## Chapter 1 at a Glance

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### Global financial stability overview and near-term risks
- Financial stability risks have been contained so far, reflecting ongoing monetary and fiscal policy support and the rebound of the global economy this year.
- Investors have become increasingly concerned about the economic outlook amid rising virus infections and greater uncertainty about the strength of the recovery.
- After declining notably through the summer, global long-term yields have risen in late September, in some countries entirely reversing their earlier moves, on concerns that price pressures may be more persistent than initially anticipated.
- While investors still anticipate such pressures to moderate and gradually subside, risks to the inflation outlook appear to be skewed to the upside in many countries.
- Global financial stability risks could materialize if investors reassess the economic and policy outlook, potentially triggering a sudden repricing of risk that tightens financial conditions and puts growth at risk in the medium term.

### Financial conditions and asset valuations
- Financial conditions in advanced economies have eased further, on net, since the April 2021 Global Financial Stability Report, buoyed by expectations that monetary policy will remain accommodative.
- Equity prices have risen and credit spreads have continued to narrow, on balance, leading to stretched valuations in segments of financial markets.
- House prices have risen rapidly in many countries, boosted by policy support and shifting preferences.
- Financial conditions in emerging and frontier market economies are little changed, with local currency yields remaining elevated amid a significant increase in local currency issuance and inflation pressure in some countries.

### Macro‑financial vulnerabilities and sectoral stresses
- Despite some improvement during the recovery, financial vulnerabilities remain elevated in a number of sectors.
- Banks have supported credit flows during the pandemic, but bank loan underwriting standards remain restrictive in many countries; loan officer surveys point to risks to the credit outlook as the main constraint to loan growth.
- Solvency risks remain elevated in sectors hit hardest by the pandemic and for small firms; defaults and bankruptcies have declined but differences persist across countries, firm sizes, and sectors.
- In China, credit conditions have tightened, particularly for firms with weak credit ratings and in provinces with weaker public finances, underscoring the urgency of comprehensive restructuring and reform efforts, including to gradually phase out implicit guarantees and to deal with financially weak state-owned entities.
- Nonbank financial institutions, including life insurance companies, face challenges such as asset-liability duration mismatches in many jurisdictions.

### Risks from inflation and interest rates
- An abrupt, sustained increase in interest rates from low levels, particularly in the United States, could trigger a tightening of global financial conditions, interacting with existing financial vulnerabilities and resulting in a decompression of market volatility and a sharp fall in asset valuations.
- Global long-term nominal yields were volatile since the April 2021 GFSR:
  - US 10-year nominal yields rose more than 80 basis points through the end of March, then dropped as much as 55 basis points in the summer, and by late September were only 27 basis points lower since the April 2021 GFSR.
- The Federal Reserve’s median projection of the policy rate has increased notably since March, with the end-2023 projection of the federal funds rate at 1 percent; the market-implied policy rate path is somewhat shallower.
- The net downward trend in term premia may reflect safe-haven flows into US Treasury securities; heightened demand is observable in higher foreign holdings of these securities.

### Growth outlook and growth‑at‑risk
- Global GDP growth is forecast to decline in 2022, and the balance of risks to growth in 2022 is expected to remain skewed to the downside.
- The probability of growth falling below zero next year is estimated at about 4 percent, reflecting slightly elevated downside risks compared with historical norms.
- Forward real interest rates declined sharply over the summer, signaling investor concerns about medium- to longer-term growth; a significant downgrade of economic prospects could trigger a sharp decline in risk asset prices and tighter financial conditions.

### Policy recommendations and priorities
- Monetary policy:
  - Central banks should provide clear guidance about the future stance of monetary policy to avoid an unwarranted tightening of financial conditions.
  - If price pressures turn out to be more persistent than anticipated, monetary authorities should act decisively to prevent an unmooring of inflation expectations.
- Fiscal policy:
  - Fiscal support should shift toward more targeted measures and be tailored to country characteristics as the recovery progresses.
- Macroprudential policy:
  - Policymakers should take early action and tighten selected macroprudential tools to target pockets of elevated vulnerabilities while avoiding a broad tightening of financial conditions.
- Emerging and frontier markets:
  - Rebuild buffers and implement long-standing structural reforms to boost growth prospects and cushion the adverse impact of capital flow reversals and abrupt increases in financing costs.
- Corporate sector:
  - Tailored support to viable firms remains crucial; restructuring and reforms are urgent where credit conditions have tightened and implicit guarantees persist.

### Key numeric figures highlighted
- Five-year–five-year forward real yields in the United States down 60 basis points.
- Central bank assets increased to close to 60 percent of GDP.
- Domestic monetary authorities and the foreign official sector now account for close to 40 percent of securities outstanding.
- The probability of US inflation being greater than 2 percent over the next five years is more than 80 percent.
- Emerging market inflation has risen about 1.5 percentage points above the median emerging market central bank target.
- Median two-year forward policy rate for emerging markets is 4.7 percent compared with 3.3 percent at the time of the April 2021 GFSR.
- Corporate issuance outperformed 2020 by almost 20 percent.
- Emerging market hard-currency issuance is running at a record pace this year, surpassing the record in 2020.

---

### Decomposition of the change in advanced‑economy nominal yields (US bond yields, term premia, and the low‑for‑long scenario)
- US nominal yields have declined sharply despite a pickup in rate‑hike expectations.
- The decline in term premia has coincided with a sharp rise in foreign demand for US Treasuries.
- Market pricing points to a shallow policy rate path over the next few years.
- Possible drivers of lower term premia include a reassessment of the timing of US policy normalization after weaker-than-expected data and elevated foreign official demand.
- Through the end of September, debt ceiling negotiations in the United States have not left any material imprint on financial markets, notwithstanding some distortions in the US short-term Treasury market.

### Real yields and inflation breakevens
- Real yields have declined significantly across most major advanced economies since the April 2021 GFSR:
  - In the United States, the decline has occurred at the back end of the curve, with five-year–five-year forward real yields down 60 basis points.
  - In other advanced economies, the decline in real yields has been more evident at the five-year maturity.
- Inflation breakevens have risen in some countries (for example, the euro area, Japan, and the United Kingdom) but remain at or below targets.
- The forward one-year inflation breakeven curve is downward sloping, indicating expected moderation and gradual subsidence of price pressures over the short term.
- Five-year inflation breakevens in the United States and euro area have moved within a relatively tight range since the April 2021 GFSR; five-year forward inflation breakevens have increased since the start of the pandemic but more contained than short-term breakevens, pointing to well-anchored long-term inflation expectations.

### Market signals on inflation risks and investor behavior
- Concerns about upside risks to the inflation outlook have intensified, especially in the United States; investors highlight risks from persistent supply chain disruptions and shortages of materials and labor.
- Flows into inflation‑protected securities have been relatively robust this year, notwithstanding a recent slowdown.
- Pricing in options markets:
  - The probability of inflation in the United States being greater than 2 percent over the next five years is more than 80 percent.
  - Investors appear to see inflation risks as more skewed to the downside in the euro area.
- Survey-based and forward-looking measures indicate medium‑term inflation expectations remain fairly well anchored in both advanced economies and emerging markets, though near‑term expectations have moved higher.

### Emerging market local assets and bond markets
- Local currency government bond yields for most emerging market economies have risen year to date and remain elevated despite recent declines in US Treasury yields.
- In early 2021 the rise in bond yields for many emerging markets was mostly due to higher term premia; since the April 2021 GFSR changes in long-term emerging market bond yields have been driven primarily by an upward shift in policy expectations.
- Contributing factors to upward pressure on yields and term premia include significant increases in local currency issuance and broader fiscal risks amid weak nonresident flows.
- Hard-currency emerging market bond spreads have been relatively stable after recovery from the pandemic sell-off; spreads for frontier economies have changed little on net.
- Emerging market hard-currency bond issuance has been robust and is running at a record pace this year, surpassing the record in 2020.
- Corporate issuance has been very strong, outperforming 2020 by almost 20 percent; a key exception is China, where corporate issuance has been weak.
- Emerging market inflation has risen about 1.5 percentage points above the median emerging market central bank target.
- The median two-year forward policy rate is 4.7 percent compared with 3.3 percent at the time of the April 2021 GFSR.

### Managing withdrawal of monetary accommodation and central bank balance sheets
- Central bank balance sheets in advanced economies have increased substantially during the pandemic:
  - Assets held on advanced-economy central bank balance sheets have increased to close to 60 percent of GDP, almost double the level prevailing before the pandemic.
  - Domestic monetary authorities and the foreign official sector now account for close to 40 percent of securities outstanding, even after accounting for the increase in the supply of government bonds to finance the fiscal response to the pandemic.
- Key challenge during normalization: avoid an unwarranted tightening of financial conditions that may hurt the recovery.
- Historical precedents provide mixed lessons: a sudden reassessment could trigger a spike in volatility and an upward move in term premia (for example, the 2013 “taper tantrum”), whereas the Federal Reserve’s 2014 tapering episode was associated with a decline in term premia (macroeconomic backdrop differed).

### Market volatility, risk‑taking, and potential repricing
- The easing in global financial conditions during the pandemic has resulted in a collapse in volatility across asset classes, encouraging investors to take on more risk.
- Equity prices have risen further on net since the April 2021 GFSR, supported by extremely low and declining real rates and strong earnings, while equity price misalignments relative to fundamentals-based values have remained elevated.
- Credit spreads in corporate bond markets have remained tight, reflecting investors’ benign view of the credit outlook amid ample liquidity and continued policy support.
- Investors have become somewhat more cautious recently, demanding more protection against large declines in risk markets amid increased uncertainty.
- Elevated equity valuations and increased sensitivity of equity prices to government bond prices suggest equities may reprice substantially in the event of a sudden reassessment of the economic outlook or unexpected policy changes.

---

### Change in central bank balance sheet assets and related risks
- Central bank balance sheets have expanded to unprecedented levels in response to the COVID-19 pandemic.
- Most asset purchase programs have now ended or are winding down, but central banks still hold a significant amount of assets on their balance sheets.
- Monetary policy stance should continue to be informed by specific country circumstances, including:
  - the evolution of the pandemic and available policy space,
  - the inflation and economic outlook,
  - the risk of cross-border spillovers,
  - financial stability considerations.
- Despite recent hikes, monetary conditions remain broadly stimulative, with real rates deeply negative and supportive of growth; however, real rates may rise significantly in coming years.
- Given considerable slack in some economies, with output gaps persisting through 2024 according to IMF staff estimates, a rapid tightening of domestic financial conditions could adversely affect the nascent recovery.
- IMF staff analysis shows that emerging market term premia could rise by almost 140 basis points over 16 weeks in the event of a 100 basis point rise in US 10-year real yields following a hawkish surprise.
- Capital flows at risk (5th percentile of the predicted distribution) have declined from 2.1 percent of GDP at the end of 2020 to 1.7 percent of GDP.
- Cumulative local currency debt flows (excluding China) since January 2020 remain negative, down by more than $20 billion.
- There was record $250 billion cumulative hard currency issuance for emerging market sovereigns.
- Local currency debt flows to China have continued to be strong, with cumulative flows of $50 billion year to date.
- China’s inclusion in global benchmark indices has led to significant inflows, estimated at $180 billion since 2020.
- Almost 60 percent of low-income countries are already in or near high debt distress.
- Private debt funds have continued to expand during the pandemic, accumulating close to $400 billion in dry powder.

---

### Real house price growth, vulnerabilities, and mortgage market implications (2019:Q4–21:Q1)
- Time span covered: 2019:Q4–21:Q1 (percent changes in real house prices; nominal house prices adjusted for inflation using the consumer price index).
- Downside risks have increased in advanced and emerging market economies.
- House prices have surged in several countries; in some countries (Luxembourg, New Zealand, Turkey) real house prices have risen more than 15 percent since the end of 2019.
- House-prices-at-risk (5th percentile) worst-case declines over the next three years:
  - about 14 percent in advanced economies
  - 22 percent in emerging markets
- Household financial positions appear stronger than before the global financial crisis based on household net worth and owners’ real estate equity.
- Mortgage delinquencies have remained low during the pandemic, largely due to forbearance; loans in forbearance have begun to diminish as households bring payments up to date.
- Nonbank lenders have become predominant in the US mortgage origination market; nonbank vulnerabilities warrant monitoring and possible expansion of the regulatory perimeter.
- Analysis indicates consensus estimates of loan growth are generally below loan growth consistent with the IMF 2022 GDP forecast, pointing to potential downside risks to the IMF’s GDP forecasts unless credit intensity or bank loan share dynamics change.
- Expiration and runoff of support measures (guarantees, moratoria) could drive defaults higher and require banks to increase provisions; in some cases the negative impact on capital could exceed 100 basis points of CET1 ratios.
- Policy implication: lending appetite may be more sensitive to policies that improve the credit quality environment (support for borrower solvency, policies to improve credit information and bad debt recoveries) than solely to capital considerations.

---

### Share of emerging market lenders in cross‑border lending and implications
- Growing emerging-market-to-emerging-market interlinkages; international banks have cut back lending to emerging markets.
- High foreign bank participation is a potential amplifier to credit withdrawals; international lending through foreign bank branches (wholesale and intragroup funded) is relatively prone to outflows during stress, while foreign bank subsidiaries (locally capitalized and funded) are the most stable.
- A simulation finds a one standard deviation shock to both lender and borrower factors could drive a 5 percent decline in international lending.
- Emerging market Asia (excluding China), where the COVID‑19 Delta variant was spreading rapidly, is particularly vulnerable.
- Policy recommendations:
  - Tailor monetary and fiscal support to country circumstances.
  - Well telegraphed, gradual, and country‑calibrated normalization of policy support.
  - For emerging market central banks that implemented asset purchase programs, ensure transparency and clear communication; asset purchase programs should be limited in time and scale and linked to clear objectives.
  - Activate macroprudential tools where needed and urgently develop tools where they do not exist (for example, in the nonbank financial intermediary sector).
  - Promote depth of emerging market local currency markets (legal/regulatory framework, efficient money markets, transparency, liquidity, market infrastructure).
  - Strengthen insolvency frameworks and provide tailored support to viable firms.

---

### Proportion of systemically important economies with elevated vulnerabilities; life insurers, fintech, climate risks, and Evergrande
- Life insurers:
  - Hold about 20 percent of outstanding global bonds and 30 percent of corporate bonds.
  - Face elevated asset-liability-duration mismatches and negative spreads of investment yields to guaranteed policy returns in many jurisdictions.
  - Scenario shocks and impacts:
    - Benign yield increase: equity (−5 percent); real estate (−2 percent); all sovereign and corporate bond yields up +100 basis points regardless of credit rating.
    - Yield increase and corporate stress: equity (−10 percent); real estate (−6 percent); sovereign bond yields AAA-A (+100 basis points), BBB (+150 basis points), and <BBB (+200 basis points); corporate bond yields AAA-A (+150 basis points), BBB (+250 basis points), and <BBB (+300 basis points).
    - Elevated yield increase and corporate stress: equity (−20 percent); real estate (−10 percent); sovereign bond yields AAA-A (+200 basis points), BBB (+250 basis points), and <BBB (+300 basis points); corporate bond yields AAA-A (+250 basis points), BBB (+350 basis points), and <BBB (+400 basis points).
  - Impact:
    - US and UK life insurers estimated losses exceeding 30 percent of their assets in the worst-case scenario; less than 10 percent in the more modest yield increase scenario.
    - EIOPA (2020) estimates surrender volumes could increase to €372 billion in Europe in its most stressed scenario, generating a shortfall of about €340 billion.
    - Assuming similar lapse rates in the United States, surrenders could amount to over $550 billion in the United States, about $1 trillion in combined surrenders.
    - Moody’s (2021) estimates $500 billion (31 percent of US life insurance policies) is surrenderable with low penalty; ESRB (2015) calculates that 90 percent of contracts can be surrendered with a penalty lower than 15 percent of the policy value.
  - Policy implication: a gradual yield increase would help mitigate long‑term challenges; a large, sudden increase could force asset liquidations and procyclical amplification.
- Fintech lending:
  - Fintech lending increased about 60 percent for banks and 125 percent for nonbanks over 2013–19.
  - Pandemic period (2019–20): assets for fintech banks and nonbanks increased by 18 percent and 7 percent, respectively.
  - Nonperforming asset rates for fintech lenders increased during the pandemic; fintech nonbanks show significantly higher nonperforming asset ratios than traditional counterparts.
  - Policy implication: monitor fintech activity and risk management; balance financial inclusion and stability.
- Climate‑related financial vulnerabilities in China:
  - Credit extended to firms with liquidity risk in carbon-intensive sectors totals about 10 percent of GDP.
  - Policy coordination across Chinese agencies is essential to ensure an orderly transition to carbon neutrality by 2060.
- Evergrande:
  - Evergrande has about $304 billion in total liabilities.
  - The real estate sector’s total liabilities amounted to $4.84 trillion.
  - Contagion so far limited to other financially weak property developers and lower-rated firms, but systemic channels are numerous and sometimes opaque.
  - Policy options:
    - Longer term: strengthen corporate restructuring and insolvency frameworks to facilitate market-based exit of nonviable firms.
    - Short term: authorities have tools to contain and manage potential financial stress; trade-offs exist between broader support (which may reinforce implicit guarantees) and allowing market discipline.

---

### Selected numeric figures and scenarios reported in the chapter
- Five-year–five-year forward real yields in the United States down 60 basis points.
- Central bank assets increased to close to 60 percent of GDP.
- Domestic monetary authorities and the foreign official sector now account for close to 40 percent of securities outstanding.
- The probability of US inflation being greater than 2 percent over the next five years is more than 80 percent.
- Emerging market inflation has risen about 1.5 percentage points above the median emerging market central bank target.
- Median two-year forward policy rate for emerging markets is 4.7 percent compared with 3.3 percent at the time of the April 2021 GFSR.
- Corporate issuance outperformed 2020 by almost 20 percent.
- Emerging market hard-currency issuance is running at a record pace this year, surpassing the record in 2020.
- IMF staff analysis: emerging market term premia could rise by almost 140 basis points over 16 weeks in the event of a 100 basis point rise in US 10-year real yields following a hawkish surprise.
- Capital flows at risk (5th percentile) declined from 2.1 percent of GDP at end-2020 to 1.7 percent of GDP.
- Cumulative local currency debt flows (excluding China) since January 2020 remain negative, down by more than $20 billion.
- Record $250 billion cumulative hard currency issuance for emerging market sovereigns.
- Local currency debt flows to China: cumulative flows of $50 billion year to date.
- China inclusion inflows estimated at $180 billion since 2020.
- Almost 60 percent of low-income countries are already in or near high debt distress.
- Private debt funds: close to $400 billion in dry powder.
- Total social financing in China (excluding government bonds) increased to about 230 percent of GDP as of June 2021, up 15 percentage points from the end of 2019.
- Bond default rate in China is 0.7 percent.
- Evergrande total liabilities: $304 billion.
- Real estate sector total liabilities: $4.84 trillion.
- Scenario figures for China local government financing:
  - Investment expenditure would decline by RMB 5.4 trillion if new credit restricted to zero unless financed by fiscal support or asset sales.
  - Cash drawdowns of up to RMB 0.5 trillion could be used to fund part of the operating cash deficit.
  - Leaving an operating cash flow shortfall of RMB 2.3 trillion to be funded by fiscal support or asset sales.
  - RMB 2.3 trillion = ~23 percent of local government fiscal revenues.
  - Of about 7 trillion renminbi in new external financing in 2020, about 4.9 trillion was used to fund investment expenditures; the remaining 2.1 trillion covered operating cash flow deficits.
- Life insurers: about 20 percent of global bonds and 30 percent of credit investments.
- Insurer mark-to-market loss scenario: 30 percent in some jurisdictions.
- Extreme insurer liquidation risk: $1 trillion in the United States and Europe.
- Real house prices up more than 15 percent since end-2019 in some countries (Luxembourg, New Zealand, Turkey).
- Worst-case house price declines over the next three years: about 14 percent (advanced economies), 22 percent (emerging markets).
- Middle-market leveraged buyouts: deals accounting for close to two-thirds of all middle-market leveraged loan issuance.
- CLO issuance: record‑setting pace in 2021.

*GLOBAL FINANCIAL STABILITY OVERVIEW: A DELICATE BALANCING ACT — CHAPTER 1, International Monetary Fund | October 2021*

### Chapter 1 at a Glance

### Chapter 1 at a Glance

### Global financial stability overview and near-term risks
- Financial stability risks have been contained so far, reflecting ongoing monetary and fiscal policy support and the rebound of the global economy this year.
- Investors have become increasingly concerned about the economic outlook amid rising virus infections and greater uncertainty about the strength of the recovery.
- After declining notably through the summer, global long-term yields have risen in late September, in some countries entirely reversing their earlier moves, on concerns that price pressures may be more persistent than initially anticipated.
- While investors still anticipate such pressures to moderate and gradually subside, risks to the inflation outlook appear to be skewed to the upside in many countries.
- Global financial stability risks could materialize if investors reassess the economic and policy outlook, potentially triggering a sudden repricing of risk that tightens financial conditions and puts growth at risk in the medium term.

### Financial conditions and asset valuations
- Financial conditions in advanced economies have eased further, on net, since the April 2021 Global Financial Stability Report, buoyed by expectations that monetary policy will remain accommodative.
- Equity prices have risen and credit spreads have continued to narrow, on balance, leading to stretched valuations in segments of financial markets.
- House prices have risen rapidly in many countries, boosted by policy support and shifting preferences.
- Financial conditions in emerging and frontier market economies are little changed, with local currency yields remaining elevated amid a significant increase in local currency issuance and inflation pressure in some countries.

### Macro-financial vulnerabilities and sectoral stresses
- Despite some improvement during the recovery, financial vulnerabilities remain elevated in a number of sectors.
- Banks have supported credit flows during the pandemic, but bank loan underwriting standards remain restrictive in many countries; loan officer surveys point to risks to the credit outlook as the main constraint to loan growth.
- Solvency risks remain elevated in sectors hit hardest by the pandemic and for small firms; defaults and bankruptcies have declined but differences persist across countries, firm sizes, and sectors.
- In China, credit conditions have tightened, particularly for firms with weak credit ratings and in provinces with weaker public finances, underscoring the urgency of comprehensive restructuring and reform efforts, including to gradually phase out implicit guarantees and to deal with financially weak state-owned entities.
- Nonbank financial institutions, including life insurance companies, face challenges such as asset-liability duration mismatches in many jurisdictions.

### Risks from inflation and interest rates
- An abrupt, sustained increase in interest rates from low levels, particularly in the United States, could trigger a tightening of global financial conditions, interacting with existing financial vulnerabilities and resulting in a decompression of market volatility and a sharp fall in asset valuations.
- Global long-term nominal yields were volatile since the April 2021 GFSR: US 10-year nominal yields rose more than 80 basis points through the end of March, then dropped as much as 55 basis points in the summer, and by late September were only 27 basis points lower since the April 2021 GFSR.
- The Federal Reserve’s median projection of the policy rate has increased notably since March, with the end-2023 projection of the federal funds rate at 1 percent; the market-implied policy rate path is somewhat shallower.
- The net downward trend in term premia may reflect safe-haven flows into US Treasury securities; heightened demand is observable in higher foreign holdings of these securities.

### Growth outlook and growth-at-risk
- Global GDP growth is forecast to decline in 2022, and the balance of risks to growth in 2022 is expected to remain skewed to the downside.
- The probability of growth falling below zero next year is estimated at about 4 percent, reflecting slightly elevated downside risks compared with historical norms.
- Forward real interest rates declined sharply over the summer, signaling investor concerns about medium- to longer-term growth; a significant downgrade of economic prospects could trigger a sharp decline in risk asset prices and tighter financial conditions.

### Policy recommendations and priorities
- Monetary policy: Central banks should provide clear guidance about the future stance of monetary policy to avoid an unwarranted tightening of financial conditions. If price pressures turn out to be more persistent than anticipated, monetary authorities should act decisively to prevent an unmooring of inflation expectations.
- Fiscal policy: Fiscal support should shift toward more targeted measures and be tailored to country characteristics as the recovery progresses.
- Macroprudential policy: Policymakers should take early action and tighten selected macroprudential tools to target pockets of elevated vulnerabilities while avoiding a broad tightening of financial conditions.
- Emerging and frontier markets: These countries should rebuild buffers and implement long-standing structural reforms to boost growth prospects and cushion the adverse impact of capital flow reversals and abrupt increases in financing costs.
- Corporate sector: Tailored support to viable firms remains crucial; restructuring and reforms are urgent where credit conditions have tightened and implicit guarantees persist.

*GLOBAL FINANCIAL STABILITY OVERVIEW: A DELICATE BALANCING ACT — CHAPTER 1, International Monetary Fund | October 2021*

### 4. Decomposition of the Change in Advanced Economy Nominal Yields

### 4. Decomposition of the Change in Advanced Economy Nominal Yields

### US bond yields, term premia, and the low-for-long scenario
- US nominal yields have declined sharply despite a pickup in rate-hike expectations.
- The decline in term premia has coincided with a sharp rise in foreign demand for US Treasuries.
- Market pricing points to a shallow policy rate path over the next few years.
- Possible drivers of lower term premia include a reassessment of the timing of US policy normalization after weaker-than-expected data and elevated foreign official demand.
- Through the end of September, debt ceiling negotiations in the United States have not left any material imprint on financial markets, notwithstanding some distortions in the US short-term Treasury market.

### Real yields and inflation breakevens
- Real yields have declined significantly across most major advanced economies since the April 2021 GFSR.
  - In the United States, the decline has occurred at the back end of the curve, with five-year–five-year forward real yields down 60 basis points.
  - In other advanced economies, the decline in real yields has been more evident at the five-year maturity.
- Inflation breakevens have risen in some countries (for example, the euro area, Japan, and the United Kingdom) but remain at or below targets.
- Rising commodity, notably energy, prices have likely exerted some upward pressure on inflation.
- The forward one-year inflation breakeven curve is downward sloping, indicating expected moderation and gradual subsidence of price pressures over the short term.
- Five-year inflation breakevens in the United States and euro area have moved within a relatively tight range since the April 2021 GFSR; five-year forward inflation breakevens have increased since the start of the pandemic but more contained than short-term breakevens, pointing to well-anchored long-term inflation expectations.

### Market signals on inflation risks and investor behavior
- Concerns about upside risks to the inflation outlook have intensified, especially in the United States; investors highlight risks from persistent supply chain disruptions and shortages of materials and labor.
- Investors have pointed to the risk that a surge in house prices may put upward pressure on inflation via rising housing rents.
- Flows into inflation-protected securities have been relatively robust this year, notwithstanding a recent slowdown.
- Pricing in options markets:
  - The probability of inflation in the United States being greater than 2 percent over the next five years is more than 80 percent, increasing modestly since the April GFSR.
  - Investors appear to see inflation risks as more skewed to the downside in the euro area.
- Survey-based and forward-looking measures indicate medium-term inflation expectations remain fairly well anchored in both advanced economies and emerging markets, though near-term expectations have moved higher.

### Emerging market local assets and bond markets
- Local currency government bond yields for most emerging market economies have risen year to date and remain elevated despite recent declines in US Treasury yields.
- In early 2021 the rise in bond yields for many emerging markets was mostly due to higher term premia; since the April 2021 GFSR changes in long-term emerging market bond yields have been driven primarily by an upward shift in policy expectations, reflecting tighter monetary policy in some countries.
- Contributing factors to upward pressure on yields and term premia include significant increases in local currency issuance and broader fiscal risks amid weak nonresident flows.
- While overall stress in local currency bond markets has declined, conditions in some countries (mostly in Latin America) remain tense.
- By contrast, hard-currency emerging market bond spreads have been relatively stable after recovery from the pandemic sell-off; spreads for frontier economies have changed little on net.
- Emerging market hard-currency bond issuance has been robust and is running at a record pace this year, surpassing the record in 2020.
- Corporate issuance has been very strong, outperforming 2020 by almost 20 percent; a key exception is China, where corporate issuance has been weak.
- Inflation in emerging markets has risen about 1.5 percentage points above the median emerging market central bank target; forward survey estimates show inflation is anticipated to start trending down and come within range over the next 6–12 months.
- Investors appear to be pricing a significantly steeper expected policy path for many emerging markets:
  - The median two-year forward policy rate is 4.7 percent compared with 3.3 percent at the time of the April 2021 GFSR.

### Managing withdrawal of monetary accommodation and central bank balance sheets
- Central bank balance sheets in advanced economies have increased substantially during the pandemic:
  - Assets held on advanced-economy central bank balance sheets have increased to close to 60 percent of GDP, almost double the level prevailing before the pandemic.
  - Domestic monetary authorities and the foreign official sector now account for close to 40 percent of securities outstanding, even after accounting for the increase in the supply of government bonds to finance the fiscal response to the pandemic.
- Key financial stability challenge during normalization: avoid an unwarranted tightening of financial conditions that may hurt the recovery.
- Uncertainty about asset-price effects (in particular bond term premia) is elevated because of the larger role central banks play in sovereign bond markets, anticipated increase in supply, and diverging monetary policy cycles across countries.
- Historical precedents provide mixed lessons:
  - A sudden reassessment of monetary policy outlook could trigger a spike in volatility and a sharp upward move in term premia (for example, the 2013 “taper tantrum”).
  - The Federal Reserve’s 2014 tapering episode was associated with a decline in term premia, although the macroeconomic backdrop differed.

### Market volatility, risk-taking, and potential repricing
- The easing in global financial conditions during the pandemic has resulted in a collapse in volatility across asset classes, encouraging investors to take on more risk.
- Equity prices have risen further on net since the April 2021 GFSR, supported by extremely low and declining real rates and strong earnings, while equity price misalignments relative to fundamentals-based values have remained elevated.
- Sectoral equity valuations have diverged since late March 2021.
- Credit spreads in corporate bond markets have remained tight, reflecting investors’ benign view of the credit outlook amid ample liquidity and continued policy support.
- Investors have become somewhat more cautious recently, demanding more protection against large declines in risk markets amid increased uncertainty.
- Elevated equity valuations and increased sensitivity of equity prices to government bond prices suggest equities may reprice substantially in the event of a sudden reassessment of the economic outlook or unexpected policy changes.

Key numeric figures highlighted in the chapter
- Five-year–five-year forward real yields in the United States down 60 basis points.
- Central bank assets increased to close to 60 percent of GDP.
- Domestic monetary authorities and the foreign official sector now account for close to 40 percent of securities outstanding.
- The probability of US inflation being greater than 2 percent over the next five years is more than 80 percent.
- Emerging market inflation has risen about 1.5 percentage points above the median emerging market central bank target.
- Median two-year forward policy rate for emerging markets is 4.7 percent compared with 3.3 percent at the time of the April 2021 GFSR.
- Corporate issuance outperformed 2020 by almost 20 percent.
- Emerging market hard-currency issuance is running at a record pace this year, surpassing the record in 2020.

*Sources: Bloomberg Finance L.P.; Federal Reserve; and IMF staff.*

### 1. Change in Central Bank Balance Sheet Assets

### 1. Change in Central Bank Balance Sheet Assets

### Central bank balance sheets and monetary policy stance
- Central bank balance sheets have expanded to unprecedented levels in response to the COVID-19 pandemic.
- Most asset purchase programs have now ended or are winding down, but central banks still hold a significant amount of assets on their balance sheets.
- Monetary policy stance should continue to be informed by specific country circumstances, including:
  - the evolution of the pandemic and available policy space,
  - the inflation and economic outlook,
  - the risk of cross-border spillovers,
  - financial stability considerations.
- A preemptive tightening of monetary policy may help prevent a possible unanchoring of inflation expectations (as argued in Chapter 2 of the October 2021 WEO).
- Despite recent hikes, monetary conditions remain broadly stimulative, with real rates deeply negative and supportive of growth; however, real rates may rise significantly in coming years.
- Given considerable slack in some economies, with output gaps persisting through 2024 according to IMF staff estimates, a rapid tightening of domestic financial conditions could adversely affect the nascent recovery.
- The combination of a very rapid policy tightening cycle and declining inflation expectations suggests that term real rates may return to their prerecession levels fairly quickly in some countries, and even rise to historic highs in some cases over the next few years.

### Term premia, volatility, and tapering risks
- Term premia and volatility have reacted differently during past episodes of quantitative easing tapering.
- IMF staff analysis shows that emerging market term premia could rise by almost 140 basis points over 16 weeks in the event of a 100 basis point rise in US 10-year real yields following a hawkish surprise (proxied by a dummy where the S&P 500 falls while real rates rise).

### Emerging markets, capital flows, and debt risks
- Lower near-term risks to emerging market capital flows: the outlook for portfolio flows has improved, boosted by the ongoing economic recovery and robust global risk sentiment.
- Capital flows at risk (5th percentile of the predicted distribution) have declined from 2.1 percent of GDP at the end of 2020 to 1.7 percent of GDP.
- Cumulative local currency debt flows (excluding China) since January 2020 remain negative, down by more than $20 billion.
- There was record $250 billion cumulative hard currency issuance for emerging market sovereigns.
- Local currency debt flows to China have continued to be strong, with cumulative flows of $50 billion year to date.
- China’s inclusion in global benchmark indices has led to significant inflows, estimated at $180 billion since 2020.
- Almost 60 percent of low-income countries are already in or near high debt distress.
- The increase in US Treasury yields in late September has the potential to add pressure to emerging market bond yields, which have increased relative to equivalent-maturity US Treasuries primarily on domestic developments (higher inflation and fiscal concerns).
- Hard currency issuance has rebounded strongly, with many lower-rated issuers (including Cameroon, Mongolia, and Pakistan) returning to capital markets since the April 2021 GFSR.
- Domestic banks initially, and nonbank financial institutions more recently, have absorbed an increasing portion of domestic debt across major emerging markets, highlighting the risk of the financial-sovereign nexus in some countries.
- Sustainable debt issuance has picked up sharply in emerging markets (EM ESG sovereign and NFC issuance noted).

### Corporate sector credit conditions and vulnerabilities
- Corporate revenues have risen, supported by the global recovery and ongoing policy support; profitability prospects have brightened, surpassing pre-pandemic levels in several economies.
- Recovery has been uneven; near-term solvency and liquidity risks remain elevated in sectors hit most by the pandemic, such as transportation and services in advanced economies.
- By firm size, solvency risk improvement has been more evident for large firms; solvency risk has risen in some advanced and emerging market economies, especially among small firms.
- Credit quality in the speculative-grade bond market has continued to strengthen, with credit rating upgrades exceeding downgrades this year.
- After a sharp decline, US speculative-grade default rates are anticipated to remain low.
- A substantial pickup in bankruptcies has not materialized so far, supported by targeted fiscal support and unprecedented monetary policy:
  - Bankruptcies of large and medium-sized firms in the United States have declined, with sectoral differences.
  - Bankruptcies of small firms have also fallen.
  - In Japan, a similar trend decline in bankruptcies is evident; in Europe bankruptcies have been rising, with notable differentiation across countries.
- Robust merger and acquisition activity this year is expected to support consolidation among small and medium-sized firms.
- Private debt funds have continued to expand during the pandemic, accumulating close to $400 billion in dry powder.

### Financial vulnerabilities in China
- Financial vulnerabilities have risen further in China during the pandemic, remaining elevated across various sectors including nonfinancial firms, households, banks, and asset managers.
- Total social financing, excluding government bonds, had increased to about 230 percent of GDP as of June 2021, up 15 percentage points from the end of 2019.
- A few state-owned entities defaulted toward the end of 2020, prompting greater differentiation of expected state support at the regional level.
- State-owned entities accounted for about half of total onshore corporate bond defaults in 2020–21, up from about 10 percent in 2017–19, while the bond default rate is still very low at 0.7 percent.
- Corporate credit conditions have tightened amid moderating overall credit growth; tightening has been more pronounced for private and state-owned entities located in provinces with relatively high public debt and/or large fiscal deficits, or with recent local state-owned-enterprise bond defaults.

*Source: International Monetary Fund | October 2021.*

### 1. Global 12-Month Forward Earnings per Share Ratios

### 1. Global 12-Month Forward Earnings per Share Ratios

### Corporate solvency, liquidity, and profitability
- Solvency risk "has declined since the height of the pandemic, but less so for small firms."
- "Corporate profitability prospects have improved, albeit at a different pace across economies."
- "Several sectors continue to face solvency and liquidity risks in the near term."
- In panels 2 and 3 (Advanced Economies: Share of Debt at Firms with High Solvency and Liquidity Risk; Change in the Share of Firms with High Solvency Risk), solvency risk and liquidity risk are defined based on sets of balance-sheet and market-based indicators described in Online Annex 1.1 of the April 2021 Global Financial Stability Report.

### Default rates and credit spreads
- "Default rates are set to remain low, based on rating agencies’ projections and on credit spreads."
- In panel 4 (US High-Yield Corporate Bond Spread, Default Rate, and Rating Agencies’ Forecast): the "Baseline scenario" is defined as "the average of default rate forecasts by three rating firms (Fitch, Moody’s, and S&P), and each forecast is in line with the firms’ macroeconomic forecasts."

### Bankruptcies, consolidation, and private debt
- "Bankruptcies of large and medium-sized firms in the United States have dropped substantially."
- "Bankruptcies of small firms have declined in the United States and Japan but have risen in Europe."
- "Robust merger and acquisition activity is expected to support the consolidation of small and medium-sized firms."
- "Private debt funds have expanded as a potential funding source."
- Middle-market leveraged buyouts: "deals accounting for close to two-thirds of all middle-market leveraged loan issuance."
- CLO issuance: "issuance of collateralized loan obligations has been on a record-setting pace in 2021."
- Equity market leverage: "the use of equity-linked derivatives has increased," though "the ratio to market capitalization has declined."

### Nonbank financial intermediaries and insurers
- "While financial vulnerabilities have generally declined at nonbank financial intermediaries, in several advanced economies and China, nonbank financial intermediaries still feature elevated leverage, credit risk exposures, and/or liquidity mismatches."
- The life-insurance sector "owns about 20 percent of global bonds and 30 percent of credit investments."
- A stress scenario "could induce mark-to-market losses of 30 percent for insurers in some jurisdictions."
- Extreme liquidation risk: "could, in the extreme, reach $1 trillion in the United States and Europe."

### China: credit conditions, local government-owned entities, and policy implications
- Since late-2020 state-owned-enterprise bond defaults, "nearly all of the net increase in bond issuance has occurred at firms with a history of negative operating cash flows, most of which are local government-owned entities."
- Without restructuring and reform, "restricting credit to local government-owned entities could adversely affect investment and local government balance sheets."
- Scenario analysis (if new credit is restricted to zero):
  - "Investment expenditure would decline by RMB 5.4 trillion unless financed by fiscal support or asset sales."
  - "Cash drawdowns of up to RMB 0.5 trillion could be used to fund part of the operating cash deficit and ... leaving an operating cash flow shortfall of RMB 2.3 trillion ... to be funded by fiscal support or asset sales."
  - "RMB 2.3 trillion = ~23 percent of local government fiscal revenues."
- Historical allocation of 2020 new external financing: "of about 7 trillion renminbi in new external financing, about 4.9 trillion was used to fund investment expenditures; the remaining 2.1 trillion covered operating cash flow deficits."
- Policy recommendations for Chinese authorities:
  - "Continue to pursue coordinated efforts across agencies to contain leverage and phase out implicit guarantees."
  - "Accelerate restructuring of financially nonviable firms."
  - "Improve governance of local governments’ public finances."
  - "Enhance sharing of fiscal resources between financially weaker and stronger provinces (for example, through conditional central government transfers)."
- Authorities’ actions noted: continued reform of wealth management products; new restrictions to contain lending to the property sector; limits on local governments’ ability to raise off-balance-sheet financing; tightened regulatory and supervisory requirements for fintech companies.

### Market exuberance, leverage, and housing risks
- Financial risk-taking and releveraging:
  - "Merger and acquisition activity may also be a source of risk, as financial risk-taking, corporate releveraging, and use of financial leverage in deals could exacerbate existing vulnerabilities."
  - "Releveraging reemerged through debt-funded leveraged buyouts."
- Housing market developments and downside risk:
  - "House prices historically tend to drop during recessions, they have surged among major advanced and emerging market economies."
  - In some countries (Luxembourg, New Zealand, Turkey) "real house prices have risen more than 15 percent since the end of 2019."
  - Worst-case scenario house-price declines over the next three years:
    - "about 14 percent in advanced economies"
    - "22 percent in emerging markets"
  - Methodology note: "house prices at risk corresponds to downside risks to house prices, defined as the forecast house price growth at the 5th percentile of the house price distribution."

### Key numeric figures (as reported)
- RMB 5.4 trillion (investment expenditure decline if new credit restricted to zero, unless financed)
- RMB 0.5 trillion (cash drawdowns usable to fund part of operating cash deficit)
- RMB 2.3 trillion (operating cash flow shortfall to be funded by fiscal support or asset sales)
- RMB 2.3 trillion = ~23 percent of local government fiscal revenues
- About 7 trillion renminbi (new external financing in 2020)
- About 4.9 trillion renminbi (of 2020 new external financing used for investment expenditures)
- 2.1 trillion renminbi (of 2020 new external financing used to cover operating cash flow deficits)
- Life insurers: about 20 percent of global bonds and 30 percent of credit investments
- Insurer mark-to-market loss scenario: 30 percent in some jurisdictions
- Extreme insurer liquidation risk: $1 trillion in the United States and Europe
- Real house prices up more than 15 percent since end-2019 in some countries (Luxembourg, New Zealand, Turkey)
- Worst-case house price decline over next three years: about 14 percent (advanced economies), 22 percent (emerging markets)
- Middle-market leveraged buyout share: close to two-thirds of all middle-market leveraged loan issuance

*Sources: Bloomberg Finance L.P.; BofA Securities; Fitch Ratings; Haver Analytics; Moody’s Investors Service; Morgan Stanley; S&P Capital IQ; S&P Global Ratings; Thomson Reuters Datastream IBES; Bank for International Settlements; Dealogic; Epiq AACER; Eurostat; Preqin; S&P Leveraged Commentary and Data; Tokyo Shoko Research; CEIC; WIND; and IMF staff calculations.*

### 1. Real House Price Growth, 2019:Q4–21:Q1

### Real House Price Growth, 2019:Q4–21:Q1

### Global housing price trends and downside risks
- Time span covered: 2019:Q4–21:Q1 (percent changes in real house prices; nominal house prices adjusted for inflation using the consumer price index).
- Downside risks have increased in advanced and emerging market economies.
- House prices have surged in several countries, with rising house prices already evident in some countries prior to the pandemic.
- House-prices-at-risk model: filled circles indicate the worst-case price decline with a 5 percent probability (5th percentile).
  - Advanced-economies 5th percentile example: –14%
  - Emerging-market-economies 5th percentile example: –22%
  - Additional label shown: –15%

### Indicators of rapid price appreciation
- Indicators based on recursive (right-tailed) unit root tests to detect periods with rapid price appreciations.
- Shaded areas correspond to periods during which the estimated backward sup augmented Dickey-Fuller statistics exceed the corresponding 95th percentile critical value from their limit distribution, implying that prices are overshooting their underlying trend.

### House-prices-at-risk model results
- The model predicts house price growth in a worst-case scenario: the range of outcomes in the lower tail of the future house price distribution.
- Probability densities are estimated for the three-year-ahead (cumulative) house price growth distribution across advanced economies and emerging market economies.
- Data labels use International Organization for Standardization (ISO) country codes (examples shown in figures: CAN, DEU, ESP, ITA, USA, PHL, JPN, HKG, SWE, DNK, NZL, CHN, IND, GBR, NLD, LUX, MYS, RUS, FRA, TUR).

### Household balance sheets and mortgage lending
- Household financial positions appear stronger than before the global financial crisis based on household net worth and owners’ real estate equity.
- Households have benefited from lower interest rates and measures to support income and interest costs, including debt payment moratoria in some jurisdictions.
- Debt service ratios have fallen in many countries, reducing the risk of default on mortgage and other consumer debt.
- Mortgage delinquencies have remained low during the pandemic, largely due to forbearance; loans in forbearance have begun to diminish as households bring payments up to date.
- US-specific observations:
  - Mortgage delinquencies and loans in forbearance tracked (percent of total loans).
  - Nonbank lenders have become predominant in the US mortgage origination market, notably during the pandemic in terms of refinancings.
  - Nonbank lenders typically do not retain mortgages on balance sheets, sell to government-sponsored enterprises within one quarter, do not hold deposits, obtain liquidity from banks, and fund in the wholesale market—making them vulnerable to a sharp tightening in funding market conditions.
  - High concentration among nonbank lenders implies exit risk by key lenders, potentially resulting in a decline in credit.
  - Nonbank originators often act as mortgage servicers, exposing themselves to credit risk from several months of missed payments.

### New housing-market vulnerabilities and policy implications
- Compared with the run-up to the global financial crisis, underwriting standards are generally tighter: fewer mortgages with variable interest rate payments and more stringent standards for cash-out refinancings.
- However, vulnerabilities have emerged in nonbank mortgage origination and servicing channels that warrant monitoring.
- Suggested policy considerations (from analysis):
  - Careful monitoring and assessment of risks in the nonbank financial institution sector.
  - Consider whether additional supervisory tools are needed and whether the regulatory perimeter should be broadened to include some nonbank segments (Box 1.3 referenced for fintech nonbanks).
  - In some jurisdictions (United States noted), proposals were under consideration to impose risk-based capital and other requirements on nonbank mortgage lenders.

### Bank lending, GDP growth, and potential credit shortfalls
- Analysis approach: assumes credit intensity of growth remains at the 2010–19 average and that bank loans will grow at the same pace as total credit over the next few years.
- Finding: consensus estimates of loan growth (based on analyst forecasts for listed banks) are generally below loan growth consistent with the IMF 2022 GDP forecast (“GDP-consistent” loan growth) in most countries, pointing to potential downside risks to the IMF’s GDP forecasts unless credit intensity or bank loan share dynamics change.
- Credit intensity of growth varied year to year but was generally stable over 2010–19; its ratio has been greater than 1 in almost all countries over the past decade.
- Bank loan growth relative to total credit growth has been lower than total credit growth in many countries, reflecting structural shifts (development of capital markets, regulatory changes, technology).
- Economic growth appears more closely related to overall credit growth than to bank loan growth, implying capital markets may play an important role supporting the recovery.
- Loan officer surveys indicate bankers see uncertainties around the economic and credit risk outlook—rather than internal capital positions—as main constraints on loan growth.
- Bank capital ratios do not appear to explain the gap between consensus loan growth and GDP-consistent loan growth.
- Expiration and runoff of support measures (guarantees, moratoria) could drive defaults higher and require banks to increase provisions; in some cases the negative impact on capital could exceed 100 basis points of CET1 ratios.
- Policy implication: lending appetite may be more sensitive to policies that improve the credit quality environment (support for borrower solvency, policies to improve credit information and bad debt recoveries) than solely to capital considerations.

### International bank credit: risks for emerging markets
- A slowdown in international bank credit extension could create a credit shortfall in emerging markets.
- Banks have cut back international lending to emerging markets in recent years; increased regulation (higher capital requirements) contributed to retrenchment from capital-intensive activities in emerging markets.
- Emerging market banks have increased their footprint in international lending; their market share in global cross-border lending tripled to 15 percent between 2008 and 2018.
- Close to 40 percent of cross-border lending to emerging markets is from banks based in other emerging markets.
- Lending by emerging market banks appears more volatile compared with advanced-economy banks, raising potential vulnerability of recipient countries to credit withdrawals in times of stress.
- Foreign bank presence in some jurisdictions is substantial; many financial centers have large foreign bank participation and supervisory flexibility to move liquidity across borders.
- Pure cross-border lending (lender has no presence in borrower country) is the least stable form and the most prone to sudden withdrawal under stress.
- Empirical observation: countries with higher foreign bank participation experienced larger and faster outflows under stress.
- Policy implication: risks of continued weak international lending remain; close monitoring of international claims and foreign bank participation is important.

*Source: ch1 - 1. Real House Price Growth, 2019:Q4–21:Q1 (IMF staff figures and analysis).*

### 2. Share of Emerging Market Lenders in Cross-Border Lending

### ch1 - 2. Share of Emerging Market Lenders in Cross-Border Lending

### Key findings on cross-border lending and foreign bank participation
- There are growing emerging-market-to-emerging-market interlinkages.
- International banks have cut back lending to emerging markets.
- High foreign bank participation is a potential amplifier to credit withdrawals.
- International lending through foreign bank branches, which relies mainly on wholesale and intragroup funding, is relatively prone to outflows during periods of stress.
- Lending by foreign bank subsidiaries (incorporated, capitalized, and mainly funded locally) is the most stable.
- During stress episodes (the global financial crisis, euro area crisis, COVID-19 pandemic), countries with higher foreign bank participation experienced larger and faster outflows, with particular weakness in countries with higher foreign bank branch participation.
- In a simulation exercise decomposing historical growth rates of bilateral international claims into lenders’ financial conditions and borrowers’ macro and financial conditions (largely following Shim and Shin (2018)), a one standard deviation shock to both lender and borrower factors could drive a 5 percent decline in international lending.
- Emerging market Asia (excluding China), where the COVID-19 Delta variant is spreading rapidly, is particularly vulnerable.
- Emerging market banks are expected to cut back more than advanced economy banks.

### Scenarios and vulnerabilities highlighted
- Risk factors that could tighten financial conditions or weaken emerging-market fundamentals include:
  - policy normalization in advanced economies,
  - inflation pressures leading emerging market central banks to tighten monetary policy,
  - reimposition of lockdowns in the event of virus mutations and uneven access to vaccines.
- Significant emerging-market-to-emerging-market interlinkages and rising foreign bank participation could amplify these risks.
- The analysis emphasizes sensitivity to stress in either lender or borrower countries and notes that foreign bank branch funding structures increase outflow risk.

### Policy recommendations to secure a sustainable recovery and limit financial stability risks
- Monetary and fiscal policy support should be tailored to country-specific circumstances given the uneven pace of recovery.
- Policymakers should remain vigilant to maintain the flow of credit to households and firms while mitigating financial stability risks.
- The eventual normalization and removal of unprecedented policy support should be:
  - well telegraphed,
  - gradual,
  - tailored to country-specific circumstances,
  - recalibrated as dictated by the evolution of the recovery.
- Central banks should provide clear guidance about the future stance of monetary policy and progress toward the policy normalization process to avoid unnecessary volatility in financial markets and an unwarranted tightening in financial conditions.
- If price pressures turn out to be more persistent than anticipated, monetary authorities should act decisively to avoid an unmooring of inflation expectations.
- For emerging market central banks that implemented asset purchase programs during the pandemic, transparency and clear communication with respect to their objectives are crucial; in most cases, asset purchase programs should be limited in time and scale and linked to clear objectives.
- Exit strategy plans should be communicated early on and guided by clear parameters to minimize market volatility.

### Policy recommendations to address specific financial stability risks
- Act preemptively to address vulnerabilities and avoid a buildup of legacy problems; tighten selected macroprudential tools where pockets of elevated vulnerabilities exist while avoiding a broad tightening of financial conditions.
- Where macroprudential tools are not available (for example, in the nonbank financial intermediary sector), urgently develop them.
- Rebuild buffers and implement long-standing reforms in emerging and frontier markets to boost structural growth prospects and insulate against capital flow reversals and abrupt increases in financing costs.
- Promote the depth of emerging market local currency markets by:
  - establishing a sound legal and regulatory framework for securities,
  - developing efficient money markets,
  - enhancing transparency of both primary and secondary markets and the predictability of issuance,
  - bolstering market liquidity,
  - developing robust market infrastructure.
- Provide tailored support measures to viable firms in the nonfinancial corporate sector; prioritize borrowers deemed temporarily distressed but likely viable and strengthen insolvency frameworks via a fast-track process to facilitate orderly exit of nonviable firms.
- Activate appropriate macroprudential policy measures to lean against surges in house prices; deploy stringent stress tests and review tools such as stressed debt service and loan-to-value ratios.
- Gradually normalize financial policies where appropriate while reflecting uncertainties and calibrating to the pace of each country’s recovery.
- Urgently address vulnerabilities in nonbank financial intermediaries through enhanced prudential supervision and regulation; for investment funds, increase the value of waiting to sell fund shares and deploy liquidity management tools of increasing intensity sequentially.
- Use market-based liquidity backstops as the first line of defense and central bank emergency liquidity support in tail episodes; pursue internationally coordinated reform given the global nature of the investment fund business.
- Monitor and stress test the life insurance sector for the impact of a sudden increase in yields; encourage greater reporting transparency and more homogenous disclosure standards.

*International Monetary Fund | October 2021 — ch1 - 2. Share of Emerging Market Lenders in Cross-Border Lending*

### 1. Proportion of Systemically Important Economies with Elevated Vulnerabilities, by Sector

### 1. Proportion of Systemically Important Economies with Elevated Vulnerabilities, by Sector

### Elevated vulnerabilities across sectors (overview)
- Charted metric: Percent of countries with high and medium-high vulnerabilities, by GDP (assets of banks, asset managers, other financial institutions, and insurers); number of vulnerable countries in parentheses.  
- Sectors highlighted in the chapter include: Banks, Asset managers, Other financial institutions, Insurers, Nonfinancial firms, Households, Sovereigns.

### Box 1.2 — Challenges for Life Insurers: key findings and scenarios
- Life insurers hold about 20 percent and 30 percent, respectively, of outstanding global bonds and corporate bonds.  
- Life insurers represent a critical source of demand for bonds with long maturities because of their long-dated liabilities.  
- Current vulnerabilities:
  - Elevated asset-liability-duration mismatches remain, particularly in some jurisdictions (Figure 1.2.1, panel 1).  
  - Spreads of investment yields to guaranteed policy returns remain negative, at historically wide levels (Figure 1.2.1, panel 2).  
  - US and European life insurers have increased shares of lower-quality bond investments; in Japan, life insurers’ portion of higher-yielding foreign investments has risen (Figure 1.2.1, panel 3).
- Scenario analysis (panel 4): three stress scenarios applied to aggregate sector balance sheets of life insurers (Europe and United States as of December 2020; Japan as of February 2021). Shocks summarized exactly as in the note:
  - Benign yield increase: equity (−5 percent); real estate (−2 percent); all sovereign and corporate bond yields up +100 basis points regardless of credit rating.  
  - Yield increase and corporate stress: equity (−10 percent); real estate (−6 percent); sovereign bond yields AAA-A (+100 basis points), BBB (+150 basis points), and <BBB (+200 basis points); corporate bond yields AAA-A (+150 basis points), BBB (+250 basis points), and <BBB (+300 basis points).  
  - Elevated yield increase and corporate stress: equity (−20 percent); real estate (−10 percent); sovereign bond yields AAA-A (+200 basis points), BBB (+250 basis points), and <BBB (+300 basis points); corporate bond yields AAA-A (+250 basis points), BBB (+350 basis points), and <BBB (+400 basis points).  
- Impact:
  - Life insurers with longer durations and greater shares of riskier corporate bonds would be hit hardest by a sudden increase in yields.  
  - US and UK life insurers are particularly sensitive: estimated losses exceeding 30 percent of their assets in the worst-case yield increase and wider corporate spread scenario, compared with less than 10 percent in the more modest yield increase scenario.  
- Policy-surrender risk:
  - Most life insurance policies include protections (exit penalties, accumulated bonuses embedded in guarantees, tax disincentives), making sharp increases in surrenders unlikely in most scenarios.  
  - A bond yield increase of 200 basis points or more—similar to the worst-case scenario—could be associated with a significant increase in lapse rates.  
  - EIOPA (2020) estimates surrender volumes could increase to €372 billion in Europe in its most stressed scenario, generating a shortfall of about €340 billion that could be covered through asset sales.  
  - Assuming similar lapse rates in the United States, surrenders could amount to over $550 billion in the United States, about $1 trillion in combined surrenders. While this is less than 2 percent of the total market value of US and European fixed-income markets, the impact could be significant if it coincides with selling pressure from other investors.  
  - Supporting estimates: Moody’s (2021) estimates $500 billion (31 percent of US life insurance policies) is surrenderable with low penalty; ESRB (2015) calculates that 90 percent of contracts can be surrendered with a penalty lower than 15 percent of the policy value.  
- Implication:
  - A gradual yield increase would help mitigate long-term challenges by reducing duration mismatches and negative investment-return spreads.  
  - A large, sudden increase in bond yields combined with wider corporate spreads could force asset liquidations and produce procyclical amplification of shocks.

### Box 1.3 — Fintech lending during COVID-19: performance and risks
- Growth trends (2013–19):
  - Fintech lending increased by about 60 percent for banks and 125 percent for nonbanks over 2013–19.  
  - Traditional banks and nonbanks increased assets by 39 percent and 50 percent, respectively, over the same period.
- Pandemic period (2019–20):
  - Assets for fintech banks and nonbanks increased by 18 percent and 7 percent, respectively, over 2019–20, outpacing asset growth of traditional lenders.  
  - Nonperforming asset rates for fintech lenders increased during the pandemic; traditional lenders’ nonperforming asset rates stayed broadly constant.
- Performance characteristics:
  - Nonperforming asset ratio of fintech banks has generally been lower than that of traditional banks.  
  - Nonperforming asset ratio of fintech nonbanks has been significantly higher than their traditional counterparts.
- Drivers and regressions:
  - Containment measures likely shifted activity from physical to digital, increasing demand for fintech credit.  
  - The severe economic downturn hit retail borrowers and small and medium-sized enterprises particularly hard, possibly pushing them toward fintech lenders.  
  - A regression controlling for COVID-19 infection cases, lagged GDP growth, total capital ratio, log of total assets, quarter dummies, and fintech dummies shows an increase in COVID-19 infection cases is associated with higher asset growth of fintech nonbanks and a decline in their return on assets.
- Policy implication:
  - Fintech lending can promote financial inclusion but could undermine financial system stability because the borrower base may be weak.  
  - National authorities should closely monitor fintech activity and risk management to balance financial inclusiveness and stability.

### Box 1.4 — Climate-related financial vulnerabilities in China
- Transition risks:
  - Credit conditions could tighten for weak borrowers in China during the planned transition to carbon neutrality by 2060, with potential financial stability implications if not managed carefully.  
- Vulnerabilities in carbon-intensive sectors:
  - Many firms in carbon-intensive sectors face liquidity risk: combined interest expense and short-term debt exceed combined earnings and liquid assets.  
  - Credit extended to firms with liquidity risk totals about 10 percent of GDP.  
  - Net bond issuance of firms in carbon-intensive sectors (chemicals, coal operations, metal and mining, and oil and gas) moderated after the carbon-neutrality commitment announced in September 2020 and turned negative after local state-owned-enterprise bond defaults in late 2020.  
  - Relative to GDP, provinces with weaker public finances tend to be exposed to larger corporate debt from these sectors.
- Implication:
  - Policy coordination among Chinese agencies is essential to ensure an orderly transition.

### Evergrande and potential contagion channels
- Evergrande profile and recent market moves:
  - Evergrande has about $304 billion in total liabilities, including some in offshore markets.  
  - Its bond prices reached distressed levels and its share price fell more than 70 percent since mid-2021.
- Contagion so far:
  - Contagion has been limited to other financially weak property developers and lower-rated firms.
- Transmission channels and risks:
  - Aggregate direct exposures of Chinese banks to Evergrande appear limited, but smaller banking institutions with weaker capital positions may face challenges.  
  - Wider stress in the property development sector would meaningfully increase system exposures.  
  - Multiple financial institutions are involved (banks, trust companies, other shadow banking entities) via loans, bonds, other credit instruments, guarantees, and contingent liabilities—often through opaque and difficult-to-quantify channels—creating high interconnectedness.  
  - Property developers account for a notable share of borrowing in offshore markets; stress could create offshore market funding challenges for other issuers.
- Implication:
  - Authorities have tools to step in if the situation escalates, but there is a risk of broader financial stress with implications for the Chinese economy, financial sector, and global capital markets at the extreme.

*International Monetary Fund | October 2021*

### 1. China Evergrande: Share and Bond Prices

### 1. China Evergrande: Share and Bond Prices

### Key charts and statistics
- Index baseline: January 1, 2020 = 100.
- Evergrande’s bond prices are a weighted average by issuance amounts (as noted in the figure note).
- Evergrande’s total liabilities amounted to $304 billion.
- The real estate sector’s total liabilities amounted to $4.84 trillion.
- Figure panel annotations include the numeric sequence: 29, 37, 11, 11, 12, 35, 14, 29, 5, 16 (as shown in the figure).

### Recent developments and immediate observations
- Contagion so far has been limited, but Chinese real estate firms have sizable non-debt liabilities.
- The figure caption: "China: Evergrande and Property Developers under Pressure" (time markers in the figure: Jan. 2020; June 20; Nov. 20; Apr. 21; Sep. 21).

### Macroeconomic and financial risks identified
- Macroeconomic repercussions could greatly magnify the impact of financial stress, with a feedback loop back to financial conditions.
- Knock-on effects on real estate firms could adversely impact growth given sizable liabilities to various counterparts.
- A sustained fall in house prices could:
  - weigh on consumer confidence and spending;
  - reduce local government land sale revenues, forcing local governments to reduce public investment;
  - reinforce investor concerns about state support for local government-owned entities, especially in provinces with weak public finances.
- A slowdown in economic growth and a tightening in financial conditions in China could bring spillovers to the rest of the world via:
  - direct exposures of international investors to Chinese financial assets (which has been growing as a result of the inclusion of China in global benchmark indices);
  - a deterioration in global risk appetite at a time when asset valuations are stretched;
  - a tightening in financial conditions in emerging markets.

### Policy options and trade-offs
- Longer term: corporate restructuring and insolvency frameworks need to be strengthened to facilitate market-based exit of nonviable firms.
- Short term: tools are available to contain and manage potential financial stress and lessen any adverse impact on the economy.
- Trade-offs:
  - Broader support measures increase the risk of financial fragilities reemerging in the future, especially if they are accompanied by an actual or perceived relaxation of the broader effort to deleverage the financial system over time.
  - Earlier and clearly communicated intervention would likely minimize the risk of contagion, although at the cost of reinforcing a perception of individual firms being too big to fail.
  - Postponing support to instill market discipline may require broader measures to manage financial stress.

*Source: ch1 - 1. China Evergrande: Share and Bond Prices (PDF chapter/section).*

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_Source: https://www.imf.org/-/media/files/publications/gfsr/2021/october/english/ch1.pdf_