can take measures such as liquidity charges and suspended redemptions to address potential run risks.
- In Europe, most money market funds have moved toward floating valuation; exceptions include funds investing in government debt or funds that closely track advertised values (e.g., some Chinese money market funds).
- European regulations include potential redemption gates and liquidity charges to reduce run risks.
- IOSCO has contemplated additional guidelines for securities supervisors.
- U.S. reforms to the triparty repo market (greater transparency about haircuts, rules to reduce collateral risk, new clearance procedures to reduce intraday credit) have reduced potential run risks.
- Macroprudential measures to contain foreign exchange risk have been used, including reserve requirements differentiated by currency and higher risk weights for foreign exchange loans.
- Specific country examples:
  - Central and Eastern Europe: wide range of tools deployed to contain risks for foreign exchange–denominated mortgages.
  - Korea: leverage caps on banks’ positions in foreign exchange derivatives and a levy on nondeposit liabilities denominated in foreign exchange, with shorter-term deposits attracting a higher charge than long-term ones.
  - Argentina: limits on lending from foreign currency deposits (as an example of differentiated reserve limits).

### Enhanced regulation of large and interconnected institutions
- Criteria and the list of G-SIBs developed by IMF, FSB, and BIS represent an important postcrisis success.
- G-SIBs are identified using indicators of size, interconnectedness, lack of readily available substitutes, global (cross-jurisdictional) activity, and complexity; supervisory judgment permits authorities to nominate banks for public disclosure.
- G-SIBs have been subject to a systemic capital surcharge since 2016.
- A list of global systemically important insurers has been developed but not published; work on capital standards, including higher loss absorbency for systemic insurers, is delayed.
- Many countries have adapted the G-SIB methodology to develop frameworks for domestic systemically important banks (D-SIBs).

### Cross-border supervisory cooperation and crisis preparedness
- Supervisory colleges and crisis management groups have been deployed; all G-SIB host jurisdictions should have both bodies for information exchange and crisis preparedness.
- Successive FSAPs trace increasing confidence and sophistication in supervisory exchanges, but FSAP missions indicate continued progress is needed and more open communication between authorities and G-SIBs remains a priority.

### Capital buffers, concentration, and competition
- Postcrisis increase in capital buffers has been particularly substantial for G-SIBs, which have increased their regulatory capital ratios by 5 percentage points or more, compared with 1 percentage point for other institutions.
- The three-bank concentration ratio has exhibited a moderate but sustained decline since 2000.
- The size of systemic institutions relative to the economy has been declining or remaining stable in most countries, including those in the BCBS.
- Median ratio changes: the median ratio of G-SIB bank assets to GDP across 13 host countries declined by 0.4 percentage point, and that of D-SIBs by 0.1 percentage point over 39 countries.
- The asset-to-GDP ratio of G-SIBs declined in 8 of the host countries, and it did so for D-SIBs in 19 of the countries.
- Despite declines in concentration, measures of banking competition have not improved; both the Lerner index and the Boone indicator appear to have markedly increased in recent years.

### Data and supervision enhancements
- The Data Gaps Initiative contemplated a data hub for G-SIBs set up at the Bank for International Settlements to provide supervisory authorities access to a common database on risk exposures and interconnectedness.
- Two key areas for further progress: increasing the granularity of data accessible to international financial institutions and increasing access to aggregate data by national macroprudential authorities.
- Supervisory approaches have intensified, emphasizing timely and effective supervision over regulations alone, with greater attention on systemic institutions and risks.
- Examples of intensified supervision:
  - United States: Comprehensive Capital Analysis and Review.
  - Brazil: segmented or tiered supervision for institutions.
  - Euro area: supervision predicated on systemic significance of institutions.
  - Russia: centralized supervision of systemic banks.

*International Monetary Fund | October 2018 — Chapter excerpts from the Global Financial Stability Report—A Decade After the Global Financial Crisis: Are We Safer?*

### 1. Postcrisis Differences across Countries and Banks

### 1. Postcrisis Differences across Countries and Banks

### Banking concentration and competition
- Concentration within the banking sector has fallen slightly, although competition has not picked up.
- Figure notes and measures:
  - The post–global financial crisis (GFC) dummy variable captures the difference in means in the postcrisis period (2010–17) relative to the precrisis period.
  - Solid bars in the figure indicate coefficients statistically significant at the 10 percent level.
  - The Lerner index measures bank markups (output prices minus marginal costs), estimated from a translog cost function; a higher value is associated with lower competition. To express it in percentage points, the Lerner index was multiplied by 100.
  - The Boone indicator measures competition based on the elasticity of bank profits to marginal cost; a more negative value indicates greater competition.
  - The shaded area in the figure refers to the GFC.
  - Abbreviations: BCBS = Basel Committee on Banking Supervision; G-SIBs = global systemically important banks; RWA = risk-weighted assets.

### Expanding the regulatory perimeter
- Off-balance-sheet regulatory arbitrage:
  - Loopholes used under Basel I and II to move items off the balance sheet have been closed in Basel III.
  - New rules on the treatment of special purpose vehicles reduced their attractiveness for capital arbitrage.
  - Off-balance-sheet exposures are captured more rigorously by the capital framework.
  - Liquidity framework considerations of funding-source volatility have highlighted bank use of nonbank financing.
  - Movement of investment banks toward traditional banking licenses in the United States brought more institutions within the regulated perimeter.
- Shadow banking and market-based finance:
  - Systemic risk monitoring expanded to include shadow banking and market-based finance.
  - The FSB has established a typology and a broad framework for regulation; IOSCO has published recommendations on liquidity mismatch, leverage within investment funds, operational risk, and securities lending.
  - Proposed remedies include reporting, monitoring, risk management, stress testing, and deeper liquidity buffers.
  - Implementation of regulatory advances has been limited to date; efforts should continue to improve timeliness and granularity of data on interconnections, especially cross-border ones.
- Securitization:
  - Regulatory direction: greater sponsor responsibility, greater transparency, reduced complexity, and less mechanistic reliance on credit ratings.
  - Banks originating securitizations must retain part of the original structure under new standards.
  - Implementation of the revised securitization framework is in progress; rules not finalized or in force in many jurisdictions.
  - Ensuring retention rules align sponsors’ incentives remains crucial and debated.
- OTC derivatives and FMIs:
  - Migration of OTC derivative trading to central counterparties (CCPs) and reporting to trade repositories has progressed.
  - Pittsburgh G20 Summit target: all standardized OTC contracts cleared on CCPs and reported to trade repositories by end-2012.
  - Financial buffers at most CCPs deemed systemic have been increased; other buffers, including liquidity support, have been strengthened.
- Credit rating agencies:
  - Regulatory efforts produced a new code of conduct, better oversight, and reduced use of ratings in some regulatory standards.
  - Rating agencies continue to play a central role; their function has not been substituted by other agents.
- Examples of supervisory resource concerns identified in postcrisis FSAPs include: China, the Netherlands, Sweden, Switzerland, and the United Kingdom.

### Macroprudential approach and authorities
- Institutional arrangements:
  - Most countries have instituted systemic oversight authorities since the crisis.
  - Detailed arrangements vary; in most cases the role is assigned to the central bank, especially when the central bank oversees prudential supervision.
  - Committees outside the central bank are the second most prevalent organizational form.
  - Examples: Mexico’s Financial System Stability Council has nine members; the United States has the Financial Stability Oversight Council; China has the Financial Stability and Development Committee.
- Powers of macroprudential authorities:
  - Most authorities have some hard powers; powers vary greatly across jurisdictions.
  - Examples of hard powers:
    - United States: Financial Stability Oversight Council can designate systemic financial institutions and subject them to enhanced supervision by the Federal Reserve or require enhanced risk management for financial market utilities and infrastructures.
    - Monetary Authority of Singapore: full range of macroprudential tools.
  - Semi-hard powers: comply-or-explain mechanisms.
  - Soft powers: informing relevant hard-power agencies and the public; in the United States, Russia, and South Africa this includes advising on policy steps.
  - Many macroprudential authorities still lack full powers and tools; this remains an area requiring attention.
- IMF role:
  - The IMF has provided technical assistance, Article IV missions, and FSAPs to help design macroprudential agencies and develop systemic risk monitoring capacity.

### Governance and compensation
- Governance:
  - Bank supervision scope extended to corporate governance; Basel Core Principles became more demanding in governance.
  - Postcrisis, more serious consideration of risk appetite and risk management in corporate governance.
  - More than half of the FSAPs in 25 systemic jurisdictions between 2011 and 2018 identified gaps, deficiencies, or weaknesses in corporate governance.
  - By 2017 most jurisdictions had regulations addressing compensation packages in the financial sector.
  - FSB stocktaking found most major banks recognized board responsibility for determining appropriate levels of risk taking, with board committees and independent directors chairing key committees increasingly required.
  - Examples: by 2018 the Single Supervisory Mechanism had carried out thematic reviews of governance in euro-area banks; Russian authorities empowered with relevant legislation; Brazilian supervisory agency intensified and reorganized supervisory processes.
- Compensation practices:
  - Most major FSB member jurisdictions have substantively implemented the principles for sound compensation practices and their implementation standards.
  - Legal enforceability of measures such as malus and clawback is not yet clear.
  - Compensation contracts can potentially be reengineered to circumvent clauses and regenerate excessive risk-taking incentives.

### Overhauling resolution frameworks for systemic financial institutions
- Motivation and Key Attributes:
  - Crisis-era moral hazard from implicit government support spurred reforms to make investors bear more risk and minimize taxpayer support.
  - Adoption of the FSB’s Key Attributes of Effective Resolution Regimes for Financial Institutions provided a benchmark for resolution authorities.
  - Key Attributes cluster into four categories: strengthened national resolution regimes; recovery and resolution planning; arrangements for enhanced cross-border cooperation; access to information and removal of barriers to information sharing.
- TLAC and recovery/resolution planning:
  - Total Loss-Absorbing Capacity (TLAC) standard requires G-SIBs to maintain liabilities usable at failure to absorb losses and recapitalize the failing firm.
  - TLAC implementation:
    - Institutions classified as G-SIBs before the end of 2015 need to establish the TLAC standard of 16 percent of risk-weighted assets beginning January 2019 and 18 percent beginning January 2022.
    - Several FSB member jurisdictions (Canada, Sweden, Switzerland, the United Kingdom, and the United States) have incorporated TLAC into domestic rules; others (the EU and Japan) have issued policy proposals.
    - Significant amounts of TLAC-eligible securities have been issued; many G-SIBs are meeting the January 2019 requirement.
    - Banks have issued long-term subordinated debt in varying ways (e.g., European banks issuing 10-year bullet-maturity bonds; some U.S. banks issuing bonds callable at one- or two-years’ remaining maturity).
    - Emerging-market banks were granted a longer adjustment period; Chinese G-SIBs have not yet sold TLAC-eligible debt.
  - All G-SIBs have established recovery plans; resolution plans are being finalized.
  - Less progress on resolution regimes for systemic nonbanks.
- Market signals of reduced perceived government support:
  - Banks’ support ratings are markedly lower today than before the crisis for stand-alone banks.
  - A market measure of the implicit subsidy (difference between a “fair value” CDS spread from contingent claim analysis and observed CDS spread) suggests a lower likelihood of bailout than during the crisis.
  - Example: In the euro area the implicit subsidy reached 194 basis points at end-2011, and is now slightly less than 18 basis points.
- Remaining gaps and challenges:
  - National bank resolution regimes in many systemic financial sectors often have significant weaknesses and are not fully aligned with the Key Attributes.
  - Resolution regimes for nonbanks (especially systemically important insurers and financial market infrastructure) need finalization.
  - Impediments to resolvability include group structures hindering orderly resolution and inadequate loss-absorption capacity at non–G-SIBs.
  - Cross-border resolution gaps: confidentiality issues impede information sharing; greater coordination and planning needed for cross-border resolution of G-SIBs; crisis management groups should be established for systemic nonbanks such as insurers and CCPs.
  - The IMF has worked with country authorities via FSAPs and technical assistance to improve predictability, effectiveness, and transparency of regimes.
  - Initiatives are under way to improve funding sources for the time of resolution.

*Source: text - 1. Postcrisis Differences across Countries and Banks (PDF chapter).*

### CHAPTER 2 REGuLATORY REFORM 10 YEARS AFTER ThE GLOBAL FINANCIAL CRISIS: LOOkING BACk, LOOkING FORWARD

### CHAPTER 2 REGuLATORY REFORM 10 YEARS AFTER ThE GLOBAL FINANCIAL CRISIS: LOOkING BACk, LOOkING FORWARD

### Regulatory Efforts Going Forward: Where to Focus?
- Incomplete aspects of the global regulatory agenda should be fully implemented, including:
  - solvency frameworks for insurers
  - the leverage ratio
  - outstanding items on the liquidity agenda
- Supervisory priorities:
  - continue to intensify supervision, particularly of systemic institutions
  - maintain supervisory intensity, especially onsite and for systemic banks
  - ensure accountability and willingness to act in a timely manner for macroprudential oversight
- Cross-border cooperation:
  - further develop cross-border cooperation in data sharing and systemic risk oversight
  - implement resolution frameworks consistent with the Key Attributes, with improvements for systemic and cross-border institutions

### Complete the Global Regulatory Reform Agenda
- Corporate governance and conduct:
  - ensure corporate governance reins in cultures of excessive risk taking
  - hold boards accountable for risk culture, confront difficult issues such as compensation and the use of credit ratings
- Shadow banking and market-based finance:
  - oversight and regulation of shadow banking should continue to improve
  - FSB (2017a) assessment: aspects of shadow banking that contributed most to the global financial crisis generally no longer pose financial stability risks, but new forms may be accumulating systemic risks
  - important to close data gaps (see Chapter 3 of the April 2015 GFSR)

### Improvements in Oversight and Regulation of Shadow Banking
- Risks and dynamics:
  - in many countries, systemic risks associated with new forms of shadow banking and market-based finance outside the prudential regulatory perimeter (such as asset managers) may be accumulating and could spill over to banks
  - rapid growth in shadow banking in many emerging markets, including China, though from a small base (see Chapter 2 of the October 2014 GFSR)
- Policy options:
  - activity-based (as opposed to entity-based) regulation
  - development of macroprudential tools for nonbanks
  - close data gaps to monitor and address emerging risks

### Address the Consequences of the Postcrisis Regulatory Agenda
- Need for evaluation:
  - after 10 years, evaluate effectiveness and efficacy of reforms to weigh resilience gains against possible costs to efficiency
  - supervisors can start taking stock of regulatory effects on the broader economy and fine-tune measures; FSB has initiated this through dedicated working groups; the IMF leverages the FSAP for assessments where data permit
  - example: recent Peru FSAP used microeconomic data and found only small transitory effects of higher capital requirements on lending
- Banks–sovereign nexus:
  - banks’ government bond holdings remain large (Figure 2.9, panel 3)
  - sovereign bonds play a prominent role as safe and liquid assets in new liquidity regulations, often receive favorable capital treatment (often risk weight of zero), and are exempted from concentration limits
  - interconnection between banks and sovereigns may create a negative feedback loop that deepens crises
  - Dell’Ariccia and others (2018): improving balance sheets of banks and sovereigns is key; policies that discourage excessive sovereign bond holdings can improve financial stability and market efficiency but should minimize procyclical effects
- Risks from migration and correspondent banking:
  - regulatory reform and anti–money-laundering rules may have contributed to reassessment of correspondent banking relationships, affecting access to the global financial system for residents of some countries
  - migration of risks to nonbanks may require reevaluation of the regulatory perimeter; where financial access has been reduced, authorities should support financial inclusion
  - IMF response: help affected countries strengthen legal, prudential, and supervisory frameworks through FSAPs and technical assistance

### Confront New Risks
- Central counterparties (CCPs):
  - G20 2009 mandate to centrally clear standardized derivatives reduced counterparty risk and leverage, but concentrated credit risk within CCPs
  - failure of a CCP to absorb losses could amplify aggregate shocks; margin calls and haircuts tend to rise as the financial cycle worsens, potentially leading to procyclicality
  - regulatory and supervisory needs: ensure CCP capital and liquidity buffers are solid; establish adequate resolution frameworks that account for cross-country nature
  - consider macroprudential tools and, under extreme circumstances, provision of central bank liquidity to solvent and systemic CCPs (Wendt 2015)
  - some jurisdictions (Australia, the euro area, Switzerland, the United Kingdom, the United States) already consider emergency liquidity support to domestic financial market infrastructures
- Fintech and cybersecurity:
  - fintech (big data, automation of loan processing, distributed ledger technology, new lending and electronic trading platforms) is still small but has grown rapidly (IOSCO 2017; Figure 2.9, panel 5)
  - regulatory challenge: support innovation, efficiency, and inclusion while safeguarding against risks that could amplify shocks (FSB 2017b)
  - cyber threats pose financial stability risks due to increasing IT reliance and interconnectedness; direct and indirect costs (including reputational) can be large (Kopp, Kaffenberger, and Wilson 2017; Bouveret 2018)
  - supervisory gaps: many supervisors lack dedicated units and face skills shortages; supervisors must engage with financial institutions to develop identification, response, and recovery capabilities

### Key Statistics and Observations from Figures and Panels
- Perceptions of likelihood of bailout of systemic institutions measured between 2007 and 2017; support rating ranges from 1 (low) to 7 (high)
- Implicit subsidy (G-SIB too-important-to-fail subsidy) measured as difference between “fair value” CDS spread from equity prices and CDS spread on a bank’s bonds
- Shadow banking in S29 countries presented as percent of GDP (panel 1)
- Country-level exposure of banks to and use of funds from shadow banks shown as percent of GDP, 2016 (panel 2)
- Domestic bank holdings of general government debt securities shown as percent of total (panel 3)
- CCPs and other counterparties in derivatives clearing shown by share of different counterparties, percent (panel 4)
- Global fintech investment (venture capital–backed) shown in billions of U.S. dollars and number of deals (panel 5); 2018 full-year data extrapolated from 2018:Q1
- Cyber risk vulnerability severity by industry and sector (United States, 2017) (panel 6)
- Data sources include Bank for International Settlements; Bloomberg Finance L.P.; CB Insights; Financial Stability Board; Protiviti; and IMF staff calculations
- Note: in panel 1, shadow banking is computed from the Financial Stability Board Shadow Banking Monitor 2017 for a group of 29 countries (S29)

### Conclusion: Policy Priorities and Risks to Guard Against
- Progress since the global financial crisis is clear: capital, liquidity, and systemic oversight measures have been successful; derivatives and wholesale funding vulnerabilities have been reduced
- Remaining gaps across areas: macroprudential frameworks, systemic risk monitoring, data, cross-border cooperation, bank compensation practices, use of credit rating agencies
- New and evolving risks require vigilance:
  - concentrated risk in CCPs
  - growth of credit intermediation by nonbank financial institutions without commensurate regulatory monitoring and tools
  - rapid fintech development with still-developing understanding of risks
  - increasing cybersecurity risks for institutions, infrastructure, and supervisors
- Overarching imperative:
  - resist reform fatigue and rollback pressures; avoid complacency
  - regulators and supervisors must remain humble and vigilant, ready to act as the financial system continues to evolve

*International Monetary Fund | October 2018*

### Box 2.1. The IMF’s Role in the Global Regulatory Reform Agenda

### Box 2.1. The IMF’s Role in the Global Regulatory Reform Agenda

### Background and rationale
- Lack of timely and reliable data hindered policymakers’ ability to detect emerging risks and imbalances during the global financial crisis; this problem was emphasized by the IMF in March 2009 (Johnston and others 2009).
- Key data gaps identified: financial sector data for detecting buildup of risk; cross-border interconnections; financial linkages of global systemically important financial institutions; sectoral accounts; national balance sheets.
- In October 2009, the G20 finance ministers and central bank governors endorsed the G20 Data Gaps Initiative (DGI) to address the key data gaps identified by the crisis. The initiative is led by the Financial Stability Board Secretariat and IMF staff.

### DGI phases and objectives
- First phase (2009–15) aims:
  - Better capture the buildup of risk in the financial sector.
  - Improve data on connections within the international financial network.
  - Monitor the vulnerability of domestic economies to shocks.
  - Improve communication of official statistics.
- Second phase (DGI-2), launched in September 2015, focuses on:
  - Implementation of the regular collection and dissemination of reliable and timely statistics for policy use.
  - Introduction of action plans that set out specific targets for the implementation of its 20 recommendations by 2021.
  - Increased emphasis on linkages across economic and financial sectors to assess risks, interconnections, and spillovers within and across economies.
  - Improving cooperation, communication, and sharing of data.

### Main achievements to date
- The DGI led to the development of the IMF’s Special Data Dissemination Standards (SDDS) Plus, launched in February 2012, targeting those economies that have systemically important financial sectors.
- Most of the G20 economies now report the seven financial soundness indicators (FSIs) that are expected from adherents to the SDDS Plus, and work is well advanced to initiate collection of FSI measures beyond simple averages (for example, median, skewness, quartiles) to provide information on tail risks, concentration, and shifts in risk distribution.
- A framework for reporting credit default swaps was developed and implemented, and new international guidance was developed for securities statistics.
- A framework for the collection and sharing of data on global systemically important banks was established and reporting of such data to the International Data Hub is progressing.
- All G20 economies report their international investment positions quarterly and core Coordinated Portfolio Investment Survey data semiannually.
- Most of the G20 economies disseminate residential property price indices.

### Links with other reform efforts
- The DGI has been a key component of the financial sector reform agenda.
- By contributing to a better understanding of trends and volatility of capital flows, DGI data are related to the G20 work on international financial architecture.
- Global regulatory reforms such as Basel III and the work on the Legal Entity Identifier support the DGI by contributing to the robustness of various data frameworks (that is, security-by-security and cross-border exposures of nonbank corporations).

### Remaining work through 2021
- DGI work will address key remaining data gaps through 2021:
  - Compilation of government finance statistics beyond the central government.
  - Sectoral accounts, including details on shadow banking activities.
  - Sharing of granular data.

### Financial Soundness Indicators (FSIs) expected from SDDS Plus adherents
1. regulatory Tier 1 capital to risk weighted assets;
2. regulatory Tier 1 capital to assets;
3. non-performing loans net of provisions to capital;
4. non-performing loans to total gross loans;
5. return on assets;
6. liquid assets to short-term liabilities;
7. residential real estate prices.

- This box was prepared by Florina Tanase and Evrim Bese Goksu.

*Source: Box 2.1. The IMF’s Role in the Global Regulatory Reform Agenda, Global Financial Stability Report—A Decade After the Global Financial Crisis: Are We Safer, International Monetary Fund | October 2018.*

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_Source: https://www.imf.org/-/media/files/publications/gfsr/2018/oct/ch1/doc/text.pdf_