## Preface and Foreword — Key Assessment and Market Context

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### Current financial conditions and market valuation
- Financial conditions have eased since the April 2025 GFSR as policy uncertainty receded, major central banks became more accommodative, and the US dollar weakened by 10 percent so far this year.
- Equity markets rebounded to record highs; corporate and sovereign funding spreads are at historically narrow levels; global funding liquidity remains abundant.
- Risk assets and concentration:
  - Valuations of risk assets appear stretched; concentration risks in certain segments reached historic highs (notably the M7: Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia, and Tesla).
  - IMF staff model: S&P 500 forward P/E at about the 96th percentile since 1990; fair-value forward P/E estimated at the 81st historical percentile → estimated overvaluation of about 10 percentage points.
  - IT sector weight in the S&P 500: 35 percent; Magnificent 7 weight: 33 percent.
- Potential triggers of abrupt corrections:
  - Equity price correction could have broader macro effects if stock market–driven wealth effects sustain consumption.
  - Higher long-term yields on US Treasuries and euro area bonds could reshape hedging strategies and asset correlations.

### Major market developments highlighted
- US dollar dynamics:
  - US dollar depreciation of 10 percent year-to-date; dollar softness accompanied by substantial foreign exchange hedging demand and increased currency hedging activity after the April 2 tariff announcement.
  - Total non‑US holdings of US securities rose from $16 trillion to $31 trillion between 2015 and 2024.
- Bond market functioning and fiscal supply:
  - Government debt has shifted toward the government sector as expanding global fiscal deficits propel sovereign bond issuance.
  - Term premia driven up by rising bond supply and quantitative tightening; steepening yield curves and more negative swap spreads noted.
- Nonbank financial intermediation (NBFI):
  - NBFIs have grown, deepened ties with banks, and expanded their role in sovereign and corporate debt markets, increasing interconnectedness and potential amplification of vulnerabilities.

*Italic: Excerpted from the Preface and Foreword, Global Financial Stability Report: Shifting Ground beneath the Calm, October 2025.*

---

### Major Vulnerabilities, Transmission Channels, and Stress Scenarios

### Sovereign bond market functioning and potential forced sales
- Bond market fragilities and forced liquidation exposures:
  - Forced US Treasury liquidations from large fund outflows and an abrupt increase in yields could reach almost $300 billion (waterfall approach).
  - Using a “waterfall” liquidation approach calibrated to April 2025 outflow patterns and a 60 basis point increase in interest rates: forced sales estimated at $66 billion (over half in Treasuries).
  - In a severely adverse scenario (bond fund outflows at their 99th historical percentile and interest rates rise by 100 basis points), forced Treasury sales would exceed current dealer Treasury inventories.
- Margin and derivative exposures:
  - Under a 100 basis point curve shift, variation margin calls would amount to about $20 billion (heterogeneous across funds).

### Global banking sector stress tests and capital impacts (GST)
- GST coverage and baseline resilience:
  - GST sample: 669 banks from 29 countries, accounting for 74 percent of global sector assets.
  - Global average CET1 ratio increased from about 12.5 percent in 2022 to 13 percent in 2024; aggregate CET1 ratio declines by 70 basis points from 13 percent in 2024 to 12.3 percent at the end of the stress horizon under the adverse scenario.
- Adverse scenario outcomes:
  - Under a severe stagflationary adverse scenario: banks representing about 18 percent of global bank assets would see CET1 fall below 7 percent.
  - With additional shocks to NBFIs (risk weights increase from 20 percent to 50 percent and all available commitments drawn), the share increases to 21 percent of global banks by assets.
  - 82 of 669 banks projected to fall below CET1 of 7 percent under the adverse scenario.
  - Under stricter criteria (CET1 below 7 percent or CET1 declining by 5 percentage points or more): 137 banks (accounting for 25 percent of global bank assets).
  - A few institutions (about 1 percent of global assets) would fall below 4.5 percent CET1 and require a $25 billion recapitalization to restore CET1 to 4.5 percent.
- Adverse scenario assumptions:
  - Across‑the‑board 10 percent increase in tariffs over baseline for advanced economies and some EMs, higher inflation from supply‑chain rechanneling, a 1 percentage point increase in policy rates globally in the first year, and term premia rising by 300 basis points to 500 basis points across AEs and EMs.

### Banks’ exposures to NBFIs and liquidity pressures
- Scale and concentration:
  - In Europe and the United States, loans to NBFIs represent, on average, 9 percent of banks’ loan portfolios—about $4.5 trillion (about $2.6 trillion corresponding to loans and the rest to undrawn commitments).
  - Exposure to private equity and credit funds: $497 billion, up 59 percent between Q4 2024 and Q2 2025.
  - In the United States, banks representing almost 50 percent of sample assets have exposures to NBFIs exceeding their Tier 1 capital.
  - Large banks account for 90 percent of all lending to NBFIs; concentration more severe among large regional banks and banks with assets under $100 billion.
- Liquidity stress outcomes (full drawdown of commitments; risk weights increase to 50 percent and to 100 percent in sensitivity tests):
  - Under full drawdown, 4 percent of US banks (representing less than 1 percent of total assets) would have negative net available liquidity.
  - Under strict liquid-asset definition:
    - 5 percent of euro area banks (representing 5 percent of sample assets) would have negative net available liquidity.
    - 14 percent of US banks (representing 8 percent of sample assets) would have negative net available liquidity.
  - More conservative capital shock (risk weights to 100 percent; commitments fully drawn):
    - CET1 ratios fall by 100 basis points or more in 50 percent of banks in Europe (representing 39 percent of total assets).
    - CET1 ratios fall by 100 basis points or more in 12 percent of US banks (representing 67 percent of total assets).
- Bank solvency and liquidity nexus:
  - Banks with high NBFI exposure (>100 percent of Tier 1 capital) tend to rely more on noncore and wholesale funding and face both solvency and liquidity pressures when NBFI lines are drawn.

---

### Foreign Exchange Market Risks, Hedging Dynamics, and Operational Fragilities

### FX market scale, structure, and hedging pressures
- Market size and structure:
  - FX market average daily turnover exceeds $9.6 trillion.
  - Growth driven by FX swaps; majority of FX swaps are short duration (tenors up to three months).
  - US dollar remains dominant; US dollar involved in a large share of transactions and remains central to funding and hedging.
- Hedging dynamics and non‑US holdings:
  - Total non‑US investor holdings of US securities: $16 trillion → $31 trillion (2015–2024).
  - Evidence on hedge ratios (as of June 2020): insurers ~44 percent; pension funds ~35 percent; mutual funds ~21 percent.
  - Japanese life insurers typically hedge 50 percent to 70 percent of bond portfolios (McGuire and others 2021).
  - Optimal hedge ratio for non‑US investors has significantly increased recently for US equities and Treasuries; amid dollar weakening, many non‑US investors may increase hedging by selling US dollars forward, potentially amplifying dollar weakness.
- Empirical effects of uncertainty shocks:
  - A one‑standard‑deviation increase in global macrofinancial uncertainty indicators can widen the three‑month basis by up to 13 basis points over a week.
  - Weekly excess exchange rate return volatility increases by about 5–10 basis points in response to shocks to the VIX, EPU, and MOVE indices.
  - Bid‑ask spreads widen by 1–3 basis points in response to these shocks.
  - Large uncertainty shocks (exceeding two standard deviations) produce disproportionately larger, nonlinear effects.
  - Effects are larger and more persistent for emerging market currencies (cross‑currency bases and bid‑ask spreads widen, on average, more than twice the amounts estimated for advanced economies).

### Operational and settlement risks
- Settlement and PvP:
  - Settlement risk (Herstatt risk) remains material—about 25 percent of deliverable turnover of currencies occurs without risk mitigation mechanisms.
  - CLS PvP participation reduces settlement risk premiums: panel analysis (Jan 2000–May 2025) finds CLS participation associated with a decline of 34 basis points in excess FX returns and a decline of 3 basis points in volatility, on average.
  - Natural experiment: Hungary’s forint joining CLS on Nov. 16, 2015 → decline in average daily excess FX returns of about 11 basis points in the one‑month window around accession.
- Trading venue outages:
  - Outages at interdealer platforms (EBS, FX Matching) increased bid‑ask spreads and reduced volumes in affected currencies.
  - During outages, spot market trading volumes declined by $2.8 billion on average across affected currencies; a $1 billion decrease in trading volume associated with a 0.3 basis point widening of spot bid‑ask spreads.
  - Spot bid‑ask spreads across all major currency pairs widened from about 3 to 4 basis points on average during outages; swap spreads from about 4 to 5 basis points.
- Policy backstops:
  - Federal Reserve US dollar liquidity swap lines are effective: newly activated swap lines reduced CIP deviations by up to 30 basis points, nearly offsetting initial VIX shock effects and significantly lowering excess exchange rate return volatility.
  - Economies with reserve buffers about one standard deviation above average experience notably smaller CIP deviations and lower excess exchange rate return volatility following uncertainty shocks.

### Spillovers to other asset classes
- A one‑standard‑deviation widening of cross‑currency bases (about 25 basis points) reduces longer‑term sovereign bond yields by about 25 basis points (effects lasting up to three months); shorter‑term yields fall more sharply.
- A one‑standard‑deviation widening tightens financial conditions by 0.4 to 0.7 standard deviations over the following year (about half of the tightening observed in March 2020).
- In economies with high FX mismatches, the same shock can tighten financial conditions by as much as two standard deviations.

*Italic: CHAPTER 2 — Risk and Resilience in the Global Foreign Exchange Market, Global Financial Stability Report, October 2025.*

---

### Emerging Markets and Frontier Economies — Local Currency Bond Markets and Sovereign‑Bank Nexus

### LCBM structure, investor base, and resilience
- Coverage and dataset:
  - Newly compiled dataset: government debt issued in domestic markets in 56 EMDEs, covering over 90 percent of local currency government debt outstanding in EMDEs.
- Debt and issuance trends:
  - Government debt in EMDEs rose to close to $30 trillion (nearly $12 trillion excluding China).
  - Median debt‑to‑GDP ratio close to 60 percent.
  - Primary market bond issuance by frontier economy borrowers reached just over $13 billion by end‑August 2025.
  - Median sovereign eurobond yield among EM issuers now exceeds 6.5 percent; several frontier economy bonds trade above 10 percent.
- Investor composition and implications:
  - Nonresident share of local currency debt averaged about 22 percent cross‑country; resident banks median ownership share close to 30 percent.
  - Empirical results:
    - A 10‑percentage‑point increase in VIX, with nonresident ownership at cross‑country average of 22 percent, is associated with a 19 basis point increase of the five‑year local currency yield spread and a 0.7 basis point increase in the bid‑ask spread.
    - If nonresident ownership increases by one standard deviation to 34 percent, sensitivities rise to 23 basis points (yield spread) and 0.9 basis point (bid‑ask spread).
    - Increasing resident bank ownership by one standard deviation (from 29 percent to 44 percent) dampens yield spread sensitivity from 19 to 11 basis points and bid‑ask spread from 0.8 to 0.7 basis points.
- Absorption capacity and vulnerabilities:
  - Low absorption capacity + low resident share → reliance on foreign borrowing and higher sudden‑stop risk.
  - Low absorption capacity + high resident share → risk of financial repression and stronger sovereign‑bank nexus.
  - Resident NBFI presence can dampen liquidity impacts in some regions (emerging Asia) but not uniformly (Latin America).

### Sovereign–bank nexus and simulated distress
- Bank exposure and systemic vulnerability:
  - Reverse simulations indicate banking systems with more than 20 percent of assets in domestic government bonds are unlikely to withstand haircuts of 30 percent or more without breaching the 10 percent regulatory threshold.
  - Scenario: 40 percent haircut on government bond holdings leads to more than half of banking sectors in sample experiencing regulatory capital ratio falls (simulated impacts).
  - Monthly co‑movement: a one‑standard‑deviation increase in emerging market sovereigns’ implied default probability associated with around half a standard deviation rise in banks’ expected default frequency; effect intensifies in extreme stress.
- Policy caveat:
  - Rapid LCBM expansion that outpaces investor demand can increase term premia and deepen sovereign–bank links, raising systemic risks.

---

### Corporate Credit, Private Credit, and Real Estate Vulnerabilities

### Corporate sector and tariff sensitivity
- Corporate balance sheets:
  - Aggregate corporate sector resilient to date, but margins revised down for most firms; Magnificent 7 margins revised up.
  - Private fixed investment in information‑processing equipment contributed around 57 percent of US real GDP growth since Q4 2024.
- Tariff sensitivity:
  - Tariffs initiated to date include semiconductors (100 percent), steel and aluminum (50 percent), and copper (50 percent).
  - IMF staff tariff sensitivity: for the average country, additional tariffs reduce firms’ profit margin by 1 percentage point (green line in referenced figure).
  - Scenario: phased‑in tariffs plus higher refinancing costs → share of corporate debt with interest coverage ratio below 1 could reach 55 percent in some countries.
- Refinancing and private credit:
  - Firms face rising refinancing costs as debt matures; elevated valuations have enabled financial engineering (share buybacks ~ near $1 trillion on annualized basis so far this year for US financial, technology, communications services firms).
  - Private credit sector: retail participation growing; some perpetual nontraded BDCs hold 10 percent to 40 percent of assets in marketable leveraged loans (vs. 1 percent to 3 percent in publicly traded BDCs).
  - Liquidity mismatch risks rise if retailized private credit allows more frequent redemptions.

### High‑yield bond market and mutual fund concentrations
- Market shares and liquidity:
  - Open‑ended investment funds and ETFs’ share of the US high‑yield bond market rose from 37 percent in 2015 to 45 percent in 2024.
  - ETFs share of US high‑yield bond market: 7 percent in 2024 (from 3 percent in 2015).
  - Average monthly trading volume in US high‑yield bond market: about $200 billion.
- Outflows and liquidity mismatch:
  - In eight global episodes, outflows exceeded 2 percent of assets under management (over $10 billion of outflows) for high‑yield funds.
  - March 2020: US high‑yield bonds mark‑to‑market loss of 12 percent vs. 7 percent for investment‑grade bonds.

### Commercial real estate (CRE) and China banking concerns
- CRE:
  - US CRE delinquency rates for CMBS rose to 7.29 percent for August 2025 (stressed office sector).
  - Direct CRE investment growth rate recovered to 34 percent year‑over‑year in latest quarter, reaching $185 billion.
- China:
  - PBOC benchmark policy rate: lowered to 1.4 percent from 2.2 percent three years ago.
  - Average net interest margins across banking system: 1.42 percent in Q2 2025.
  - Return on equity: 8.2 percent in Q2 2025 (from 8.9 percent a year earlier).
  - Return on assets: 0.63 percent in Q2 2025 (from 0.69 percent a year earlier).
  - One‑year time deposit rate estimated at 0.95 percent (J.P. Morgan); PBOC official one‑year deposit rate: 1.5 percent; one‑year LPR: 3 percent.
  - Authorities injected 500 billion yuan (about $69 billion) of capital into large state‑owned banks earlier this year.

---

### Policy Implications and Priority Actions

### Fiscal and macro policy
- Fiscal policy:
  - Emphasize fiscal discipline to ensure debt sustainability amid expanding sovereign issuance.
  - Urgent fiscal adjustments urged to protect sovereign bond market resilience.
- Monetary policy:
  - Preserve central bank operational independence; maintain focus on price stability.
  - For tariff‑affected jurisdictions with weaker demand, gradual easing could be appropriate; where inflation remains above target, proceed cautiously.

### Financial sector regulation and supervision
- Banking sector:
  - Implement internationally agreed prudential standards, notably Basel III; ensure sufficient capital and liquidity buffers.
  - Strengthen financial sector safety nets: emergency liquidity assistance frameworks, access to central bank funding, recovery and resolution frameworks.
- Nonbank financial intermediation (NBFI) and digital assets:
  - Improve data collection, coordination, and cross‑border analysis for NBFIs and digital assets (stablecoins).
  - Address liquidity mismatches in investment funds by expanding liquidity management tools (swing pricing, redemption notice periods).
  - Implement FSB’s high‑level recommendations on crypto assets; ensure AML/CFT measures and authorities’ powers.

### Market functioning, FX resilience, and operational safeguards
- Foreign exchange markets:
  - Enhance surveillance, including systematic FX liquidity stress testing and closure of FX data gaps.
  - Strengthen operational resilience of FX market participants and infrastructures; expand payment‑versus‑payment adoption to reduce settlement risk.
  - Strengthen global financial safety net: sufficient international reserves, expanded central bank swap lines, and readiness to use IMF lending toolkit as part of the safety net.
- Sovereign bond markets and LCBM development:
  - Expand central clearing for cash bond and repo transactions; improve market transparency and balance sheet efficiency.
  - Promote predictable issuance, develop money and repo markets, strengthen primary dealer frameworks, and diversify investor bases.
  - For EMDEs: deepen local‑currency financing, broaden investor base, and improve market infrastructure per the IMF–World Bank LCBM framework.

### Specific recommendations for NBFIs, private credit, and funds
- NBFI oversight:
  - Strengthen reporting and oversight; require private credit funds to limit frequent redemptions, implement robust liquidity management, stress testing, and disclosure.
  - Consider stricter oversight of continuation funds and semiliquid vehicles oriented to retail investors.
- Investment fund tools:
  - Expand availability and usability of liquidity management tools (swing pricing, gates, notice periods); adopt FSB/IOSCO guidance.

*Italic: Source — Global Financial Stability Report: Shifting Ground Beneath the Calm; International Monetary Fund | October 2025.*

### Preface                                                                                                                 

### Preface

### Key assessment of current financial stability
- Financial conditions have eased since the April 2025 Global Financial Stability Report, as policy uncertainty has receded somewhat, major central banks have become more accommodative, and the US dollar has weakened.
- Equity markets have rebounded to record highs, corporate and sovereign funding spreads are at historically narrow levels, and global funding liquidity remains abundant.
- Despite these improvements, valuations of risk assets appear stretched, especially as the global economy slows, and concentration risks in certain segments have reached historic highs.
- History cautions that asset prices can abruptly correct following booms in the technology sector; if stock market-driven wealth effects support strong consumption, a correction could have broader implications for the real economy.
- Higher long-term yields on major sovereign benchmarks—most notably for US Treasuries and euro area bonds—could reverberate across the system, influencing hedging strategies and reshaping correlations with risky assets.

### Major vulnerabilities and transmission channels
- The hedging role of longer-term bonds may be eroding, exposing fragilities in the financial sector–sovereign nexus.
- Financial sector exposure to sovereign assets remains elevated across both banks and nonbanks.
- While banks globally are generally well capitalized, a vulnerable subset persists in most jurisdictions, and banks’ exposures to nonbank financial intermediaries are expanding.
- Stress in sovereign bond markets can transmit:
  - directly to banks through balance-sheet losses; and
  - indirectly through nonbanks via market price channels.
- Stress tests for nonbanks in this report reveal considerable scope for sell-offs in benchmark bonds.
- The growing size of nonbank financial intermediation could amplify vulnerabilities by increasing risk-taking and interconnectedness while limiting visibility into balance sheets and linkages.

### Foreign exchange market considerations
- Growing macrofinancial uncertainty can strain even highly liquid foreign exchange markets, raising funding costs, impairing liquidity, and heightening FX volatility—effects that are notably pronounced in emerging markets.
- These FX pressures can spill over into other asset classes and trigger broader negative feedback loops, particularly where significant currency mismatches and fiscal vulnerabilities exist.
- The year has seen US dollar softness and a substantial increase in foreign exchange hedging demand.

### Implications for emerging market and developing economies (EMDEs)
- Emerging markets with strong fundamentals that have shifted toward local currency financing have seen stabilized bond yields and bolstered market liquidity during periods of global stress.
- Emerging markets and developing economies with weaker policy credibility and limited domestic savings remain dependent on foreign currency borrowing and may overly rely on domestic banks to buy government bonds.
- Although funding costs remain contained for most EMDEs so far this year, new major shocks could still test their resilience.

### Financial innovation and data gaps
- New financial market innovations, such as stablecoins backed by short-term government securities, have introduced new participants in financial markets.
- Limited visibility into nonbank balance sheets and interconnectedness is a key challenge; stronger data and disclosures are critical to diagnose vulnerabilities and guide policy responses during stress events.

### Policy implications and priorities
- Central bank independence is integral to ensure monetary policy continues to focus on maintaining price stability and anchoring inflation expectations amid rising fiscal and term-premia risks.
- Structural improvements in market resilience—such as central clearing and leverage requirements—should help mitigate vulnerabilities, although they remain a work in progress in many jurisdictions.
- Strengthened data collection and disclosure for nonbank financial intermediation are essential to enhance monitoring and to design effective policy responses in stress episodes.
- For EMDEs, deepening local-currency financing and broadening the investor base can improve resilience to global shocks.

_Excerpted from the Preface, Global Financial Stability Report: Shifting Ground beneath the Calm, October 2025._

### FOREWORD

### FOREWORD

### Shifting ground and main takeaways
- Global financial markets appear calm despite continued trade and geopolitical uncertainty.
- IMF’s growth-at-risk framework indicates risks to global financial stability remain elevated.
- Key signals of shifting ground:
  - Continued appreciation of risk asset prices; valuations of some risk assets “have once again become stretched” after the brief correction from the April 2 tariff announcement.
  - The US dollar has depreciated by 10 percent so far this year, having decoupled relative to wide US–G10 interest rate differentials in the months following the April 2 tariff announcement.
  - Debt has shifted toward the government sector as expanding global fiscal deficits propel sovereign bond issuance.
  - Nonbank financial intermediaries (NBFIs) have grown and deepened ties with banks, expanding their role in sovereign bond and corporate debt markets and increasing sectoral interconnection.

### Vulnerabilities and potential stress scenarios (with exact figures)
- Bond market functioning:
  - Forced US Treasury liquidations from large fund outflows and an abrupt increase in yields could reach almost $300 billion (waterfall approach).
  - Indicators of shakier bond market functioning include steepening yield curves, more negative swap spreads, and erosion of convenience yields.
- Banking sector stress:
  - Under an adverse macroeconomic scenario, about 18 percent of global banks by assets would see their Common Equity Tier 1 (CET1) capital ratio fall below the important threshold of 7 percent plus a G-SIB buffer.
  - With additional shocks to NBFIs, this share would increase to 21 percent of global banks by assets.
  - The NBFI shock assumption: risk weights increase from 20 percent to 50 percent and all available commitments are drawn.
- Emerging markets:
  - Emerging market government debt has grown significantly, with divergent debt structures across countries.
  - Increased resident investor share in local government bond markets is associated with a decline in sensitivity of emerging market bonds to shocks to the VIX.
  - For weaker emerging markets, long-term real interest rates (r) are higher than long-term growth rates (g), increasing their debt service burden and mounting funding risks.
- Corporate sector:
  - Corporate sector generally resilient to date, but tariffs could compress profit margins and increase refinancing costs.
  - In a scenario with phased-in tariffs plus higher refinancing costs, the share of corporate debt with an interest coverage ratio falling below 1 would reach 55 percent in some countries.
  - Liquidity is strained among vulnerable borrowers in leveraged loan and private credit markets, contributing to borrower downgrades.
- Stablecoins and crypto-related risks:
  - Stablecoins, led by those pegged to the US dollar, are growing rapidly and playing a larger role in financial intermediation.
  - Three main financial stability implications highlighted:
    1. Currency substitution and reduced effectiveness of policy tools in weaker economies.
    2. Changes in bond market structure with potential implications for credit disintermediation.
    3. Investor runs on stablecoins may generate forced selling of reserve assets and potentially disrupt market functioning.

### Policy recommendations and priority actions
- Fiscal policy:
  - Emphasize fiscal discipline to ensure debt sustainability as sovereign issuance expands.
- Monetary policy:
  - Maintain a close monetary policy focus in line with central bank mandates; reinforce the independence and credibility of central banks to anchor expectations.
- Financial sector supervision and regulation:
  - Strengthen financial sector supervision and oversight of nonbank financial institutions.
  - Enhance reporting and oversight of NBFIs and continue efforts to improve the efficiency of local bond markets.
  - Implement internationally agreed prudential standards, including standards on cryptoassets.
- Market functioning and resilience:
  - Monitor and prepare for potential abrupt corrections in asset prices given changing asset correlations and structural shifts in foreign exchange markets.
  - Address interconnectedness between banks and NBFIs to limit contagion channels.

*Source: FOREWORD, Global Financial Stability Report: Shifting Ground Beneath the Calm, International Monetary Fund | October 2025*

### ExECuTIvE SuMMARY

### ExECuTIvE SuMMARY

### Foreign exchange market risks and structural fragilities
- Flight to quality and increased demand for hedging during episodes of macrofinancial uncertainty can:
  - Raise foreign currency funding costs.
  - Impair foreign exchange market liquidity, reflected in wider bid-ask spreads and heightened exchange rate return volatility (Figure ES.9).
- Structural fragilities that exacerbate FX market pressures include:
  - Large currency mismatches.
  - Concentrated dealer activity.
  - Increased NBFI involvement.
- Additional risks:
  - Heightened settlement risk—the possibility that one party delivers currency without receiving the countervalue—due to expansion of foreign exchange trading.
  - Operational risks to FX market infrastructure from technical failures and cyberattacks.
- Policy actions recommended to address FX market risks:
  - Enhance surveillance, including systematic foreign exchange liquidity stress testing that captures interactions with underlying vulnerabilities.
  - Close foreign exchange data gaps.
  - Ensure capital and liquidity buffers in financial institutions are adequate and supported by robust crisis management frameworks.
  - Strengthen the global financial safety net, including sufficient international reserve buffers and an expanded network of central bank swap lines.
  - Enhance operational resilience of key FX market participants, including against cyber risks.
  - Promote broader use of payment-versus-payment arrangements to reduce settlement risks.

### Macro and fiscal policy guidance
- Macroeconomic stability is crucial to financial stability.
- Monetary policy guidance:
  - For tariffed jurisdictions facing weaker demand, a gradual easing of the policy rate could be appropriate.
  - For countries where inflation is still above target, central banks need to proceed carefully with any monetary easing and maintain their commitment to price stability.
  - Preserve central bank operational independence to anchor inflation expectations and enable achievement of mandates.
- Fiscal policy guidance:
  - Urgent fiscal adjustments to reduce deficits are crucial to protect the resilience of sovereign bond markets.
  - High debt and delayed fiscal adjustments in many countries could further raise borrowing costs for governments, underscoring the need for more ambitious fiscal measures to reduce sovereign risks.
  - Improvements in market structure to enhance bond market resilience:
    - Expand central clearing for cash bond and repo transactions to lower counterparty risks.
    - Improve balance sheet efficiency and boost transparency.
    - Standing liquidity facilities are vital to backstop bond markets.
- Emerging markets-specific guidance:
  - Use foreign exchange interventions, macroprudential measures, and capital flow management consistent with the IMF’s Integrated Policy Framework when signs of fragility are observed (rising inflation expectations, surges in exchange rate and capital flow volatility), provided these measures do not impair progress on necessary fiscal and monetary adjustments.
  - Further develop local bond markets by enhancing macroeconomic fundamentals—raising domestic financial savings and strengthening fiscal and monetary credibility.
  - Deepening measures: enhance predictability and transparency of debt issuance, develop efficient repo and money markets, strengthen primary dealer frameworks, and diversify the investor base.

### Financial sector resilience and regulation
- IMF’s Global Stress Test (GST) highlights importance of improving capitalization to address risks from weak banks.
- Regulatory recommendations:
  - Implement internationally agreed-upon standards that ensure sufficient levels of capital and liquidity, notably Basel III.
  - Review undue regulatory complexity to ensure efficiency without undermining overall resilience or international minimum standards.
  - Strengthen financial sector safety nets: establish emergency liquidity assistance frameworks, ensure banks can quickly access central bank funding, and advance recovery and resolution frameworks to manage shocks without systemic disruption or taxpayer losses.
- Nonbank financial intermediation and digital assets:
  - Improve data collection, coordination, and analysis, including across borders, for effective oversight of NBFIs and digital assets such as stablecoins.
  - Address liquidity mismatches in investment funds by improving and expanding availability and usability of liquidity management tools.
  - For crypto assets including stablecoins, implement the Financial Stability Board’s high-level recommendations:
    - Establish effective risk-management frameworks.
    - Safeguard anti-money laundering/combating the financing of terrorism measures.
    - Ensure relevant authorities have needed powers and can cooperate effectively.

### Market developments and systemic vulnerabilities (Chapter 1 highlights)
- Recent market movements and trends:
  - Risk asset prices continued to appreciate in recent months; the US dollar has depreciated by 10 percent to date this year.
  - Government debt has continued to rise.
  - Nonbank financial intermediaries (NBFIs) and stablecoins have continued to grow.
  - Markets appear complacent despite trade tensions, geopolitical uncertainties, and rising concerns about sovereign indebtedness.
- Evidence of increasing vulnerabilities:
  - Valuation models indicate risk asset prices are well above fundamentals, increasing probability of disorderly corrections when adverse shocks occur.
  - Analysis of sovereign bond markets highlights growing pressure from widening fiscal deficits on the functioning of markets.
  - Stress tests for banks and NBFIs reveal increasing interconnectedness and persistent maturity mismatches that could amplify shocks.
- Interaction of vulnerabilities:
  - An abrupt yield increase—triggered, for instance, by debt sustainability concerns—could strain banks’ balance sheets and pressure open-ended funds.
  - Heightened interconnectedness between banks and NBFIs would exacerbate adverse shocks.
- Policy priorities urged by the chapter:
  - Remain attentive to potential risks to inflation, especially where inflation is still above target, and preserve central bank operational independence.
  - Curb government deficits.
  - Implement internationally agreed-upon prudential standards.
  - Strengthen financial sector safety nets and NBFI oversight.
  - Promote effective regulation and supervision of stablecoins.

### Executive Directors’ views and policy emphases (IMF Executive Board discussion, September 29, 2025)
- Directors’ assessment:
  - Broad agreement with staff’s assessment of the global economic outlook, risks, and policy priorities; welcomed recent economic resilience despite repeated shocks.
  - Concern that recent resilience could be fragile due to lingering vulnerabilities, elevated policy uncertainty, and fragmentation.
  - Some Directors viewed staff’s overall characterization as overly pessimistic.
- Risks and downside tilts identified:
  - Prolonged policy uncertainty, escalation in trade tensions, rising fiscal vulnerabilities, increased fragilities in financial markets, erosion of good governance and independence of key economic institutions.
  - Labor supply shocks, regional conflicts (including Russia’s war in Ukraine), and commodity price volatility.
- Policy recommendations emphasized by Directors:
  - Reinvigorate multilateral cooperation to reduce trade policy uncertainty and re-anchor trade in an open, rules-based, transparent system; modernize trade rules and lower barriers, including through regional agreements that remain open and non-discriminatory.
  - Provide tailored fiscal advice sensitive to country-specific circumstances; prioritize rebuilding fiscal buffers and creating space for new spending while safeguarding debt sustainability.
  - Fiscal consolidation should be anchored in robust medium term fiscal frameworks combining spending rationalization and revenue generation, while protecting the vulnerable.
  - Consider targeted, temporary discretionary support when warranted; prioritize reforms (pensions, health care, wage bills, tax expenditures) to create fiscal room for growth-promoting spending.
  - Preserve central bank independence and ensure monetary policy is data-driven, calibrated to country-specific circumstances, and clearly communicated.
  - Use temporary FX interventions and capital flow measures in economies with excessive exchange rate volatility and shallow FX markets, consistent with the Integrated Policy Framework.
  - Continue macroprudential measures and timely implementation of internationally-agreed regulatory frameworks like Basel III.
  - Address data gaps and strengthen regulation of NBFIs and digital assets, including stablecoins.
  - Boost productivity and re-ignite medium-term growth via comprehensive, carefully sequenced structural reform packages; priority reforms include encouraging labor mobility and participation, increasing digitalization and AI readiness, and improving the business climate and competition.
  - If pursuing industrial policies, ensure transparency, focus on market failures with high positive spillovers, and support with complementary structural reforms; maintain strong governance and monitor impact.

### Financial Market Developments and Asset Valuations (introduction and context)
- Context and recent dynamics:
  - The world economy faces persistent trade and geopolitical uncertainties and structural challenges to medium-term growth.
  - After the United States’ April 2 tariff announcements and a subsequent 90-day pause, global financial markets largely brushed off shocks; asset prices rebounded strongly since the April 2025 Global Financial Stability Report.
  - Market volatility has declined on net, supported by expectations of further easing of monetary policy across most major advanced economies and emerging markets.
  - The apparent calm masks complacency; tariffs are at their highest levels in almost a century and front-loaded consumption and investments are fading.
- Key observations:
  - Global financial stability risks remain elevated according to the IMF’s growth-at-risk metrics, having receded only modestly since the April 2025 Global Financial Stability Report.
  - The US dollar’s 10 percent depreciation this year reflects a reassessment of its decade-long bull run and increased hedging by non-US investors against further weakening.
  - Risk asset valuations have become stretched again per IMF staff models; an abrupt correction could be exacerbated by unusual asset correlations and lead to unwinding of leverage and strains across markets, including FX.
  - Debt is moving toward the government sector as expanding fiscal deficits propel sovereign bond issuance; advanced-economy sovereign bond markets are increasingly dependent on price-sensitive investors.
  - NBFIs are expanding their role in core sovereign and corporate debt markets, including private credit, increasing interconnections with banks and raising potential for excessive risk taking, rising leverage, and maturity mismatch vulnerabilities.
  - Corporate credit risks: weaker firms are struggling amid higher tariffs and refinancing rates, with borrower downgrades and restructurings having risen; retail interest in private credit markets and high-yield bond funds could amplify credit downturns.

*Source: ExECuTIvE SuMMARY, text - ExECuTIvE SuMMARY, Global Financial Stability Report: ShIFTING GROuNd BENEATh ThE CALM (October 2025).*

### CHAPTER 1 ShIFTING GROuNd BENEATh ThE CALM: STABILITY ChALLENGES AMId ChANGES IN FINANCIAL MARkETS

### CHAPTER 1 ShIFTING GROuNd BENEATh ThE CALM: STABILITY ChALLENGES AMId ChANGES IN FINANCIAL MARkETS

### Asset prices amid still-elevated uncertainty
- Financial market volatility has declined since April, but measures of economic uncertainty remain elevated.
- Monetary policy easing is expected to continue, although with divergence across countries.
- Market expectations of inflation depend on oil prices and trade policy uncertainty.
- Equity prices globally have risen since April largely on outperformance in AI-related sectors, particularly the M7 (Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia, and Tesla).
- Corporate spreads have narrowed since April.
- Key indicators and data notes:
  - Latest levels for the VIX and the MOVE indices are as of October 2, 2025.
  - Trade Policy Uncertainty (30D MA) is the 30-day moving average of percentiles calculated from the entire daily series in Caldara and others (2020).
  - Crude oil futures (30D MA) correspond to the 30-day moving average of percentiles calculated from the third generic crude oil futures contracts for West Texas Intermediate, due to expire in around three months from the date of this publication.
- Observations on dynamics since April:
  - Economic surprises trended negative for several months following the April sell-off, but investor sentiment improved.
  - Equity and corporate credit valuations have returned to being fairly stretched, with concentration of valuations at a handful of firms at historical highs.

### The dollar, bonds, and risk assets diverge
- Longer-term sovereign bond yields in most advanced economies have risen since April, even as investors expect monetary policy to continue to ease.
  - Term premiums have been driven up by a rising bond supply and ongoing quantitative tightening by central banks, plus a slowdown in duration demand (including by liability-driven investors).
- The US dollar has weakened against a basket of both G10 and emerging market currencies and has decoupled relative to interest rate differentials for several months after the April tariff announcement.
  - The dollar has depreciated by about 10 percent so far this year against major currencies.
- Possible drivers of dollar weakness discussed:
  - Revaluation of dollar strength amid concerns over the US fiscal position.
  - Shift in allocation away from US-dollar-denominated assets driven by concerns about US policy uncertainty.
  - Increased currency hedging activity to mitigate losses on unhedged dollar exposure appears to have contributed to recent dollar weakness.

### Size and composition of non-US holdings of US dollar assets; hedging dynamics
- Total non-US investor holdings of US securities increased from $16 trillion to $31 trillion from 2015 to 2024.
- Many of these holdings are characterized by incomplete hedging and could be subject to sudden, large-scale sell-offs.
- Evidence on hedge ratios:
  - Hedge ratios for insurers, pension funds, and mutual funds stood at around 44 percent, 35 percent, and 21 percent, respectively, as of June 2020 (Du and Huber 2024).
  - Japanese life insurers typically hedge 50 percent to 70 percent of their bond portfolios in practice (McGuire and others 2021).
  - More recent estimates suggest many investors appear underhedged compared with the statistically derived optimal hedge ratio (Shin, Wooldridge, and Xia 2025).
- Optimal hedge ratio developments:
  - A measure of optimal hedge ratio from a non-US investor’s perspective—based on minimization of asset return volatility—has significantly increased recently for portfolios of both US equities and Treasuries across currencies.
  - Amid dollar weakening, non-US investors with significant unhedged dollar exposures could be prompted to increase currency hedging, which would involve selling US dollars forward or repatriating dollar deposits and could amplify dollar weakening in a self-fulfilling manner.
  - “Rush to currency hedge” behavior reportedly increased in the months after the April 2 tariff announcements (Parsons and Davis 2025).
- Market structure and vulnerabilities:
  - Hedging is expensive and foreign exchange market depth is modest in many jurisdictions relative to large dollar asset exposures.
  - Jurisdictions with large dollar asset exposures relative to the size of FX markets have wider CIP deviations, resulting in tighter dollar funding conditions.
  - Evidence of recent flows: after a brief period of outflows in April, Treasury securities experienced net inflows of about $105.5 billion. US equity net inflows were $95.4 billion over April and May, according to Treasury International Capital System data.

### Financial stability risks from hedging and CIP deviations
- A financial stability risk of a “rush to hedge” is that selling the US dollar forward could increase dollar funding pressures, especially in shallower foreign exchange markets with limited hedging instruments and where absorption capacity for hedging flows is lower.
- With many foreign investors selling US dollars forward, the relative price of the US dollar forward versus spot would decline, resulting in larger deviations from covered interest parity (CIP), an indicator for dollar funding pressures.
- Jurisdictions with larger US dollar asset exposure relative to foreign exchange market depth currently have wider CIP deviations.

### Equity markets: high valuations and concentration risks
- The rebound in global equity prices since April has outpaced expected future earnings, reflecting buoyant investor sentiment.
- The S&P 500 12-month forward price-to-earnings (P/E) ratio has climbed back to about the 96th percentile since 1990 while continuing to trade at a premium compared with other advanced and emerging markets.
- Concentration risk:
  - Valuations are concentrated in a handful of firms, especially the Magnificent 7 and AI-related stocks in the broad benchmark equity index, at historical highs.
- Sector and regional performance notes:
  - AI-related mega-cap IT firms were perceived to be less negatively affected by tariffs and have driven equity market performance since April.

*International Monetary Fund | October 2025 — CHAPTER 1, Global Financial Stability Report*

### CHAPTER 1 ShIFTING GROuNd BENEATh ThE CALM: STABILITY ChALLENGES AMId ChANGES IN FINANCIAL MARkETS

### CHAPTER 1 ShIFTING GROuNd BENEATh ThE CALM: STABILITY ChALLENGES AMId ChANGES IN FINANCIAL MARkETS

### Equity valuation pressures
- IMF staff model estimates indicate the fair-value forward P/E ratio for the S&P 500 should be about the 81st historical percentile.
- Comparing model-implied fair value with actual observed forward P/E suggests the equity valuation is currently stretched, with an estimated overvaluation of about 10 percentage points.
- The current overvaluation is still below historical peaks, for example, during the dot-com bubble.

### Concentration risk in US equities
- Concentration risk within the S&P 500 is at a historic high, with a narrow group of mega-cap IT- and AI-related firms predominantly driving the index.
- IT sector weight in the S&P 500: 35 percent.
- Magnificent 7 weight in the S&P 500: 33 percent.
- A measure of concentration risk based on the Herfindahl-Hirschman Index is now substantially higher than during the dot-com bubble.
- Normalized concentration risk for the S&P 500 has increased by about 20 percentage points over the past decade, while comparable benchmark indices in other jurisdictions have shown far less increase.

### Profit margins, tariffs, and downside risks
- Stock analysts have meaningfully revised down expected profit margins for most firms, while margins for the Magnificent 7 have been revised up.
- A forward-looking risk is that tariffs could lead to margin compression across most S&P 500 sectors, including the Magnificent 7.
- Private fixed investment in information-processing equipment (a proxy for AI investments in data centers) has contributed around 57 percent of US real GDP growth since the fourth quarter of 2024.
- Tariffs initiated to date include: semiconductors (100 percent), steel and aluminum (50 percent), and copper (50 percent).
- US household exposure to equities (as a share of total household assets) is currently about 30 percent and on an upward trajectory since the global financial crisis, increasing household balance sheet vulnerability to sharp corrections in benchmark indices.

### Financial conditions and growth-at-risk (GaR)
- Financial conditions have eased since the April 2025 Global Financial Stability Report amid a rebound in asset prices and a weaker dollar.
- The abrupt tightening in financial conditions after the April 2 tariff announcement proved short-lived; conditions in the euro area and the United States have returned to levels immediately before the event.
- In emerging markets (including China), external financing risks have lowered amid a weaker dollar, easing financial conditions (though the Financial Conditions Index for China does not capture the recent slowdown in bank lending).
- Private sector credit growth has shifted just below the 10th percentile of its historical distribution.
- The IMF’s updated GaR assessment indicates one-year-ahead global growth is forecast to fall below 0.5 percent, with a 5 percent chance.
- This GaR outcome reflects a 0.1 percentage point improvement compared with April but remains around the 30th historical percentile.
- The balance of risks to global growth over the next year continues to be tilted to the downside; the probability of growth falling below 2 percent remains broadly unchanged compared with April.

### Emerging and frontier markets: current pressures and investor stance
- Dollar depreciation and progress on trade deals have eased pressures on emerging market financial markets.
- Subdued energy prices have helped contain import costs and reduce external vulnerabilities for energy importers.
- Progress on disinflation has allowed several emerging market central banks to ease policy rates, but many banks are proceeding cautiously and cutting rates gradually due to concerns about inflation trajectory and stickiness of core inflation.
- The more favorable external environment has helped narrow hard currency bond spreads, lower implied foreign exchange volatility for most markets, and catalyze a rebound in capital flows.
- A lingering concern for several emerging markets is the large debt burden alongside high real interest costs (r) relative to long-term growth prospects (g), posing ongoing challenges to fiscal sustainability.

_Italic: Source — CHAPTER 1 ShIFTING GROuNd BENEATh ThE CALM: STABILITY ChALLENGES AMId ChANGES IN FINANCIAL MARkETS (text - CHAPTER 1 ShIFTING GROuNd BENEATh ThE CALM: STABILITY ChALLENGES AMId ChANGES IN FINANCIAL MARkETS), International Monetary Fund | October 2025_

### 2025. AEs = advanced economies; EMs = emerging markets; ex. = excluding; FCI = Financial Conditions Index; GFSR = Global

### CHAPTER 1 ShIFTING GROuNd BENEATh ThE CALM: STABILITY ChALLENGES AMId ChANGES IN FINANCIAL MARkETS

### Global Growth-at-Risk
- Near-term global financial stability risks have declined only slightly since April and remain somewhat elevated by historical norms.
- The balance of risks to global growth remains tilted to the downside.
- The mode of the latest growth forecast density accords with the IMF’s October 2025 World Economic Outlook database forecast for 2026.
- Credit growth input uses a PPP-GDP weighted aggregate of country-specific quarterly growth rates in total credit to the private nonfinancial sector from the Bank for International Settlements; credit growth for the current quarter reflects the latest available reading as of 2025:Q1.
- The 5th percentile threshold (growth-at-risk metric) is tracked over time; lower percentiles represent higher downside risk.

### Pressures and Vulnerabilities in Emerging Markets
- EM stress has declined since the April 2025 Global Financial Stability Report, but tight risk pricing masks ongoing uncertainties.
- Fund flows:
  - Inflows primarily benefited funds dedicated to local currency bonds; hard currency and blended funds did not see similar inflows.
- Sovereign spreads and valuations:
  - Hard currency emerging market sovereign spreads have compressed despite persistent macroeconomic uncertainty.
  - After rising sharply in April 2025, investment-grade emerging market spreads have since narrowed to levels last seen in 2007.
  - High-yield spreads have fallen to post-pandemic lows.
  - Tight spreads raise concerns that valuations may not reflect underlying fragilities and potential external shocks.
- FX option markets and investor caution:
  - The ratio of implied volatilities of three-month 10-delta butterfly options to three-month at-the-money options is much higher than historical average for sub-investment-grade emerging market currencies and lower than historical average for investment-grade EM currencies—signaling anticipated sharp currency moves in weaker EMs.
- Fiscal dynamics and r–g:
  - Several emerging markets face elevated debt burdens, high interest costs, and softening growth momentum.
  - Emerging markets with weaker credit ratings tend to have projected long-term real interest rates higher than their long-term real growth prospects.
  - Such a loop of high real interest costs and mounting debt burdens could undermine long-term debt sustainability and complicate fiscal consolidation.
- Risk of repricing:
  - Should global financial conditions tighten again or growth underperform, pressure on sovereign creditworthiness could swiftly resurface.

### Frontier Economies: Issuance, Yields, and Alternative Funding
- Primary market bond issuance by frontier economy borrowers reached just over $13 billion by the end of August 2025.
- Market access remained uneven; frontier borrowers increasingly use shorter tenors and smaller deal sizes.
- Yields and refinancing risk:
  - The median sovereign eurobond yield among emerging market issuers now exceeds 6.5 percent.
  - Several frontier economy bonds trade above 10 percent, prompting concerns about refinancing costs.
  - Rollover risks are amplified with large amounts of bonds needing repayment in late 2025 and early 2026, especially for sub-Saharan issuers.
- Alternative funding arrangements (examples reported):
  - Panama secured a €1.2 billion bilateral loan from a subsidiary of Bank of America with a two-year maturity.
  - Egypt issued a $1 billion sovereign sukuk through a private placement fully subscribed by Kuwait Finance House.
  - Angola entered into a $1 billion structured financing arrangement linked to its own sovereign bonds; the deal included contingent liabilities that triggered additional payments amid market volatility earlier in the year.
- Policy-relevant concerns:
  - Alternative funding can be cost-effective relative to market rates but raises transparency and debt sustainability concerns when obligations are not subject to the same market discipline or reporting standards as publicly traded bonds.
  - Divergence in financing conditions is growing across frontier economies between those issuing in public markets at reasonable cost and those reliant on less-conventional borrowing.

### Sovereign Bond Markets and Fiscal Pressures
- Bond market stability is fundamental as sovereign bonds serve as benchmarks for asset prices, collateral in lending, and derivatives.
- Since the abrupt sell-off after the April 2 tariff announcement, bond markets stabilized, but indicators point to fragility:
  - Steepening yield curves.
  - More negative swap spreads.
  - Persistent erosion of convenience yields.
- Fiscal deficits and yields:
  - Investor concerns about large fiscal deficits appear to have added pressure on long-term bond yields.
  - Notable steepening of yield curves among the G4 (US Treasuries, European government bonds, UK gilts, Japanese government bonds).
  - Swap spread widening (spreads becoming more negative) has been increasingly driven by fiscal considerations and shows strong co-movement with the projected average budget balance over the next five years.
  - Example projection: the Congressional Budget Office/Joint Committee on Taxation projects the One Big Beautiful Bill Act (Public Law 119–21; enacted July 4, 2025) to raise US federal deficits by about $3 to $3.5 trillion over the next decade (tariff-based offsets were invalidated by federal courts and are excluded from credible deficit scoring).
- Quantitative tightening and free float:
  - Continuation of quantitative tightening by major central banks has increased the amount of free-floating bonds for price-sensitive investors to absorb, exerting upward pressure on term premiums and keeping yields elevated.
  - Regulatory limits on dealer balance sheets and falling demand from liability-driven investors have likely exacerbated spread widening.
- Emerging market pass-through and fiscal cost:
  - In several EMs the spread between 10-year interest rate swaps and 10-year local currency bonds has turned more negative over the past decade, declining by almost 50 basis points for the median EM.
  - Some countries (Colombia, Mexico, South Africa) experienced declines exceeding 100 basis points.
  - Assuming an average stock of domestic debt at 40 percent of GDP, a −50 basis point swap spread equates to an increased annual fiscal cost of 0.2 percent of GDP.
  - Negative swap spreads can raise private sector interest rates or crowd out private sector debt and weaken monetary policy pass-through.

### Emerging Market Swap Spreads and Financing Costs
- The median emerging market swap spread has widened (become more negative) as the debt-to-GDP ratio has climbed.
- Widening swap spreads are associated with:
  - Higher sovereign spreads.
  - Covered interest parity (CIP) deviations.
  - Larger increases in holdings of domestic debt by foreigners during the average year.
- Interpretation:
  - Wider (more negative) swap spreads reflect a premium investors require to absorb large sovereign bond issuances, even as domestic large investors (pension funds, insurance companies) have supported sovereign bond markets.
  - The growing disconnect between bond yields and domestic interest rate swaps increases the cost of financing and may impede monetary policy transmission.

*Italic: Source — International Monetary Fund, Global Financial Stability Report, October 2025 (Chapter 1).*

### 1. Average Spread between 10-Year Emerging Market Interest Rate Swap

### 1. Average Spread between 10-Year Emerging Market Interest Rate Swap and 10-Year Government Bond, versus Debt-to-GDP Ratio

### Swap spreads and drivers
- Sample of countries: Brazil, Chile, Colombia, Hungary, India, Indonesia, Malaysia, Mexico, Poland, and South Africa.
- Panel definitions and measurement:
  - In panel 1, the swap spread is labeled as ASW.
  - Panel 2 divides countries into two groups for each variable: those with the largest increase/smallest decline for that variable in a given year and those with the smallest increase/largest decline. The bars show the annual change in swap spreads in each grouping, average over 2016 to 2025.
- Observed dynamics and market interpretation:
  - Swap spreads compressed as yields relative to domestic funding rates became attractive.
  - Foreign investors’ preference for interest rate swaps over bonds—due to smaller balance sheet impact or ease of access amid capital controls—may have helped compress swap spreads.
- Axis ranges and labeling visible in source charts:
  - Left scale (percentage points): −1.4, −1.2, −1.0, −0.8, −0.6, −0.4, −0.2, 0.
  - Right scale (basis points or percent as indicated): −20, −15, −10, −5, 0, 5.
  - Time axis includes years: 2016 17 18 19 20 21 22 23 24 25.
- Currency note: USD = US dollar.

### Convenience yields for longer-duration bonds
- Role and concern:
  - Government bonds are a main component of safe assets; fiscal expansion by major economies increased safe-asset supply.
  - Demand for long-duration safe assets declined amid a reduction in foreign exchange reserves denominated in the largest reserve currencies.
  - Erosion in convenience yields can signal and amplify funding market strains, raising concerns about the utility of safe assets as high-quality collateral and potentially increasing repo haircuts and funding costs.
- Measures and findings:
  - Domestic convenience yield (DCY): premium domestic investors forego over high-grade corporate bonds, adjusted for credit and liquidity differences.
  - Cross-border convenience yield (CCY): yield discount investors accept to hold US Treasuries relative to foreign-currency-hedged foreign government bonds.
  - DCYs for European government bonds, gilts, and US Treasuries have been mostly stable with episodic volatility.
  - CCY for US Treasuries has experienced a secular erosion against other G4 government bonds over the past decade but remained broadly stable since April (April 2025 reference).
  - The April market episode: DCYs declined sharply for European government bonds and US Treasuries before returning toward prior levels; CCYs remained stable, suggesting Treasuries’ safe-asset status broadly maintained.
- Implications:
  - Relative stability of convenience yields likely helped keep funding markets orderly during the April episode.
  - The secular decline of CCYs indicates potential cross-border diversification in safe-asset holdings.

### Sovereign bond market functioning and the role of NBFIs
- Market episodes and comparison:
  - US Treasury markets in April 2025 experienced stress but stopped short of the severe dislocations seen in March 2020 (“dash for cash”).
  - During both March 2020 and April 2025 episodes, Treasury yields initially declined as VIX increased, then reversed beyond a certain VIX level.
- Nonbank financial intermediaries (NBFIs) and leveraged strategies:
  - In April 2025, cash-futures basis trades did not unwind as in March 2020.
  - A swap-spread trade reportedly unwound and contributed to Treasury market volatility in April 2025.
  - Large hedge funds still hold near-record net interest rate derivatives and leveraged repo positions, indicating continued exposure to basis and swap spread trades.
- Structural and circumstantial supports in April 2025:
  - Policy reversal after the April 2 tariff announcement limited duration and severity of the shock.
  - Repo markets remained relatively stable in 2025, aided by increased banking sector reserves and supportive standing facilities.
  - Dealer balance sheet usage exerted limited upward pressure on repo rates.
  - Increased volumes of repo central clearing (through “sponsored clearing”) helped preserve dealer balance sheet capacity; higher haircuts in central clearing likely curbed repo leverage.
- Mutual funds and margin exposure:
  - US-domiciled bond mutual funds manage about $5 trillion in assets, with almost one-quarter allocated to US Treasuries.
  - Outflows from open-ended bond funds in April 2025 were much smaller than in March 2020 and did not appear to induce significant forced selling.
  - Under the scenario of a 100 basis point curve shift, variation margin calls would amount to about $20 billion; heterogeneity across funds implies some face margin calls while others receive variation margin credit.
- Financial stability takeaway:
  - Bond mutual fund outflows, dealer balance sheet capacity, central clearing dynamics, and hedge fund derivative positions remain key channels through which stress can amplify.
  - Continued monitoring of NBFI leverage, margining risks, and convenience-yield dynamics is important for assessing sovereign bond market resilience.

*Source: IMF staff calculations and figures from the Global Financial Stability Report (chapter content provided in source PDF).*

### 2. Treasury Inventory and Repo (Gross and

### 2. Treasury Inventory and Repo (Gross and Net) Positions by US Primary Dealers, 2019–25

### Treasury inventory, repo, and dealer intermediation capacity
- Panel data cover 2019–25 for treasury inventory and repo (gross and net) positions by US primary dealers (percent of total marketable debt).
- Dealer balance sheets and reserves influence repo spreads; Panel 1 presents average beta coefficients for 2025 from regressing repo spreads on changes in reserves and dealer balance sheets in a rolling window of one year.
- Forced Treasury sales in severe stress scenarios can exceed dealer Treasury inventories, potentially overwhelming dealer intermediation capacity.

### Bond mutual funds, flows, and forced liquidations
- US-domiciled bond mutual funds hold almost $5 trillion in total assets, of which one quarter is in US Treasuries.
- Using a “waterfall” liquidation approach calibrated to outflow patterns seen in April 2025 and a 60 basis point increase in interest rates:
  - Forced sales are estimated at $66 billion, with over half the liquidation being Treasury securities.
- Larger shocks increase both the total volume of forced sales and the share of Treasury holdings liquidated.
- In a severely adverse scenario where bond fund outflows reach their 99th historical percentile and interest rates rise by 100 basis points:
  - Forced Treasury sales would exceed current dealer Treasury inventories, potentially causing disorderly conditions in Treasury markets.
- Margin call exposure:
  - Variation margin calls on interest rate derivatives are less significant than liquidity pressures from fund outflows, with heterogeneity across funds.
- Data sources and notes:
  - Sources include Lipper; Securities and Exchange Commission N-PORT; IMF staff calculations. N-PORT data from the second quarter of the 2025 batch, retaining only submissions for the first quarter of 2025.
  - Scenarios project flow percentages observed during historical episodes to current holdings; the 99th percentile outflow scenario uses each fund’s 99th percentile of outflows (its first percentile of flows). Margin calls include Treasury futures and interest rate swaps based on a linearized pricing model (estimated contract duration).

### Global bank stress test findings (Global Stress Test, GST)
- The GST examined 669 banks from 29 countries, accounting for 74 percent of global sector assets.
- Under the July 2025 World Economic Outlook reference scenario, the global banking system remains broadly resilient.
- Under a severe stagflationary adverse scenario:
  - Banks representing about 18 percent of global bank assets can be considered weak, as their Common Equity Tier 1 capital (CET1) ratio falls below 7 percent.
  - The global average CET1 ratio increased from about 12.5 percent in 2022 to 13 percent in 2024.
  - The aggregate global CET1 ratio declines by 70 basis points, from 13 percent in 2024 to 12.3 percent at the end of the stress horizon.
  - The adverse scenario assumes an across-the-board 10 percent increase in tariffs over the baseline for advanced economies and some emerging markets, higher inflation from supply chain rechanneling, a corresponding 1 percentage point increase in policy rates globally in the first year, and term premia rising by 300 basis points to 500 basis points across advanced economies and emerging markets.
- Distribution and severity:
  - 82 of 669 banks globally are projected to fall below a CET1 ratio of 7 percent in the adverse scenario.
  - Under stricter criteria (CET1 below 7 percent or CET1 declining by 5 percentage points or more), the number of weak banks increases to 137 globally, accounting for 25 percent of global bank assets.
  - No country’s banking system would fail to meet the minimum 4.5 percent CET1 ratio in aggregate under the adverse scenario, but a few institutions (accounting for about 1 percent of global assets) would fall below 4.5 percent and would require a $25 billion recapitalization to restore CET1 to 4.5 percent.
- Drivers of CET1 change:
  - Rising loan losses and operating expenses are the main forces behind capital depletion under the adverse scenario.
  - A steeper yield curve increases net interest margins, partially offsetting valuation and loan-loss effects.

### Bank exposures to NBFIs and contagion/liquidity risks
- NBFI exposure scale:
  - In Europe and the United States, NBFI loans represent, on average, 9 percent of banks’ loan portfolios, with exposures amounting to about $4.5 trillion (about $2.6 trillion corresponding to loans and the rest to undrawn commitments).
- Concentration and funding fragility:
  - In the United States, banks representing almost 50 percent of the sample assets have exposures to NBFIs exceeding their Tier 1 capital.
  - Large banks account for 90 percent of all lending to NBFIs; concentration is more severe among large regional banks and banks with assets under $100 billion.
  - Exposure to private equity and credit funds is $497 billion and rose 59 percent between the fourth quarter of 2024 and the second quarter of 2025.
  - US banks with high NBFI exposure (exposure > 100 percent of Tier 1 capital) tend to rely more on noncore and wholesale funding.
- Stress implications:
  - IMF staff scenario: if average risk weight for NBFI exposures rises from 20 percent to 50 percent and borrowers draw down 100 percent of credit lines and undrawn commitments:
    - CET1 ratios would decline by more than 100 basis points in about 10 percent of US banks and 30 percent of European banks.
    - Adding this NBFI shock to the GST adverse scenario would increase the share of weak banks, mostly in Europe.
    - The average additional CET1 ratio impact is 120 basis points for euro area banks and 65 basis points for US banks.
  - A few banks could face liquidity pressures to cover potential outflows from NBFI credit and liquidity lines.

*Sources: Bloomberg Finance L.P.; Federal Reserve; Office of Financial Research; Lipper; Securities and Exchange Commission N-PORT; Fitch Connect; Fitch Solutions; IMF staff calculations.*

### 6. Number of Banks with Negative Net

### 6. Number of Banks with Negative Net Available Liquidity

### Key findings on liquidity stress from NBFI exposures
- The shock assumptions for the analysis:
  - Risk weights for NBFI exposures increase from 20 percent to 50 percent (primary shock) and to 100 percent (more conservative scenario).
  - NBFIs draw all unused commitments available (commitments fully drawn).
  - The narrow liquidity metric used to assess net available liquidity includes cash and balances at banks.
- Sample and data timing:
  - Euro area: 109 banks, second-quarter 2024 data.
  - United States: 362 banks, second-quarter 2025 data.
- Direct liquidity outcomes under full drawdown of NBFI lines:
  - 4 percent of US banks (representing less than 1 percent of total assets) would lack enough liquid assets to meet outflows, turning their net available liquidity negative.
  - Under a stricter definition of liquid assets (including only cash and deposits at other banks):
    - 5 percent of banks in the euro area (representing 5 percent of sample assets) would have negative net available liquidity.
    - 14 percent of banks in the United States (representing 8 percent of sample assets) would have negative net available liquidity.
- Concentration of impact:
  - Liquidity pressure is concentrated among smaller US banks and large euro area banks that provide large liquidity and credit facilities relative to their size.
  - These banks also exhibit:
    - Lower liquidity ratios;
    - Higher asset encumbrance (in the euro area);
    - In the United States, a higher share of noncore deposits and a lower initial CET1 ratio compared with peers.
- Additional caveat:
  - The analysis notes there could be additional impact of liquidity stress on solvency for these banks, which is not considered in the liquidity assessment.

### Capital impacts and related stress scenarios
- More conservative capital shock (commitments fully drawn and risk weights reach 100 percent):
  - CET1 ratios fall by 100 basis points or more in 50 percent of banks in Europe, representing 39 percent of total assets.
  - CET1 ratios fall by 100 basis points or more in 12 percent of banks in the United States, representing 67 percent of total assets.
- The NBFI shock methodology (as described) does not incorporate credit valuation adjustments related to banks’ derivative links with NBFIs, which could affect banks’ risk-weighted assets and liquid asset needs.

### Analysis and implications
- Most euro area and US banks have sufficient liquidity buffers to honor NBFI commitments, but a nontrivial subset would face liquidity pressures under full drawdown scenarios.
- Those banks exposed to liquidity stress may need to use less-liquid assets to cover outflows, potentially creating secondary market effects.
- The combination of higher risk weights and full drawdowns materially worsens capital positions for a sizable share of banks, particularly in Europe by assets affected.
- The assessment underscores interconnected risks between NBFI exposures, liquidity buffers, and capital adequacy, and highlights that solvency effects beyond the liquidity metric could materialize but were not modeled here.

*Source: IMF staff analysis in Chapter 1, "Shifting Ground Beneath the Calm: Stability Challenges Amid Changes in Financial Markets", Global Financial Stability Report, October 2025.*

### 1. Ownership of US Treasury Bills

### 1. Ownership of US Treasury Bills

### Treasury bill demand after the 2016 money market mutual fund reform
- The 2016 money market mutual fund reform spurred a large increase in demand for Treasury bills, affecting the relative prices of other assets.
- The Treasury bill growth rate is calculated on the basis of outstanding total US Treasury debt, after excluding Federal Reserve Treasury holdings.
- The Treasury bill spread is calculated as the difference between the three-month Treasury bill rate and the three-month overnight index swap rate.
- The spread for commercial paper is the difference between 90-day non–financial commercial paper and the three-month overnight index swap rate.
- Data and series referenced in the charts include labels and time points such as Jan. 2014, Jul. 2014, Jan. 2015, Jul. 2015, Jan. 2016, Jul. 2016, Jan. 2017 and use left and right scales in billions of dollars and percent, respectively.

### Implications of stablecoin adoption for Treasury bills and market functioning
- If stablecoins displace money market mutual funds, yield effects may be muted because demand would be reallocated from the funds.
- If stablecoins displace bank deposits, which fund longer-term bonds and loans, demand could shift toward Treasury bills.
  - Such a shift may steepen yield curves and raise concerns about credit disintermediation as banks could face reduced funding capacity for lending to households and businesses.
  - Altering yield curve dynamics can complicate interest rate control by central banks.
- Effects would be amplified if stablecoins denominated in foreign currencies were widely adopted; the impact depends on geographic adoption patterns, asset allocation strategies, and supply of short-term government bills.
  - An increase in bill issuance can mitigate price pressures, though at the cost of higher exposures to short-term interest rate risk for the government.
- Wider stablecoin adoption risks beyond the yield curve:
  - Stablecoins may be subject to run risk; fire sales of reserve assets—such as bank cash deposits and government securities—could spill over into bank deposits and government bond and repo markets, increasing volatility and potentially requiring central bank intervention.
  - Loss of parity with the reference currency would impose direct losses and heightened uncertainty on a large user base.
  - Financial fragmentation in payment systems from limited interoperability among stablecoins and between stablecoins and existing financial market infrastructure may further accentuate risks.

### Corporate credit risk and sensitivity to tariffs
- Corporate sector summary:
  - Corporate balance sheets in many countries remain healthy in aggregate despite downward revisions to profit margins since the April 2025 Global Financial Stability Report, keeping corporate credit risks at bay while vulnerabilities remain unresolved.
  - In the United States, interest income on assets increased more than liabilities during high-interest-rate years, lowering firms’ net interest payments; net interest payments have recently started to increase as maturing corporate debts need refinancing at higher fixed rates.
  - Firms have engaged in financial engineering rather than investing cash flow; share buybacks have continued to grow (example: so far this year, US financial, technology, and communications services firms have bought back near $1 trillion of stocks on an annualized basis).
  - In Japan, the ratio of share buybacks to market capitalization is on pace to reach around 2.4 percent in 2025, in contrast to 1.1 percent in 2024.
  - Elevated valuations have enabled firms to restructure loans, contributing to higher leveraged loan default rates and indicating some weaker firms are struggling.
  - Stretched valuations are vulnerable to correction, particularly if tariffs dampen corporate profitability and if firms pass rising input costs to consumers, potentially raising inflation with stagnant demand.
- IMF staff tariff sensitivity assessment:
  - For the average country, additional tariffs would reduce firms’ profit margin by 1 percentage point (green line in referenced figure).
  - Some countries have firms with much higher sensitivity to additional tariffs (red bubbles in referenced figure) and could experience a steeper erosion of margins.
  - Two extreme pass-through scenarios used to estimate earnings deterioration:
    - 100 percent cost pass-through from a country’s exporters to US consumers.
    - 0 percent pass-through with equal distribution of tariff-related costs between importing and exporting firms.
  - Sensitivity analysis indicates that, with rising debt refinancing costs as large volumes of debt mature, a sizable share of firms could end up with an interest coverage ratio below 1, especially in countries where tariff costs are high.
  - Countries with currently low percentages of risky corporate debt (debt with an interest coverage ratio below 1) could experience large increases in their share, heightening credit risk.
- Notes on figures and samples:
  - Sample includes Bangladesh, Brazil, Canada, Chile, China, Colombia, France, Germany, India, Japan, Korea, Malaysia, Mexico, the Philippines, South Africa, Spain, Türkiye, the United Kingdom, the United States, and Vietnam.
  - Additional tariffs are calculated relative to January 20, 2025, and as of July 12, 2025.
  - Debt-at-risk is defined as the share of debt with an interest coverage ratio below 1 in total.

### Private credit vulnerabilities and broader retail participation
- Direct lending borrowers:
  - Elevated policy rates and uncertainty continue to exert pressure, though the industry has shown flexibility managing short-term pressures.
  - Continued earnings growth, declining policy rates, use of payment-in-kind features, and recent restructurings have helped relieve some cash-flow pressure.
  - Overall interest coverage ratio remains low, but the share of borrowers with a cash-only interest coverage ratio below 1 has declined considerably, returning to levels observed before the interest rate hiking cycle.
  - Liquidity remains strained among more vulnerable borrowers, contributing to a rise in borrower downgrades.
  - Defaults remain more common among firms that borrowed from private credit before monetary policy tightening in Apr. 2022–Feb. 2023; older vintages include more firms constrained by liquidity.
- Retail participation in private credit:
  - Retail investors have become—and are expected to remain—major contributors of new funds for the expansion of private credit.
  - Private credit asset managers are developing new products to attract retail investors, including retirement savings accounts, countering institutional fundraising slowdowns.
  - Broader retail participation may change the industry by introducing higher liquidity risks and making investments more procyclical.
  - Most private credit funds currently pose little maturity transformation risk because traditional structures (private credit collateralized loan obligations and closed-end funds) do not typically allow redemptions during the fund’s lifespan.
  - Expansion to retail is associated with growth of semiliquid investment vehicles offering periodic liquidity windows (quarterly redemptions) or exchange-traded funds with daily liquidity.
  - Products with stronger retail participation, such as perpetual nontraded BDCs, seem to track cyclicality of market sentiment more closely.
  - Liquidity management considerations for perpetual nontraded BDCs:
    - They usually maintain leverage meaningfully below regulatory maximums, providing room to borrow if unexpected redemptions occur, but that strategy is vulnerable to asset devaluation during an economic shock which would increase actual leverage and reduce borrowing capacity.
    - They hold larger portfolios of marketable assets (mostly traded leveraged loans) amounting to 10 percent to 40 percent of total assets, compared with 1 percent to 3 percent typically observed in publicly traded BDCs that do not permit redemptions; these marketable portfolios can serve as liquidity cushions but their effectiveness is limited if market liquidity evaporates during stress.
- Policy-relevant implication:
  - These vulnerabilities underscore the need for robust asset-liability management and sufficient sources of liquidity to cover crowded redemptions during a shock.

*Source: IMF staff compilation from figures and notes in the provided text.*

### 1. Assets under Management for Private Credit Funds

### 1. Assets under Management for Private Credit Funds

### Perpetual nontraded business development companies
- Perpetual nontraded business development companies’ funds closely followed market sentiment in 2022–23.

### Investment funds’ rising share of the high-yield bond market
- Since 2015, open-ended investment funds and exchange-traded funds’ share of the US high-yield bond market has risen from 37 percent to 45 percent.
- Exchange-traded funds have grown their share of the US high-yield bond market to 7 percent in 2024, from 3 percent in 2015.
- The United States makes up about 60 percent of the global high-yield bond market.

### Outflows, trading volumes, and liquidity mismatch
- Monthly flow data for high-yield bond funds and exchange-traded funds over the past decade show that in eight episodes globally, outflows exceeded 2 percent of assets under management (over $10 billion of outflows).
- Other fixed-income sectors have suffered outflows over 2 percent of assets in only one or, at most, two instances during the same period.
- Average monthly trading volume in the United States high-yield bond market is about $200 billion.
- The liquidity mismatch implies a high outflow-to-trading-volume ratio compared with other fixed-income markets.
- In March 2020, US high-yield bonds experienced a mark-to-market loss of 12 percent, considerably larger than the 7 percent loss in US investment-grade bonds.

### Concentration and contagion risks
- Bond funds and exchange-traded funds that are not dedicated to the high-yield asset class or indexed to high-yield bond benchmarks have increased their holdings, raising issuer concentration risks.
- A single investment fund can hold a substantial portion of the bonds issued by certain borrowers, particularly those rated CCC or lower.
- The total debt of the issuing firms in panel 5 amounts to $90 billion, about 4 percent of the ICE Bank of America Global High-Yield Index.
- The sensitivity of high-yield bond exchange-traded funds to S&P 500 returns is higher than the sensitivity of their underlying index to S&P 500 returns, suggesting that the rise in exchange-traded funds may increase contagion risk and possibly amplify price moves across asset markets during periods of stress.

### Commercial real estate and related statistics (contextual)
- Global commercial real estate (CRE) prices across all regions have continued their tenuous recovery since the April 2025 Global Financial Stability Report.
- In the United States, delinquency rates for CRE that backs commercial mortgage-backed securities rose to 7.29 percent for August, driven by continued stress in the office sector.
- After bottoming out in 2023, the direct CRE investment growth rate recovered to 34 percent year-over-year in the latest quarter, reaching $185 billion.

### Policy recommendations and regulatory measures
- Central banks:
  - Stay attentive to the risks to inflation associated with tariffs.
  - Where inflation is still well above target and tariffs might constitute a supply shock, proceed carefully with any easing and maintain commitment to price stability mandates.
  - Preserve central bank operational independence.
- Global financial safety nets and foreign exchange market resilience:
  - Strengthen capacity and operational readiness of global financial safety nets, including bilateral and regional currency swap lines.
  - Improve data reporting and transparency, stronger systemic risk monitoring and stress testing (especially on foreign exchange mismatches), and greater operational resilience among key intermediaries.
- Sovereign bond market resilience:
  - Urgent fiscal adjustments to curb government deficits and improvements in market structure.
  - Continue migration toward central clearing of cash bond and repo transactions to reduce counterparty risk, strengthen intermediaries’ capacity through balance sheet netting, and increase transparency.
  - Standing liquidity facilities that backstop core government bond markets are crucial.
- Emerging markets and the IMF Integrated Policy Framework:
  - Deploy policies consistent with the IMF Integrated Policy Framework to mitigate external pressures while deepening local financial markets.
  - Use foreign exchange interventions, macroprudential measures, and capital flow management measures where appropriate, provided buffers are available.
  - Frontier economies should exercise caution against excessive reliance on less-conventional and potentially more fragile forms of borrowing, such as private placements and bespoke instruments.
- Nonbank financial intermediation (NBFI) oversight:
  - Improve data collection, coordination, and analysis—particularly across borders—to ensure consistent oversight.
  - Regulators should ensure private credit funds create and redeem shares at a low frequency or require long notice or settlement periods, in line with FSB recommendations.
  - Require stringent use of liquidity management tools and stress testing for private credit firms; ensure clear and comprehensive disclosure of risks and redemption limitations for funds permitting retail participation.
  - Consider stricter oversight of potential continuation funds.
- Investment fund liquidity tools and structural reforms:
  - Further improve and expand the availability and usability of liquidity management tools.
  - Timely and consistent implementation of revised recommendations and guidance from the Financial Stability Board (FSB) and International Organization of Securities Commissions.
  - Use swing pricing and other antidilution mechanisms to mitigate liquidity mismatches.
  - Provide more definitive guidance to lengthen redemption frequency for funds investing in illiquid assets—including high-yield bonds—while noting potential need for legal framework amendments in some jurisdictions.
- Banking sector resilience and safety nets:
  - Implement Basel III and other internationally agreed-upon standards to ensure sufficient capital and liquidity.
  - Review undue complexity in regulations without undermining overall resilience or international minimum standards.
  - Supervisors should monitor banks’ exposures to NBFIs and coordinate across financial sectors to monitor systemwide risks.
  - Consider building macroprudential buffers where feasible and have frameworks for emergency liquidity assistance with strong safeguards.
- Crypto-assets and stablecoins:
  - Implement FSB’s high-level recommendations for crypto assets and the broader IMF-FSB policy recommendations.
  - Ensure market and prudential authorities have adequate powers, effective risk management frameworks, AML/CFT measures in line with international standards, and inter-authority cooperation.
  - Guard against excessive capital flow volatility and adopt unambiguous tax treatment of crypto assets.

*Source: IMF Global Financial Stability Report: Shifting Ground Beneath the Calm (October 2025).*

### 1. Global Property Fund Index and

### Global Property Fund Index and Commercial Real Estate Trends (Box 1.1–1.3 excerpts)

### Commercial real estate (CRE) — market dynamics and headwinds
- Index and delinquency timing
  - The change in the MSCI Global Quarterly Property Fund Index is annualized; the last observation is for the second quarter of 2025.
  - “US delinquency rates” refers to August 2025.
- Sentiment and market performance
  - Forward-looking commercial real estate sentiment has become somewhat more downbeat (JLL Research Real Estate Sentiment Survey).
  - MSCI IMI Liquid Real Estate indices for Europe (excluding the United Kingdom), the United Kingdom, and the United States are indexed to December 2019 (December 2019 = 100); the last observation is for September 2025.
- Capitalization rates and repricing
  - US capitalization rates have increased in office and retail segments, indicating that new CRE investors will likely demand lower property prices before investing.
  - The repricing process makes refinancing of CRE debt more challenging at a time when a substantial volume of US CRE debt is due to mature in a higher interest rate environment (see April 2025 Global Financial Stability Report reference in source).

### Residential real estate — uneven recovery and drivers
- Timing and scope
  - In panels reporting residential activity, the last observation for real house prices is for the first quarter of 2025.
  - Debt-service ratio data in panel 3 are through the fourth quarter of 2024.
- Observed patterns
  - Residential real estate markets globally are entering a phase of uneven recovery.
  - Some advanced economies: price growth has resumed modestly, supported by falling interest rates.
  - Some emerging market economies are facing extended declines in real house prices.
  - Lower household debt-service burdens are associated with stronger real house price growth.
- Distributional detail
  - The distribution of residential property price changes over the latest and previous quarter is categorized in bands: Less or equal than −5%; −5 to 0%; 0 to 5%; 5 to 10%; Greater or equal than 10% (panel structure retained from source).

### China — low interest rates, bank profitability, and lending
- Policy rates and yields
  - The People’s Bank of China benchmark policy rate was lowered to 1.4 percent from 2.2 percent three years ago.
  - Bond yields have fallen to near historical lows (as described in source).
- Bank margins and profitability
  - Average net interest margins across the banking system declined to a historic low of 1.42 percent in the second quarter of 2025.
  - Return on equity fell to 8.2 percent in the second quarter of 2025 (from 8.9 percent a year earlier).
  - Return on assets fell to 0.63 percent in the second quarter of 2025 (from 0.69 percent a year earlier).
  - The loan spread (China’s one-year loan prime rate minus one-year government bond yield) has remained elevated (around 150 basis points).
  - Deposit spread (proxied by the gap between the one-year China government bond yield and the one-year time deposit rate) compressed sharply in late 2024 as bond yields fell faster than deposit rates.
- Deposit and lending rate levels (estimates and official)
  - One-year time deposit rate is estimated by J.P. Morgan at 0.95 percent.
  - PBOC’s official benchmark one-year deposit rate stands at 1.5 percent (viewed as the ceiling).
  - One-year lending prime rate (LPR) stands at 3 percent currently.
- Credit supply and policy action
  - Loan growth at the six largest state-owned banks slowed below the five-year average on subdued demand.
  - Authorities injected 500 billion yuan (or about $69 billion) of capital into large state-owned banks earlier this year to help expand lending capacity.
- Financial stability concern
  - Persistently low interest rates risk “reversal interest rates” dynamics: sustained low rates could cut into banks’ profits and capital base, curbing lending despite accommodative monetary policy.

### Private credit, banks, and insurers — evolving linkages and risks
- Structural evolution
  - Private credit has grown substantially, raising concerns that credit provision is migrating from regulated banks and public markets to a comparatively lightly regulated and opaque private credit industry.
  - The system is increasingly integrated: banks, insurers, and private credit funds operate in intertwined partnerships rather than as pure substitutes.
- Bank–private credit partnerships
  - Over the last three years, several private credit managers have entered more than 20 partnerships with banks in various countries.
  - Common structures: “originate-to-distribute” models where banks originate loans and private credit funds retain or purchase exposures; banks may provide leverage and servicing.
  - Potential risks: partnerships may lead to looser underwriting standards and weaker loan monitoring; many arrangements have not been tested over time.
- Insurers’ exposures and rating dynamics
  - In North America, private credit represents about one-third of insurers’ total investments (source: Moody’s data referenced in the source).
  - A growing share of insurers’ private credit exposure is via structured instruments that provide leverage: middle-market CLOs, CRE CLOs, fund-finance instruments, collateralized fund obligations, and private placements of private credit funds’ debt.
  - Most insurers’ private credit positions are classified as investment grade; demand for investment-grade classification has increased the importance of smaller, specialized rating agencies in the United States.
  - Risk: Misclassification of below-investment-grade instruments into the investment-grade bucket could cause default losses to exceed expectations, erode insurers’ capital, and create liquidity gaps.
  - Policy implication: Ensure soundness and transparency of private rating assessments and require adequate disclosure of methodologies and reports.

*Sources: MSCI; Trepp; JLL Research; IMF staff calculations; Federal Reserve Bank of St. Louis, Federal Reserve Economic Data; Bloomberg Finance L.P.; Moody’s; NAIC; CEIC; J.P. Morgan; WIND; and IMF staff calculations (as cited in the source content).*

### References

### References

### Chapter 2 — Key Findings (Chapter 2 at a Glance)
- The global foreign exchange (FX) market is essential to the international monetary and financial system; smooth functioning is vital for global financial stability.
- The FX market’s average daily turnover exceeds $9.6 trillion.
- Structural shifts increasing involvement of nonbank financial institutions (NBFIs) and growing trade in derivatives offer benefits but may raise vulnerability to adverse shocks.
- Increased macrofinancial uncertainty can:
  - Significantly raise funding costs.
  - Impair liquidity.
  - Amplify excess exchange rate return volatility.
- Shocks have more pronounced effects for:
  - Emerging markets.
  - Currencies with high NBFI participation, concentrated dealer networks, and elevated hedging activity.
- FX market stress can spill over to other asset classes, tightening financial conditions and posing risks where currency mismatches and fiscal vulnerabilities are significant.
- Outages in critical payment systems and settlement failures:
  - Significantly impair market liquidity.
  - Increase excess exchange rate return and its volatility.
  - Raise the cost of FX transactions.
- Investor behavior amid elevated uncertainty:
  - Following US tariff announcements in early April 2025, investors in some countries reduced US dollar holdings while others maintained exposures, demonstrating diverging cross-country responses.

### Key Policy Recommendations (bullet form preserved)
- Enhance FX market surveillance through systemic risk monitoring, stress testing, and scenario analysis to capture liquidity shocks and spillovers.
- Close critical FX data gaps by improving reporting and transparency, especially regarding NBFIs and bilateral exposures outside centralized infrastructures.
- Ensure robust liquidity and capital buffers, backed by effective safeguards, such as access to central bank liquidity with proper oversight, sufficient international reserves, and expanded central bank swap lines.
- Strengthen operational resilience of financial market infrastructures and financial institutions through cyber risk frameworks, contingency planning, and coordinated oversight.
- Reduce settlement risks and market inefficiencies in over-the-counter FX markets by encouraging payment‑versus‑payment adoption and exploring digital innovations to develop interoperable financial platforms.

### Introduction and Market Structure — Key Quantities and Features
- The FX market is the largest and most liquid financial market globally.
- Cross-border transactions account for about two-thirds of global FX market turnover.
- The US dollar is the dominant trading currency.
- Structural evolution:
  - Diversification of market participants with greater NBFI participation.
  - Decline in the share of spot trading; notable growth in the use of derivatives, especially FX swaps for funding and hedging.
  - Expanded execution methods and trading platforms with increasing electronification.
- Risks associated with NBFI activity:
  - Many NBFIs face less regulatory oversight and may lack access to central bank facilities.
  - NBFI strategies—leverage, short-term arbitrage, high‑frequency trading—can amplify market swings and shift inventory risk to market‑making dealers.
  - Liquidity mismatches in NBFIs (for example, mutual funds funding longer-term or less liquid assets with short-term liabilities) create structural fragilities that can heighten systemic risk during volatility.
- Derivatives use:
  - Enhances liquidity and risk management.
  - Facilitates leveraged investments and interconnectedness; under stress, margin calls and forced deleveraging can amplify volatility and liquidity strains.

### Figure 2.1 — Key Descriptions and Notes
- Figure 2.1 illustrates key developments in the global FX market:
  1. FX Market Turnover, by Instrument (Daily average trillions of dollars, net-net basis): shows market growth driven mainly by increased swap trades.
  2. FX Market Turnover, by Currency (Daily average trillions of dollars, net-net basis): confirms USD dominance; note that because each FX transaction involves two currencies, the sum of individual currencies is twice total turnover.
  3. FX Market Turnover, by Counterparty (Daily average percent of total market turnover, net-net basis): shows shift in participants with greater NBFI role.
- Sources cited for the figure: BIS 2025a; and IMF staff calculations.
- Note: Daily averages correspond to April. The BIS Triennial Central Bank Survey (2025a) adjusts figures reported on a net-net basis to correct for double counting in local and cross-border interdealer transactions. Abbreviations shown: CNY = Chinese yuan; EUR = euro; FX = foreign exchange; GBP = British pound; JPY = Japanese yen; USD = US dollar.

### Selected References and Thematic Coverage (examples drawn from the references list)
- Topics covered by cited works include:
  - Reversal interest rate and monetary policy dynamics (Abadi, Brunnermeier, and Koby 2023).
  - Treasuries’ convenience yield and hedging (Acharya and Laarits 2023).
  - Term structure pricing methods (Adrian, Crump, and Moench 2013).
  - FX market structure, NBFI participation, and related risks (BIS 2025a; Schrimpf and Sushko 2019; Chaboud and others 2024).
  - Measurement of geopolitical risk and trade policy uncertainty (Caldara and Iacoviello 2022; Caldara and others 2020).
  - Global safe assets and demand for Treasury debt (Gourinchas and Jeanne 2012; Krishnamurthy and Vissing‑Jorgensen 2012).
  - Nonbank financial intermediation monitoring and implications (FSB 2024; ECB 2024).
  - Stablecoins, crypto flow estimation, and related policy analysis (Ahmed and Aldasoro 2025; Reuter 2025; IMF forthcoming “A Primer on Stablecoins”).
  - Country and program analyses relevant to financial system stability (IMF Country Reports 2024/258; 25/233; 2025/100; IMF Departmental Paper No 2021/018).
- Empirical and policy contributions from central banks, rating agencies, and private‑sector research (Bank of England 2025; Moody’s 2024; Morningstar DBRS 2024/2025; S&P Global Ratings 2025; BNP Paribas 2025).

*Source: text - References — GLOBAL FINANCIAL STABILITY REPORT: ShIFTING GROuNd BENEATh ThE CALM, International Monetary Fund | October 2025*

### CHAPTER 2 RISk ANd RESILIENCE IN ThE GLOBAL FOREIGN ExChANGE MARkET

### CHAPTER 2 RISk ANd RESILIENCE IN ThE GLOBAL FOREIGN ExChANGE MARkET

### Key vulnerabilities and market structure
- Market opacity: over-the-counter derivatives markets dominate FX trading and complicate risk monitoring.
- Dealer concentration: Nearly half of global FX turnover is intermediated by a small group of dominant dealers—mostly large, regulated banks—exposing the market if these institutions scale back activity during stress (BIS 2022).
- Currency mismatches: Persistent mismatches, where liabilities and assets are in different currencies, drive sustained demand for short-term FX derivatives and increase rollover and funding risks (FSB 2022).
- NBFI role: A rising share of nonbank financial institutions (NBFIs) in customer flows can amplify procyclical behavior and liquidity pressures.
- Electronification and algorithmic trading: Improved access, speed, and transparency coexist with added complexity, fragmentation, and operational risk; algorithms can align prices in stable conditions but break down during volatility, producing a “liquidity mirage” and deepening informational asymmetry.

### External and operational risks
- Sensitivity to macroeconomic and policy shocks: Changes in macroeconomic uncertainty, investor risk sentiment, and interest rate expectations can trigger rapid portfolio adjustments, liquidity strains, and FX volatility.
- Settlement risk and PvP coverage: Settlement risk is elevated for cross-border transactions, particularly because most emerging market currencies remain outside PvP frameworks. The CLS foreign exchange settlement system reduces settlement risk for 18 currencies through its PvP mechanism, but many currencies remain outside PvP systems because of technical, regulatory, and economic constraints (Glowka and Nilsson 2022).
- Operational disruptions: Technical failures, cyberattacks, or power outages (examples cited: 2018 Fedwire cyber incident; 2000 and 2025 TARGET2 outages) can impair FX market functioning, increasing liquidity strains, volatility, and failed settlements.
- Spillovers to other markets: Elevated FX volatility and hedging costs—reflected in wider cross-currency bases, wider bid-ask spreads, and excess exchange rate return volatility—can increase yields and risk premiums, erode intermediation capacity, tighten financial conditions, and amplify systemic stress.

### Stylized facts, metrics, and historical episodes
- Historical episodes such as the global financial crisis and the COVID-19 market turmoil show significant deterioration in FX funding and market liquidity:
  - Metrics used to capture stress include cross-currency basis (CIP deviation), bid-ask spreads, and excess exchange rate return volatility.
  - Figure 2.2 demonstrates that CIP deviation, bid-ask spreads, and excess exchange rate return volatility tend to rise with macrofinancial uncertainty (see note: CIP deviation calculated using three-month overnight index swap rates for 12 currencies against the US dollar; bid-ask spread = [(ask rate − bid rate) ∕ mid rate] × 100; excess exchange rate return = log(exchange rate at time t ∕ exchange rate at time t − 1) − log(forward rate at time t − 1 ∕ exchange rate at time t − 1)).
- Recent event referenced: “tariff announcement” = the April 2, 2025, US declaration of new import tariff rates; shown in Figure 2.2 panels alongside COVID-19 and Global financial crisis episodes.

### Empirical approach and data
- Unique dataset: CLS Group trades covering FX spot and swap transactions for 18 major currencies, disaggregated by four institutional sectors: banks, investment funds, other NBFIs, and nonfinancial firms.
- Sample period: daily and weekly information from January 1, 2015, to May 31, 2025.
- Macrofinancial uncertainty indicators: Chicago Board Options Exchange Volatility Index (VIX), Merrill Lynch Option Volatility Estimate (MOVE) index, and the economic policy uncertainty (EPU) index of Baker, Bloom, and Davis (2016).

### Conceptual transmission framework: how shocks affect FX conditions and macrofinancial stability
- Direct channels: adverse macrofinancial or operational shocks → changes in FX flows (trade, financial, remittances) → shifts in market conditions (higher FX volatility, higher bid-ask spreads, higher hedging and funding costs, higher settlement risk for non-PvP currencies).
- Amplifiers:
  - Currency mismatch (funding; hedging; speculation) increases reliance on FX swaps and sensitivity to CIP deviations.
  - Dealer concentration and dealer balance sheet constraints reduce market-making capacity during stress.
  - NBFI share in customer flows can heighten procyclicality.
- Feedback loops:
  - Portfolio rebalancing toward dollar-denominated assets raises demand for dollar funding via FX swaps, pressuring dealer balance sheets and widening cross-currency bases.
  - Wider cross-currency bases raise hedging and funding costs, prompting forced asset sales or reductions in foreign-currency lending, increasing volatility and further tightening FX market conditions.
- Role of central banks: central bank interventions, including dollar liquidity swap lines, have historically helped break vicious cycles from shock-induced portfolio rebalancing and restore market functioning.

### Key empirical questions addressed
- How do different macrofinancial uncertainty shocks affect FX trading across market participants?
- How do these shocks influence FX market conditions—measured by cross-currency basis, excess exchange rate return volatility, and bid-ask spreads—and are effects amplified by structural fragilities?
- Does FX market stress spill over into sovereign bond and equity markets, with broader implications for financial stability?

### Policy implications and mitigation options
- Strengthen foreign currency liquidity buffers and stable dollar funding for financial institutions to reduce reliance on short-term FX swaps.
- Enhance resilience of dealer balance sheets to limit procyclical reductions in market-making capacity under stress.
- Expand settlement risk reduction mechanisms: increase inclusion of emerging market currencies in PvP frameworks where technically and legally feasible.
- Improve operational resilience of FX market infrastructure: coordinated backup systems, cyber resilience, and contingency planning given past outages and cyber incidents.
- Consider central bank liquidity provision (including dollar swap lines) as a targeted tool to break funding feedback loops during episodes of elevated macrofinancial uncertainty.

*Source: CHAPTER 2 RISk ANd RESILIENCE IN ThE GLOBAL FOREIGN ExChANGE MARkET, Global Financial Stability Report, October 2025.*

### CHAPTER 2 RISk ANd RESILIENCE IN ThE GLOBAL FOREIGN ExChANGE MARkET

### CHAPTER 2 RISK AND RESILIENCE IN THE GLOBAL FOREIGN EXCHANGE MARKET

### Market structure and recent expansion
- Average daily trading volumes in the global FX market have increased fivefold since the late 1990s.
- Growth has been driven by FX swap and spot transactions; FX swap activity has risen notably in recent years, reflecting increased NBFI participation.
- A majority of FX swaps are short duration, typically with tenors up to three months.
- The US dollar remains the dominant trading currency in spot and swap markets.
  - About one-fourth of transactions involve the euro against the US dollar.
  - One-fifth of transactions involve the Japanese yen.
  - The euro–US dollar share of total transactions has declined from about one-third in 2015, while the share of other currencies relative to the dollar has increased.
- The dollar’s relative importance seemed to have remained stable through May 2025, with no major shift after the US tariff announcements in early April 2025.

### Market participants, concentration, and NBFI role
- A large share of FX transactions takes place between banks.
- Among NBFIs, investment funds dominate FX trading, driven by portfolio diversification and risk management needs.
- Banks remain central to the FX ecosystem and are highly interconnected with other market participants; banks in major economies, especially the United States, form the core of the global FX network.
- Dealer bank concentration varies across currency pairs:
  - Euro–US dollar transactions are intermediated by US banks and banks in France, Germany, and the United Kingdom.
  - Yen–US dollar transactions are predominantly facilitated by banks in Japan and the United States.
  - Dealer concentration is higher in swap markets with longer tenors.
- NBFI trading activity:
  - The median share of NBFIs in FX trading activity has averaged about 8 percent over the past decade.
  - For some currency pairs, such as euro–US dollar, NBFI participation has exceeded 15 percent in recent years.
  - NBFIs’ hedging of currency exposures, measured by net FX swap positions against the US dollar, has generally been on an increasing trend and appears positively correlated across major currencies (a synchronized “hedging pressure”).

### Transmission channels: liquidity, hedging costs, and asset prices
- A wider cross-currency basis implies a higher cost of hedging FX risk embedded in long positions of US-dollar-denominated assets, prompting institutions to reduce their hedge ratios and take on greater FX risk.
- As hedging costs rise, institutions may:
  - Reduce hedge ratios and assume greater FX risk.
  - Increase holdings of safer and more liquid assets (self-insurance), raising demand for sovereign bonds—particularly short-duration bonds in countries with stronger fiscal fundamentals—and exerting downward pressure on bond yields.
- Capital and leverage constraints matter:
  - When risk-weighted capital requirements become more binding, institutions may shift toward safer assets, increasing demand for sovereign bonds that typically carry zero risk weights.
  - When leverage constraints tighten, FX market stress is more likely to push local currency sovereign bond yields higher, as institutions face broader funding pressures.
- Spillovers to other asset markets occur when leveraged investors and intermediaries (hedge funds, pension funds, insurers) unwind positions as hedging costs rise, amplifying volatility across asset classes.
- Excess exchange rate return volatility can:
  - Increase uncertainty around asset valuations and macroeconomic outcomes.
  - Undermine investor confidence and prompt portfolio rebalancing away from riskier assets.
  - Tighten banks’ balance sheet constraints and potentially reduce domestic credit provision, reinforcing feedback between FX market stress and broader financial instability.

### Operational resilience and systemic risk
- Operational disruptions (trading platform outages, messaging systems, payment and settlement infrastructure) can delay trade execution and settlement, increase market illiquidity and counterparty risk, and amplify volatility.
- The global FX market’s decentralized structure and substitutability across platforms have so far meant disruptions to individual platforms have not been systemic; however, simultaneous outages across multiple platforms (for example, from cyber incidents or power outages) could trigger systemic stress by cutting off access to liquidity and risk management tools.
- Prolonged disruptions to payment systems and settlement infrastructures—examples cited include CLS; TARGET2; Fedwire; and the Clearing House Automated Payment System—are inherently more disruptive and require robust safeguards and backup arrangements to contain systemic risks.

### Macrofinancial uncertainty, safe-haven flows, and trading dynamics
- Nonresident NBFIs typically increase holdings of safe haven assets during periods of elevated macrofinancial uncertainty:
  - Net purchases of US dollars in both spot and swap markets tend to rise with spikes in the VIX or the US EPU index.
  - Net spot purchases of other safe haven currencies (euro, Swiss franc) by nonresident NBFIs also react strongly to these shocks.
- In the April 2025 US tariff episode:
  - Nonresident NBFIs increased purchases of safe haven assets.
  - Overall net spot purchases of US dollars by non-US banks and non-US NBFIs were relatively subdued compared with previous episodes such as the 2020 COVID-19 shock.
  - Demand for US dollar swaps by non-US NBFIs rose sharply, suggesting a shift to hedge previously unhedged exposures.
  - Despite the shock magnitude, stress in the FX market remained limited with no major disruption.
- Empirical findings on uncertainty shocks:
  - The analysis considers uncertainty measures including the VIX (financial market volatility), MOVE (monetary policy uncertainty), and the EPU index (economic policy uncertainty).
  - Effects of uncertainty shocks are particularly pronounced after large shocks to the VIX or the MOVE index, defined as unexpected changes exceeding two standard deviations.
  - Uncertainty shocks of the magnitude observed during episodes like the 2020 COVID-19 turmoil can raise weekly spot trading growth by up to 24 percentage points.
  - NBFIs, particularly investment funds, respond more strongly to global uncertainty shocks than banks or nonfinancial firms:
    - After a spike in the VIX or the MOVE index, weekly growth rates in trading volumes of nonresident NBFIs rise by about 40 percentage points, on average.
    - Dealer and nondealer banks’ weekly growth rates rise by about 15 percentage points.
  - These sectoral asymmetries may reflect NBFIs’ greater exposure to market-driven risks and heavier reliance on market funding and collateralized borrowing, making them more vulnerable to asset price volatility and margin calls.

*Italic: Source — CHAPTER 2 RISK AND RESILIENCE IN THE GLOBAL FOREIGN EXCHANGE MARKET, text - CHAPTER 2 RISk ANd RESILIENCE IN ThE GLOBAL FOREIGN ExChANGE MARkET*

### 1. Net US Dollar Spot Flows versus VIX and EPU, 2015:M1–2025:M5

### 1. Net US Dollar Spot Flows versus VIX and EPU, 2015:M1–2025:M5

### Uncertainty shocks and spot US dollar flows
- After a spike in macrofinancial uncertainty, demand for US dollars among nonresident institutions, especially NBFIs, tends to rise.
- A VIX shock raises FX swap activity by about 5 percentage points among banks and nearly twice as much among NBFIs.
- The response to MOVE shocks is weaker in regressions that include the term-spread differential as a control.
- Short-dated (below seven days) swaps are mainly used by banks and money market desks to square books, fund inventories, or arbitrage rate differentials; these flows roll over daily and serve intraday liquidity needs.
- Longer-dated transactions (those of more than seven days) show a stronger response to uncertainty, indicative of hedging activity.

### FX swap flows, hedging, and balance-sheet drivers
- Hedging behavior is driven by FX exposures and currency mismatches:
  - Countries whose banks have larger dollar funding gaps tend to exhibit stronger responses to uncertainty shocks.
  - Net international investment positions in the dollar help explain cross-country differences in hedging behavior, as US and non-US investors often face opposing hedging needs.
- The banking sector’s US dollar FX mismatch is measured as the ratio of dollar-denominated assets minus dollar-denominated liabilities, normalized by dollar-denominated assets.
- The dollar net investment position is the difference between foreign holdings of US long-term debt and US holdings of foreign long-term debt, scaled by total outstanding holdings of long-term debt.

### Effects of uncertainty shocks on FX market conditions
- Uncertainty shocks widen CIP deviations, increase excess exchange rate return volatility, and widen bid-ask spreads:
  - A one-standard-deviation increase in global macrofinancial uncertainty indicators widens the three-month basis by up to 13 basis points over a week.
  - Weekly excess exchange rate return volatility increases by about 5–10 basis points in response to shocks to the VIX, EPU, and MOVE indices.
  - Bid-ask spreads widen by 1–3 basis points in response to these shocks, equivalent to about half a standard deviation on average.
- The standard deviation benchmarks used in the analysis:
  - CIP deviations: about 40 basis points.
  - Excess exchange rate return volatility: 0.3 percentage point.
  - Bid-ask spreads (normalized by the mid-rate): 0.06 percent.
- Large uncertainty shocks (those exceeding twice the standard deviation) produce disproportionately larger effects, indicating a nonlinear response.
- Effects are larger and more persistent for emerging market currencies:
  - Cross-currency bases and bid-ask spreads widen, on average, more than twice the amounts estimated for advanced economies.
  - Estimated effects on excess exchange rate return volatility also increase notably for emerging markets.

### Market fragilities that amplify shock transmission
- Banking sector FX mismatches and cross-currency funding gaps amplify CIP deviations and volatility when the cross-currency funding ratio (CCFR) is large (above the sample median).
- Hedging pressure from NBFIs tightens synthetic dollar funding conditions and amplifies deviations from CIP.
- Dealer concentration (high Herfindahl-Hirschman Index) and a large NBFI share in a currency’s trade raise excess exchange rate return volatility by reducing competition and market depth, increasing transaction costs, and limiting the market’s capacity to absorb shocks.
- Dealer balance sheet constraints matter:
  - Stronger capital ratios of primary dealer banks are associated with greater capacity to supply derivatives and absorb risk.
  - Stronger capital positions help mitigate the effects of uncertainty shocks by reducing CIP deviations and excess exchange rate return volatility.

### Role of policy backstops and reserves
- Federal Reserve US dollar liquidity swap lines are highly effective in easing dollar funding stress and stabilizing FX swap markets:
  - Newly activated swap lines reduced CIP deviations by up to 30 basis points, nearly offsetting the entire impact of the initial VIX shock, and significantly lowered excess exchange rate return volatility.
- International reserves act as a stabilizing force during stress episodes:
  - Economies with stronger reserve buffers—about one standard deviation above the average—experience notably smaller CIP deviations and lower excess exchange rate return volatility following macrofinancial uncertainty shocks.

*International Monetary Fund | Global Financial Stability Report: Shifting Ground Beneath the Calm (October 2025).*

### 1. Effect of an Increase in Uncertainty on CIP Deviation Relative to

### 1. Effect of an Increase in Uncertainty on CIP Deviation Relative to the US Dollar Conditional on Banks’ FX Mismatch

### Effects on CIP deviations and excess exchange rate return volatility
- Figures report effects of one-standard-deviation increases in each uncertainty indicator and high-uncertainty shocks on three-month overnight index swap covered interest parity (CIP) deviations and excess exchange rate return volatility over a one-week horizon.
- Large uncertainty (VIX or US EPU index) shocks are represented as dummy variables equal to 1 when the first-order autoregression residuals of the underlying indices are two standard deviations above average.
- CCFR measures a country’s banking sector’s US dollar mismatch as the difference between its US dollar assets and US dollar liabilities, divided by US dollar assets, using quarterly Bank for International Settlements data.
- “Additional effect” refers to the additional impact of uncertainty shocks when vulnerabilities are one standard deviation above their averages.
- Hedging pressure measures the net hedging activity of NBFIs and is calculated as the difference between their aggregate short and long FX swap (forward) positions, scaled by the global average of outstanding US dollar contracts.
- HHI is the sum of the squared market shares of all bank dealers. “Share of NBFIs” captures the proportion of non-interdealer swap market activity accounted for by NBFIs.
- The three vulnerability measures are computed for each currency area. Whiskers show the 90 percent confidence intervals.

### Key numeric signals shown in figure annotations (exact values from charts)
- CIP deviation axes: −40, 10, −30, −20, −10, 0 (basis points).
- Excess exchange rate return volatility axes: −0.05, 0.20, 0, 0.05, 0.10, 0.15 (percentage points).
- Observed qualitative result: “Increased NBFI hedging activity amplifies the effect of financial uncertainty on CIP deviation …”
- Observed qualitative result: “… whereas dealer concentration and greater participation of NBFIs in a currency’s trading amplify excess exchange rate return volatility.”

---

### Dealers’ Constraints and Foreign Exchange Market Conditions

### Dealers’ capital ratio interaction with uncertainty shocks
- Figures show effects of one-standard-deviation increases in the VIX and the US EPU index and their associated uncertainty shocks on FX market conditions, along with mitigating effects of a proxy of dealer balance sheet strength.
- Dealer balance sheet strength is proxied by the capital ratio of primary dealer banks from He, Kelly, and Manela (2017).
- Whiskers show the 90 percent confidence intervals.
- CIP deviation axes in the figure: −30, 40, −20, −10, 0, 10, 20, 30 (basis points).
- Excess exchange rate return volatility axes in the figure: −0.3, 0.1, −0.2, −0.1, 0 (percentage points).
- Qualitative findings:
  - “A higher capital ratio boosts dealers’ capacity to supply FX liquidity, limiting CIP deviation ...”
  - “… whereas a lower ratio limits dealers’ willingness to intermediate, worsening FX market conditions.”

---

### Policy Mitigating Factors: FX Swap Lines

### Effectiveness of swap lines
- Figures show the effects of a one-standard-deviation increase in the VIX and the US EPU index and their associated uncertainty shocks on FX market conditions, along with the mitigating effects of policy backstops like new central bank swap lines.
- Large uncertainty (VIX or US EPU) shocks are represented as dummy variables equal to 1 when the first-order autoregression residuals of the underlying indices are two standard deviations above the average.
- Currencies in the sample with new swap lines are the Danish krone, the Norwegian krone, the Singapore dollar, and the Swedish krona.
- Whiskers show the 90 percent confidence intervals.
- CIP deviation axes in the figure: −50, 50, −40, −30, −20, −10, 0, 10, 20, 30, 40 (basis points).
- Excess exchange rate return volatility axes in the figure: −0.3, 0.3, −0.2, −0.1, 0, 0.1, 0.2 (percentage points).
- Qualitative findings:
  - “FX swap lines help reduce CIP deviations ...”
  - “… and lower excess exchange rate return volatility.”

---

### Spillovers of FX Market Stress to Other Asset Classes

### Empirical spillover findings
- A widening of cross-currency bases triggers a flight-to-quality that compresses local currency sovereign bond yields and reduces stock prices.
- A one-standard-deviation widening (about 25 basis points) reduces longer-term sovereign bond yields by about 25 basis points, with effects lasting up to three months.
- Shorter-term yields fall even more sharply, reflecting increased demand for less interest-rate-sensitive assets.
- A one-standard-deviation widening tightens financial conditions by 0.4 to 0.7 standard deviations over the following year.
  - This tightening is about half the tightening observed during the dash-for-cash episode induced by COVID-19 in March 2020.
- Transmission is amplified by vulnerabilities such as currency mismatches on balance sheets or elevated public debt:
  - In economies with low FX mismatches, the effect of cross-currency basis widening is negligible.
  - In economies with high FX mismatches, a one-standard-deviation shock can tighten financial conditions by as much as two standard deviations.
- Fiscal vulnerabilities amplify effects on sovereign yields:
  - The effect of cross-currency basis widening on five-year sovereign bond yields is greater for economies with high public debt relative to GDP.

### Methodology notes (exact descriptions from source)
- Analysis employs panel regressions and a granular instrumental variables approach.
- Cross-currency bases are instrumented with variables that capture idiosyncratic shocks to demand for dollar funding in the FX swap market for three different tenors (less than 7 days, between 7 and 35 days, and more than 35 days).
- Cross-currency basis and idiosyncratic demand shocks are standardized for each currency and tenor.
- Shaded areas represent 90 percent confidence intervals, obtained using Driscoll-Kraay standard errors, with the number of lags equal to 4 T, in which T denotes the number of time periods in the sample.
- Specifications include time and currency effects. Currencies in the sample: the euro, the Japanese yen, the British pound, the Swiss franc, the Canadian dollar, the Australian dollar, the New Zealand dollar, the Swedish krona, and the Norwegian krone, trading against the US dollar.

---

### Conclusion and Policy Recommendations

### Key conclusions (exact language preserved)
- The global FX market reacts strongly to macrofinancial shocks despite its deep liquidity.
- Heightened risk aversion tends to increase demand for safe assets, straining FX market and funding liquidity conditions, particularly in emerging markets.
- Structural vulnerabilities—high dealer concentration, growing role of NBFIs, intensified FX hedging and funding pressures—can amplify these effects.
- Operational disruptions in FX market infrastructure can restrict trading and impair liquidity, exacerbating market stress.
- FX settlement risk remains a material concern, particularly for economies that cannot access robust risk mitigation infrastructure.
- The adoption of simultaneous settlement systems, such as PvP platforms, significantly reduces excess FX returns and volatility and can thereby reduce settlement uncertainty and currency risk premiums.

### Policy recommendations (grouped and verbatim in emphasis)
- Strengthening Surveillance to Monitor Systemic Risk Arising from FX Market Stress
  - Adopt a more structured surveillance approach to better capture FX market vulnerabilities and their potential to disrupt macrofinancial stability.
  - Enhance FX liquidity stress tests to assess sectoral resilience to funding shocks and sudden tightening in spot and swap market conditions.
  - Incorporate scenarios involving heightened volatility, wider bid-ask spreads and cross-currency bases, and FX market vulnerabilities into systemwide stress tests.
  - Monitor and mitigate rollover and liquidity risks from short-tenor FX swap positions.
  - Use scenario analysis to evaluate the impact of operational disruptions (severe and persistent technical failures, cyberattacks, physical disasters, defaults by major FX dealers) and the availability of contingency measures.
  - Close data gaps on bilateral exposures, settlement practices, intraday trading, and counterparty concentrations via enhanced regulatory reporting and improved data sharing.

- Ensuring Adequate Capital and Liquidity Buffers at Financial Institutions, Supported by a Robust Crisis Management Framework
  - Ensure financial institutions with a dominant and systemic role in FX markets maintain adequate hedges and capital and liquidity buffers.
  - Strengthen access to intraday central bank liquidity and credit facilities, including for NBFIs, alongside stronger regulatory and supervisory oversight to limit moral hazard.
  - Effectively monitor and manage liquidity risks in significant currencies.
  - Maintain sufficient international reserve buffers in economies relying heavily on external financing.
  - Strengthen and expand the network of central bank swap lines as global FX liquidity backstops.
  - Recognize the IMF’s lending toolkit as part of the global financial safety net to support countries facing FX liquidity pressures.
  - Manage systemic risk with a policy action mix in line with the IMF’s Integrated Policy Framework, including FX intervention and macroprudential and capital flow management measures calibrated to country-specific conditions.

- Adequate Management of Operational and Settlement Risk
  - Financial market infrastructures should identify plausible sources of operational risk and implement robust systems, policies, and procedures in line with the Principles of Financial Market Infrastructures (BIS-CPSS-IOSCO 2012).
  - Implement comprehensive business continuity planning, cyber resilience frameworks, and regular testing of contingency arrangements.
  - Financial institutions should adopt comprehensive operational risk management practices addressing vulnerabilities in technology, processes, and third-party dependencies.
  - Reduce FX settlement risks via wider adoption of PvP arrangements; interim dealer arrangements include “pre-settlement netting” and “on-us” settlement.
  - Strong anti-money laundering/combating the financing of terrorism measures should be implemented to reduce settlement uncertainty.
  - Policy initiatives leveraging digital technologies (linking faster payment systems, developing cross-border central bank digital currency) could help address settlement risk if properly designed.
  - Empirical note: CLS’s netting process typically reduces funding requirements by approximately 96 percent.

*International Monetary Fund | October 2025*

### CHAPTER 2 RISk ANd RESILIENCE IN ThE GLOBAL FOREIGN ExChANGE MARkET

### CHAPTER 2 RISk ANd RESILIENCE IN ThE GLOBAL FOREIGN ExChANGE MARkET

### FX Market Dynamics around the April 2, 2025 US Tariff Announcement
- Event and immediate market reaction
  - On April 2, 2025, the United States announced increased tariff rates on imports.
  - Measures of financial uncertainty like the Chicago Board Options Exchange Volatility Index spiked, and the broad US dollar index depreciated by about 2 percent on impact.
  - Market volatility eased after the suspension of some tariffs on April 9, but the dollar continued to weaken.
- Spot and swap trading activity (CLS settlement data)
  - Spot dollar purchases by nonresident investors rose notably ahead of April 2, increasing by about $265 billion on a net basis between January 1 and April 1.
  - Following the tariff announcement, spot purchases continued to rise through mid-April but have since declined; as of the end of May, cumulative net spot purchases remained broadly stable.
  - Cross-country patterns:
    - Canada was a net buyer of spot dollars from November 2024 through mid-April 2025 but shifted to net selling thereafter.
    - Spot dollar sales on a net basis by major euro area countries increased after April 2.
  - Sector patterns:
    - Most of non-US institutions’ activity around the tariff episode was driven by nonbank financial institutions, contrasting with the COVID-19 market turmoil in March 2020, when banks dominated FX trading.
- Swap/hedging activity and implications
  - The FX swap activity of non-US nonbank investors against the US dollar increased notably after the April 2 tariff announcement.
  - Hedging demand from these investors—which involves selling US dollar forward contracts—has been stronger and more persistent compared with the COVID-19 shock.
  - Although the overall cumulative change in swap positions has been only slightly larger than that of the COVID-19 episode, combined with muted net spot dollar purchases, this may have contributed to US dollar depreciation pressure during April and May.
  - Cumulative swap flows shown in the analysis should not be interpreted as net mark-to-market positions because they do not account for maturity and refinancing activities and record flows using forward rates fixed at the time of contract.

*Key contextual notes from the box*
- Net purchases of other safe haven currencies, such as the euro and Japanese yen, rose notably after April 2, exceeding levels observed during the COVID-19 turmoil.
- As Canada became net sellers of US dollars during this period, the country appeared to shift toward the euro, and major euro area countries moved toward the yen.

*Figure/Index references (as presented in source)*
- VIX and Nominal Broad USD Index plotted January 2, 2025, to May 15, 2025, showing the April 2 tariff announcement date and market moves.

---

### The Relevance of FX Settlement Risk and PvP Mechanisms
- Nature and consequences of settlement (Herstatt) risk
  - FX settlement risk (Herstatt risk) arises when one party delivers the currency it sold but fails to receive the currency it bought, which can trigger liquidity pressures, credit losses, and systemic disruptions during stress.
  - Settlement risk remains a concern, particularly in emerging market and developing economies that often lack access to simultaneous settlement mechanisms like payment-versus-payment (PvP) systems and rely more on correspondent banking relationships and heterogeneous payment/legal frameworks.
- Historical episodes illustrating persistence of settlement risk
  - Bankhaus Herstatt failure on June 26, 1974, motivated multilateral regulatory responses.
  - In 2008, Kreditanstalt für Wiederaufbau transferred €300 million (equivalent to $426 million at the time) to Lehman Brothers on the morning of Lehman’s bankruptcy filing but never received the corresponding payment, resulting in a unilateral loss.
  - In March 2020, Barclays suffered a $129 million FX loss when its counterparty, UAE Exchange, failed to deliver the currency owed amid COVID-19-related market stress.
- Risk mitigation developments and remaining gaps
  - Key mitigation approaches: presettlement netting and simultaneous settlement mechanisms (PvP and on-us settlement, with “on-us with loss protection” offering protection if settlement occurs simultaneously or within preauthorized credit lines).
  - Establishment of CLS in 2002 as a multicurrency PvP system substantially reduced counterparty risk by ensuring simultaneous settlement across time zones and currencies.
  - International standard-setting bodies and frameworks (Basel Committee, CPMI–IOSCO, Global Foreign Exchange Committee, FX Global Code) have issued guidelines to strengthen legal certainty, settlement finality, and adoption of PvP mechanisms.
  - Despite progress, about 25 percent of the deliverable turnover of currencies is without risk mitigation mechanisms (Glowka and Nilsson 2022).

- Empirical evidence that PvP reduces settlement risk premiums
  1. Hungary’s accession to CLS (natural experiment)
     - Hungary’s forint joined CLS on November 16, 2015.
     - A difference-in-difference analysis using the Czech koruna and Polish zloty as benchmarks shows CLS entry led to:
       - A decline in average daily excess exchange rate returns of about 11 basis points (bps) in the one-month window before and after accession.
       - A decline in volatility of about 3 bps over the same window.
     - The average excess returns over the month before CLS accession were about 28 bps, suggesting CLS participation eliminated this excess return.
  2. Panel analysis (January 2000 to May 2025)
     - Analysis across 26 currencies (including 16 settled through CLS and 4 with other PvP arrangements: Brazil, India, Malaysia, Thailand) shows:
       - CLS participation is associated with a significant decline of 34 bps in excess FX returns, on average.
       - CLS participation is associated with a decline of 3 bps in volatility, on average.
     - These results support the view that PvP systems contribute to global FX market stability by lowering settlement risk and associated risk premiums.

*Analytical notes*
- Currencies settled through other PvP arrangements include the B3 Foreign Exchange Clearinghouse (Brazil), the Clearing Corporation of India Limited’s Forex Settlement, and the Hong Kong–based Clearing House Automated Transfer System.

---

### Operational Resilience: Effects of Trading Venue Outages (EBS and FX Matching Case Study)
- Role of primary trading venues and the interdealer market
  - Core FX network overlaps with the interdealer market; primary market venues (notably Electronic Broking Services and London Stock Exchange Group’s FX Matching) are central to price formation and liquidity provision.
  - Despite growth in the number and types of FX trading venues over two decades, core liquidity and price discovery in the interdealer segment remain concentrated in a few venues, notably EBS and FX Matching.
- Case study outages and methodology
  - EBS experienced an outage in 2023; FX Matching had a disruption in 2015. Both outages occurred during London–New York session overlap, a period of high liquidity.
  - Analysis examines spot and forward bid-ask spreads and trading volumes for currencies primarily traded on affected platforms versus others, using outages to isolate interdealer-market disruption effects.
- Empirical findings on liquidity and transaction costs
  - During the outages, the cost of FX transactions, as measured by bid-ask spreads, increased in the spot and swap markets for affected currencies.
  - Spot market trading volumes on days of the outages declined by $2.8 billion, on average, across affected currencies (all dollar volumes adjusted for inflation and expressed in December 2024 US dollars).
  - Instrumental-variable analysis using outages as instruments implies a $1 billion decrease in trading volume is associated with a 0.3 basis point widening of bid-ask spreads in the spot market.
    - (Related literature estimates translate to an increase of 0.2–1.1 basis points for a decrease of $1 billion in forecastable futures trading volume for several major currencies between January 1979 and December 1992.)
  - Price impact/liquidity depth deterioration:
    - Trading volume required to move daily FX returns by one standard deviation (about 3.4 percent) declines from $19.2 billion to $18.6 billion for affected currencies during outages.
  - The deterioration of market liquidity is also reflected in an increase of about 0.2 standard deviations (about 11 percent) in market illiquidity measures during outages.

*Interpretation and potential implications*
- Operational disruptions at core venues can raise inventory holding costs for dealer banks, widen bid-ask spreads, reduce volumes, and make price discovery less efficient.
- Larger drops in trading volumes because of more severe incidents (prolonged outages or simultaneous disruptions across multiple venues) could lead to more pronounced widenings of bid-ask spreads and greater liquidity impairment.

---

*Italicized source attribution: CHAPTER 2 RISk ANd RESILIENCE IN ThE GLOBAL FOREIGN ExChANGE MARkET, text - CHAPTER 2 RISk ANd RESILIENCE IN ThE GLOBAL FOREIGN ExChANGE MARkET, International Monetary Fund | October 2025*

### Box 2.3. Implications of Operational Disruptions in Foreign Exchange Markets

### Box 2.3. Implications of Operational Disruptions in Foreign Exchange Markets

### Effects on market liquidity for affected currencies
- Outages on interdealer platforms reduce liquidity for currencies primarily traded on the platform (Figure 2.3.1, panel 1).
- Measures impacted:
  - Spot bid-ask spread (sampled at 30-minute intervals).
  - Forward bid-ask spread (sampled at 30-minute intervals).
  - Realized illiquidity (constructed at a daily frequency).
  - Price dispersion (constructed at a daily frequency).
- Definition of key metrics:
  - “Realized illiquidity,” defined as in Ranaldo and Santucci de Magistris (2022), refers to the ratio of the realized absolute variation of intraday returns to the volume of transactions in billions of US dollars and measures the price impact of trading volume.
  - Price dispersion is the coefficient of variation of transaction prices for each pair of currencies traded across different counterparty sectors.

### Spillovers to other venues and broader transaction-cost effects
- Outages raised transaction costs in the spot and swap markets across all currencies, including those mainly traded on venues that remained operational (Figure 2.3.1, panel 2).
- Evidence consistent with liquidity spillovers resulting from migration of trading from affected platforms to other venues, producing congestion and strained liquidity conditions.
- Quantified changes in bid-ask spreads during outages:
  - Bid-ask spreads across all major currency pairs against the US dollar widened, on average, from 3 to 4 basis points in the spot market.
  - Bid-ask spreads widened, on average, from 4 to 5 basis points in the swap market.

### Economic magnitude and stability implications
- The increase in transaction costs is characterized as economically moderate but indicates that even relatively short-lived outages of trading platforms can materially affect FX market liquidity.
- Implication: resilient infrastructures and intermediaries are important to safeguard against more severe operational disruptions that could pose risks to financial stability.

### Empirical approach and sample details
- Estimation:
  - Bars in the figure represent estimated coefficients from panel regressions of the outcome variables on an indicator variable for platform outage.
  - Panel 1 specification: indicator = 1 during a platform outage only for the currencies traded primarily on the platform and 0 otherwise; includes time and currency-year effects.
  - Panel 2 specification: indicator = 1 during a platform outage for all currencies; includes currency-year effects.
  - Specifications for the bid-ask spreads also include currency–time of day–year effects.
- Sampling and standardization:
  - Bid-ask spreads are sampled at 30-minute intervals, whereas the other measures are constructed at a daily frequency.
  - The sample period covers the day of each outage as well as 90 days before and after.
  - All the measures are standardized separately in each of the two 181-day windows and for each currency traded on the platform.
- Currency sample:
  - The currencies in the sample are the euro, the Japanese yen, the British pound, the Swiss franc, the Canadian dollar, the Australian dollar, the New Zealand dollar, the Swedish krona, and the Norwegian krone, trading against the US dollar.
- Inference:
  - Error bars represent 90 percent confidence intervals, obtained using Driscoll-Kraay standard errors, with the number of lags equal to 4 T , in which T denotes the number of time periods in the sample.

*Source: Box 2.3. Implications of Operational Disruptions in Foreign Exchange Markets, Chapter 2, Global Financial Stability Report, International Monetary Fund, October 2025.*

### Annex 3.2 for the full list).

### Annex 3.2 for the full list

### Overview and focus
- EMDEs have experienced significant outflows from their domestic local currency bond markets (LCBMs) during global shocks (example: the 2013 “taper tantrum”).
- Governments have two main options to fund increased debt issuance: find more resident buyers for local currency debt or continue to rely on foreign-currency-denominated sovereign bond issuance or external loans.
- This chapter focuses on LCBMs and uses a newly compiled data set of government debt issued in domestic markets in 56 EMDEs, broken down by investor type, which constitutes over 90 percent of local currency government debt outstanding in EMDEs.
- Major aims of LCBM development highlighted:
  - Reduce currency mismatch and sudden stop risks by anchoring financing in local currency.
  - Limit losses and spillovers to domestic investors in the event of domestic debt restructuring.

### Framework for assessing EMDE sovereign debt markets
- Framework components:
  - Debt absorption capacity (domestic savings and market infrastructure).
  - Resident share of sovereign debt (composition of investor base: nonresidents, banks, NBFIs, central bank).
- Two core financial stability objectives for sovereign issuers:
  - Expand local currency issuance to domestic investors to reduce currency mismatch and risk of capital outflows.
  - Minimize risks to domestic financial institutions by building a larger and more diverse share of resident buyers willing and able to hold local currency government bonds.
- Four broad outcomes from interaction of absorption capacity and resident share:
  - High absorption capacity + high resident share: insulated from global shocks; strong asset-liability matching; risk of greater exposure to local shocks and potential crowding out.
  - Low absorption capacity + high resident share: financial repression and sovereign-bank nexus risks.
  - High absorption capacity + low resident share: potential asset bubbles in other local markets.
  - Low absorption capacity + low resident share: reliance on foreign borrowing, greater vulnerability to sudden stops and debt sustainability risks.
- Resilience depends on:
  - Macroeconomic factors (monetary and fiscal credibility).
  - Deep, liquid sovereign debt markets with a diverse domestic buyer base and high absorption capacity.

### Recent trends in EMDE sovereign debt markets — key statistics and patterns
- Government debt in EMDEs has been rising rapidly since 2010, reaching close to $30 trillion (nearly $12 trillion excluding China).
- The median debt-to-GDP ratio reached close to 60 percent of GDP.
- Gross financing needs are forecast to ease slightly but remain above prepandemic levels for many economies.
- Currency composition:
  - Major emerging markets (a minority of the broad sample) have more than two-thirds of total government debt in local currency and have avoided large net foreign currency issuance since 2010.
  - Other emerging and frontier markets still rely significantly on foreign currency debt amid less developed LCBMs.
- Sample and data notes:
  - Panel 1 includes the maximum sample of 56 countries.
  - Panel 2 includes a subset of 45 countries based on data availability.
  - Panel 3 includes only countries where general government debt as a percentage of GDP increased between 2010 and 2024.
  - “Major EMs” are Brazil, China, Colombia, Hungary, India, Indonesia, Malaysia, Mexico, the Philippines, Poland, South Africa, and Thailand.

### Market structure, instrument composition, and maturities
- Composition shifts (2010 versus 2024):
  - Major EMs primarily issue in local currency in domestic markets.
  - Other EMs and frontier markets rely more on international bonds and external loans, respectively.
- Marketable debt instrument composition (2010–25): domestic marketable, domestic non-marketable, external marketable, external non-marketable; shares vary by group.
- Major EMs have been able to issue greater amounts of longer-term local currency bonds, while other EMs and FMs issue more short-term securities and foreign currency bonds.
- Average time to maturity:
  - For major emerging markets, the average time to maturity of debt reached seven years in 2024.
  - Many frontier markets have significantly extended maturities since 2010, though some saw average interest cost on domestic debt portfolios rise significantly.
- Carrying costs and growth:
  - In several economies, the real interest rate on outstanding domestic bonds exceeds projected real GDP growth over the next five years, suggesting net real carrying cost of domestic debt may impose fiscal burdens in the years ahead.

### Investor behavior and sensitivity to global shocks
- Weak returns in LCBMs over the past decade—driven largely by continuing dollar strength—have made them less appealing to global investors benchmarked to US dollar assets.
- Portfolio flows to LCBMs have broadly decelerated over the past 10 years despite a modest uptick in recent periods.
- Empirical results (chapter summary):
  - Greater presence of nonresident investors is associated with greater sensitivity of domestic markets to global shocks.
  - Greater presence of domestic investors—particularly banks—is associated with lower sensitivities to global shocks.
- Caveat: more resident buyers of local currency debt tend to improve resilience to global shocks, but overreliance on domestic buyers can create vulnerabilities.

### Vulnerabilities: absorption capacity and the sovereign-bank nexus
- Rapid expansion of LCBMs without adequate absorption capacity and strong macro anchors can lead to:
  - Overreliance on captive investors (banks and central banks).
  - Financial repression and crowding out of private credit.
  - Sovereign-bank nexus risks where domestic debt restructuring can impose disproportionate losses on domestic banks and financial institutions, threatening systemic stability and transmitting sovereign stress across the economy.
- Empirical and historical cases: several EMDEs have resorted to domestic debt restructuring because of unsustainable public debt burdens (examples cited include Argentina, Ghana, Jamaica, Sri Lanka).

### Policy guidance for developing resilient LCBMs
- LCBM development objectives and required elements:
  - Improve macroeconomic fundamentals (raise domestic financial savings; ensure stable macrofinancial environment).
  - Develop foundational market infrastructure: money markets, primary markets, secondary markets.
  - Provide legal certainty and sustained efforts to deepen the investor base through sound debt management practices and market communication.
  - Build a larger and more diverse resident investor base with sufficient absorption capacity to hold increased local currency issuance.
- Risks of neglecting market development:
  - Without these elements, efforts to deepen sovereign debt markets often stall, raising financial stability risks from poor price discovery, shallow liquidity, and excessive reliance on banks and public institutions to absorb government debt.
- Use of IMF and World Bank tools:
  - The chapter draws on findings from the IMF and the World Bank’s LCBM diagnostic framework and broader technical assistance for LCBM development.

*International Monetary Fund | October 2025*

### 2024. Frontier markets like Pakistan also have sizable outstanding

### 2024. Frontier markets like Pakistan also have sizable outstanding 

### Portfolio flows, returns, and recent issuance
- Inflows to local currency debt averaged over 1 percent of GDP in aggregate (excluding China) from 2010 to 2014 but under 0.5 percent of GDP from 2015 to 2024.
- A strong dollar and higher US Treasury yields have played significant roles in curbing flows to LCBMs.
- Total returns on the emerging market local currency bond index have been persistently weak over the past decade, primarily undermined by poor currency returns amid a strong dollar cycle.
- Risk-adjusted returns for emerging market local currency debt have lagged comparable asset classes such as US high-yield corporate bonds.
- Returns on emerging market hard currency bonds have performed somewhat better.
- Net international sovereign bond issuance has continued at a robust pace, with total outstanding debt reaching over $1.4 trillion in 2025 despite outflows of around 20 percent of assets under management from dedicated emerging market hard currency funds since 2022.

### Changes in investor base and domestic absorption
- The nonresident share of local currency debt peaked nearly a decade ago for many emerging markets, with the decline accelerating after the pandemic.
- The decline in nonresident share generally reflects a significant increase in net issuance alongside tepid inflows, rather than large outflows, outside select cases.
- Domestic bank ownership has generally been steady over time, with a median ownership share of close to 30 percent across countries.
- NBFIs have increased their presence in a number of markets; among countries with a significant NBFI investor base, the sector is primarily composed of long-term buyers such as pension funds and insurance companies.
- In a limited number of countries (Brazil, Mexico, and South Africa), mutual and investment funds hold more than 10 percent of government bonds.

### Local market stress, stabilizing roles, and regression findings
- LCBMs experienced periods of heightened stress during the COVID-19 pandemic in 2020 and later in 2022; greater participation by domestic NBFIs appears to have coincided with the normalization of market functioning during the 2022 episode.
- Regressions show that increased resident bank holdings are associated with a decline in the transmission of global shocks to LCBMs; nonresident presence is associated with an amplification of such pressure.
- Quantified effects of a 10-percentage-point increase in the VIX:
  - When nonresident ownership of local currency bonds is at the cross-country average level of 22 percent, a 10-percentage-point increase in the VIX is associated with a 19 basis point increase of the five-year local currency yield spread and a 0.7 basis point increase in the bid-ask spread.
  - If nonresident ownership increases by one standard deviation (to 34 percent), the sensitivity rises to 23 basis points for yield spreads and 0.9 basis point for bid-ask spreads.
  - A one-standard-deviation increase in ownership by resident banks from the average of 29 percent to 44 percent is associated with dampening of sensitivity of yield spreads from 19 to 11 basis points and of bid-ask spreads from 0.8 to 0.7 basis points.
- Relevance for investors and liquidity:
  - Average monthly change in emerging market yield spreads is approximately 1.4 basis points; a 4 basis point increase in yield spreads—based on a 34 percent nonresident ownership and a 10-percentage-point increase in VIX—represents nearly three times the typical monthly movement.
  - Average monthly change in bid-ask spreads is about 0.02 basis points; an impact of 0.1 to 0.2 basis points is about 5 to 10 times the average movement.
- The role of resident NBFIs is heterogeneous:
  - Increased NBFI holdings do not statistically alter the impact of a VIX shock on yield spreads in the full sample but are associated with attenuation of the shock’s impact on bid-ask spreads.
  - In emerging Asia, where pension funds and insurers dominate NBFI holdings, increased NBFI participation is accompanied by attenuation of VIX shock impacts.
  - In Latin America (notably Brazil and Mexico), where mutual funds play a larger role, larger NBFI presence does not appear to have the same stabilizing effect on yield spreads.

### Nonlinearity, stress periods, and vulnerabilities
- The effect of global shocks on LCBMs is nonlinear and tends to be larger in volatile times and for more indebted economies.
- During periods when the VIX is above its 75th historical percentile, a 10-percentage-point increase in the VIX raises local currency yield and bid-ask spreads by more than in normal periods; amplification and attenuation effects of higher nonresident and resident holdings, respectively, are also larger, particularly for market liquidity.
- Central bank purchases during market dysfunction have reduced market stress in some episodes, but large interventions may increase risks to central banks’ balance sheets and raise issues of policy solvency, operational independence, fiscal dominance, and moral hazard.

*Source: Excerpt from Chapter 3, GLOBAL ShOCKS, LOCAL MARKETS: THE CHANGING LANDSCAPE OF EMERGING MARKET SOVEREIGN DEBT, International Monetary Fund | October 2025.*

### Annex 3.1 shows the results of a specification whereby yearly fixed

### Annex 3.1 — Specification Results and Implications for Local Currency Bond Markets

### Specification and robustness
- Added yearly fixed effects to the regression in both level and interaction terms, in addition to monthly VIX changes; coefficients on the VIX regressors decline in magnitude in this specification, suggesting other global forces may be relevant.
- Regional approach used because of lack of more granular data on types of NBFIs that hold local currency bonds at an economy level.

### Investor composition and the effects of global shocks
- Nonlinearity with government debt size: for economies with debt-to-GDP ratios above the sample median of 47 percent:
  - Domestic bank holdings are associated with smaller pass-throughs of global shocks.
  - Presence of nonresidents is accompanied by larger impacts.
  - Greater nonresident participation is also associated with narrower average yield spreads in these high-debt economies, suggesting a supportive role in reducing financing costs.
- Dynamics and persistence:
  - Effects of global shocks and investor participation on domestic bond markets typically peak within one quarter before gradually receding.
  - A larger nonresident investor share amplifies both the magnitude and the duration of the spread response (see Figure 3.8, panels 1 and 4).
  - Greater domestic bank participation dampens the initial impact and accelerates normalization of spreads, consistent with a stabilizing, market-making role (Figure 3.8, panels 2 and 5).
  - Greater domestic resident NBFI participation does not statistically alter the response of yield spreads to the VIX shock (Figure 3.8, panel 3) but significantly and durably dampens the response of bid-ask spreads, supporting market liquidity (Figure 3.8, panel 6).
- Empirical magnitudes reported in figures:
  - Analysis shows the long-term impact of a 10-percentage-point increase in VIX on five-year yield spreads to US Treasuries and five-year bid-ask spreads.
  - Baseline holding-share averages: nonresidents 22 percent; resident banks 29 percent; resident NBFIs 31 percent.
  - Holding-share increases by 1 standard deviation: nonresidents to 34 percent; domestic banks to 44 percent; domestic NBFIs to 43 percent.
  - Shaded areas in figures represent 90 percent confidence intervals.

### Vulnerabilities: Limited absorption capacity
- Resident investors’ absorption capacity may be waning despite high resident participation being associated with smaller impacts of global shocks.
- Net local currency government bond issuance continues to grow at a pace faster than prepandemic rates in several emerging markets (Figure 3.9, panel 1).
- Large issuance tends to be a significant driver of wider swap spreads; widening of local currency bond yields relative to interest rate swap rates observed in recent months for some emerging markets (Figure 3.9, panel 2).
- NBFI trends and allocations:
  - Financial assets of NBFIs in EMDEs increased by about 11 percent of GDP since 2013, as measured by an equal-weighted average across a selection of 20 economies (Figure 3.9, panel 3).
  - NBFI presence in frontier markets in this sample remains low; frontier markets will continue to rely on banks as main buyers of sovereign debt.
  - On average, NBFIs in emerging and frontier markets hold roughly 22 and 40 percent of their assets in sovereign debt, respectively.
  - Emerging and frontier market pension funds allocate roughly half their assets to fixed-income securities, materially higher than the average advanced economy fixed-income allocation of 30 percent (Figure 3.9, panel 4).
- Implication: For frontier markets, small NBFI sectors and high shares of assets held in sovereign debt indicate some countries could already be in a state of high domestic debt and low absorption capacity.

### Sovereign–bank nexus: recent evolution and risks
- Since 2014, rapid growth in local currency debt issuance has coincided with a growing sovereign–bank nexus, reflected in increased banks’ government debt holdings as a share of total assets (Figure 3.10, panel 1).
- Economies with higher debt burdens tend to have greater concentration of government bonds on banks’ balance sheets (Figure 3.10, panel 2).
- Co-movement of sovereign and bank risk:
  - Monthly data since 2010 indicate that, during stress periods, a one-standard-deviation increase in emerging market sovereigns’ implied default probability rate is associated with around half of a standard deviation rise in banks’ expected default frequency; effect intensifies during extreme stress, reaching near a one-for-one relationship on average for emerging markets (Figure 3.10, panel 3).
- Hypothetical scenario:
  - Using aggregated bank data from 15 emerging markets and 13 frontier markets, a hypothetical domestic debt restructuring event that haircuts local currency bond prices by 40 percent results in more than half of banking sectors seeing regulatory capital ratios fall (simulated impacts reported in Figure 3.10).
- Channels of the sovereign–bank nexus:
  - Direct exposure: banks’ realized losses on large government debt holdings during a fiscal crisis.
  - Safety net: contingent liabilities from implicit government guarantees of the banking system.
  - Macroeconomic: weakening fundamentals can undermine sovereign creditworthiness and erode banks’ asset quality through rising defaults and slower credit growth.
- Additional considerations:
  - State-owned banks often significantly increase sovereign holdings during periods of fiscal stress; among state-owned banks, those with weaker capitalization typically increase sovereign exposures the most, which can erode capital bases and crowd out private sector credit.
  - Rating constraints: banks’ credit ratings are generally constrained by the sovereign’s “country ceiling,” which can transmit sovereign downgrades to banks.

*Italic: Source — Annex 3.1 and related figures and text from the IMF Global Financial Stability Report: Shifting Ground Beneath the Calm (October 2025).*

### 4. Reported and Simulated Capital Ratio in Emerging Market and

### 4. Reported and Simulated Capital Ratio in Emerging Market and Developing Economies

### Bank Capital Vulnerabilities and Simulation Findings
- Reverse simulations indicate banking systems with more than 20 percent of assets in domestic government bonds are unlikely to withstand haircuts of 30 percent or more without breaching the 10 percent regulatory threshold.
- Scenario analysis in Figure 3.10, panel 4, assumes a 40 percent haircut on government bond holdings.
- The simulation that uses a fixed loss-given-default assumption of 40 percent differs from the reverse simulation, which calculates the maximum losses banks can sustain on local currency government bond holdings while still maintaining regulatory ratios above the 10 percent threshold, based on their initial capital ratio.
- Accounting effects alone highlight vulnerabilities in the sampled banking systems and likely understate the full extent of sovereign distress by not considering other amplification channels (credit risk, market risk, liquidity risk).
- Fragilities can be exposed during noncredit risk events, such as an upward shift in local yield curves (market risk) or forced sales during dash-for-cash episodes (liquidity risk).

### Deepening Local Currency Bond Markets (LCBMs): Framework and Scope
- Developing LCBMs requires sound macroeconomic fundamentals, adequate domestic financial savings, a strong policy framework, and robust financial market structure.
- The IMF–World Bank Local Currency Bond Market Framework (2021) evaluates four core building blocks—money markets, primary market issuance, secondary markets, and investor base—alongside two supporting blocks: financial market infrastructure (FMI) and legal-regulatory systems.
- This section applies the LCBM framework to assess market structure in 37 EMDEs with sizable LCBMs.
- Economies are grouped as “major emerging markets,” “other emerging markets,” and “frontier markets” on the basis of the relative size of their LCBM and availability of benchmark bonds.
- Data comparability is limited by gaps; results may not generalize to EMDEs with materially different macrofinancial or market structures.

### Building Blocks and Market-Structure Findings
- Macroeconomic and institutional conditions vary widely across EMDEs:
  - Major emerging markets tend to exhibit stronger fundamentals, deeper institutional investor bases, and lower financial dollarization, supporting yield curve formation.
  - Frontier markets often have weaker and more volatile macroeconomic conditions, bank-dominated financial systems, concentrated investor holdings, and limited intermediation.
- Exchange rate and monetary policy regimes:
  - Flexible exchange rate regimes and inflation-targeting frameworks have supported bond market development in many major emerging markets by anchoring expectations and reducing volatility.
  - Emerging markets are more often shaped by the direct policy rate channel; frontier markets are more exposed to the risk premia channel.
- Money market and monetary policy frameworks:
  - Major emerging markets typically operate under interest-rate-based frameworks linked to formal inflation-targeting regimes; many frontier markets rely on indicative or administratively set overnight rates with weak links to trades.
  - Achieving reliable reference rates requires transparent computation methodology and provisions for periods of market stress.
- Repo and collateral markets:
  - Deep and liquid repo markets foster interbank and secondary bond market trading and anchor the short-term rate; repo markets in EMDEs lag advanced economies in scale and market depth.
  - Constraints include held-to-maturity portfolios limiting collateral availability, high haircuts, operational limits on collateral circulation, legal uncertainties around collateral enforcement and netting, restrictions on short selling, and fragmented settlement infrastructure.
- Primary issuance and benchmark bonds:
  - Annual borrowing plans anchored on credible medium-term fiscal frameworks support predictable issuance; major emerging markets typically have benchmark issues above $1 billion that support liquidity and index inclusion.
  - Many frontier markets issue smaller, irregular amounts with mixed transparency and weak auction discipline.
- Primary dealer (PD) frameworks and secondary market liquidity:
  - PD frameworks in frontier markets tend to prioritize auction participation over secondary market-making; PD frameworks rarely include binding obligations for firm “two-way” quotes.
  - Few dealers maintain active trading books, producing shallow secondary market liquidity and smaller trading books even in major emerging markets.
  - Large global banks as PDs can broaden market access and contribute to liquidity but can increase sensitivity during periods of market stress.
- Investor base and exposures:
  - Sovereign-bank links and exposure to nonresident holders are more pronounced in other emerging markets than in major peers, implying higher vulnerability to funding shocks and rollover risks.
  - Major emerging markets have larger NBFI participation and deeper institutional investor bases.
  - Central banks in frontier markets hold a significant share of government securities, reflecting shallow investor bases and potential fiscal dominance.
- Yield and return patterns:
  - Major emerging markets generally sustain upward-sloping yield curves with moderate positive real yields.
  - Many frontier and smaller emerging markets record persistently high real yields and steep yield curves; a few exhibit flat or negative real yields, reflecting financial repression, shallow investor participation, or credible disinflation.
  - Based on a sample of 25 economies (14 emerging markets and 11 frontier markets), the correlation between bank exposure and the slope of the yield curve is –0.34 for frontier markets and –0.09 for emerging markets.
  - Based on a sample of 10 frontier markets and 16 emerging markets, the average real rate of return during 2002–22 was negative for 50 percent of frontier markets and 6 percent of emerging markets.

### Policy-Relevant Observations and Recommendations
- Strengthen macroeconomic anchors and credible inflation-targeting frameworks to reduce volatility and support yield curve formation.
- Improve money market infrastructure and transition to interest-rate-based monetary policy frameworks with transaction-based overnight reference rates to enhance monetary transmission.
- Deepen and standardize repo markets by addressing collateral availability, haircut calibration, operational limits on collateral circulation, legal enforceability of repo and netting arrangements, and settlement fragmentation.
- Promote predictable issuance via annual borrowing plans and credible medium-term fiscal frameworks to support benchmark bond formation—benchmark issues typically above $1 billion in major emerging markets.
- Reform PD frameworks to include obligations that support secondary market-making and two-way quoting to improve liquidity and reduce concentration of market-making duties.
- Broaden investor bases (including NBFIs and pension reforms where relevant) to deepen markets and reduce sovereign-bank nexus and concentration risks.
- Enhance legal-regulatory frameworks, FMI, and auction transparency to support larger, regular issuance and stronger secondary markets.

*Source: Global Financial Stability Report: Shifting Ground Beneath the Calm, Chapter 3 excerpts; International Monetary Fund | October 2025*

### 1. Issuance of Benchmark Bonds and Regular Liability

### 1. Issuance of Benchmark Bonds and Regular Liability

### PD systems and primary market support
- PD systems support auction demand but often expose structural weaknesses and deepen the sovereign-bank nexus.
- Panel coverage and data notes:
  - Staff assessments of PD frameworks cover 37 EMDEs.
  - Actual PD primary market coverage can be below 100 percent, but PDs are often required to underwrite the full auction if demand is insufficient.
  - The figure reports stated coverage obligations, not the 100 percent fallback underwriting.
- Benchmark size and market concentration:
  - The share of the bond universe above US $1 billion equivalent is calculated from Bloomberg data, using exchange rates as of August 31, 2025.
  - Excluded from the figure are countries with 0 percent of local currency government bonds outstanding above US $1 billion equivalent: Armenia, Botswana, Costa Rica, Jamaica, Jordan, Namibia, Sri Lanka, Uganda, Vietnam, and Zambia.
- Data and sample references:
  - Panel 4 presents estimated bid-offer spreads and trade sizes for benchmark bonds in 26 EMDEs, based on typical market conditions.
  - Data are as of August 31, 2025.

### Secondary market liquidity and trading activity
- Quoting obligations for PDs and trading book activity remain limited, impeding bond market liquidity.
- High bid-offer spreads and weak pre- and post-trade price transparency in frontier markets underscore persistent secondary market inefficiencies.
  - Wide spreads reflect small trade sizes, lack of benchmark securities, and concentrated buy-and-hold strategies, all of which limit secondary market turnover.
- Examples of market development:
  - Electronic interdealer platforms, pre- and post-trade transparency, and publication of a reliable yield curve have spurred trading activity in major emerging markets (for example, Brazil, India, and South Africa).
  - Some emerging markets (for example, India, Malaysia, and South Africa) exhibit bid-offer spreads comparable with advanced economies, but market liquidity is often concentrated in a few select benchmark bonds.
- Trading book analysis:
  - Analysis of trading books is based on banking system averages for 2020–24 covering 24 EMDEs, measured as the share of total government securities portfolios, assuming most trading book assets are sovereign securities.

### Supporting market architecture and infrastructure
- Hedging and money markets:
  - Hedging markets supported by well-functioning money markets enable both domestic and nonresident investors to manage exposure to interest rate and exchange rate risk, lifting participation and liquidity.
  - Emerging markets with deeper hedging markets have been able to weather shocks to liquidity conditions better than others during observed stress events (BIS 2024).
  - Although hedging markets, mostly FX derivatives, continued to grow in emerging markets, they have not always kept pace with issuance.
  - FX derivatives are generally more prevalent in emerging markets, but Brazil, Chile, Mexico, and South Africa are among those with fairly balanced hedging markets.
- Investor access and FMI:
  - Establishing links with international central securities depositories provides secure, standardized, cross-border access to domestic securities, reducing operational and legal barriers to entry.
  - Efficient FMIs enable safe, low-cost settlement and support investor confidence during stress.
  - As of January 2025, large emerging markets have self-attested to implementing the CPMI-IOSCO Principles for FMIs (self-assessment does not imply full compliance or guarantee sound operation in practice).
  - Central clearing of repos is present only in a few major emerging markets; Brazil, China, and India have implemented a central clearing counterparty for clearing of repos.
  - FMI in frontier markets remains uneven, and operational gaps can amplify liquidity pressures and raise risk premia by disrupting settlement and deterring investor participation during stress.

### Key policy recommendations and reform priorities
- Overarching message:
  - Strengthening LCBMs is crucial to reducing sovereign debt vulnerabilities and enhancing financial resilience, alongside macroeconomic and fiscal stability.
  - Where macrofinancial conditions are weak, rapid LCBM expansion that outpaces investor demand can increase term premia, destabilize debt dynamics, and increase financial stability risks.
  - Economies should prioritize macroeconomic stability and strong fiscal anchors that safeguard public debt sustainability.
  - Mobilizing adequate financial savings and channeling them into LCBMs is key to strengthening absorption capacity and supporting LCBM development.
- Reform priorities to strengthen market absorption capacity:
  - Develop the domestic institutional investor base; view LCBM deepening within broader financial sector development.
  - National pension system design (including shifts from pay-as-you-go to funded systems) and complementary funded arrangements (mandatory contributions to privately managed plans or provident funds) can support LCBM development (BIS 2019).
  - Additional instruments (pension-like insurance products), tax incentives, and neutral tax regimes can mobilize savings and support collective investment schemes (IMF and World Bank 2021).
  - Gradually relax mandatory investment requirements and adopt “prudent person rules” as institutional investor base matures to reduce overexposure to government securities.
- Specific steps across LCBM building blocks:
  a. Sound monetary policy frameworks and deeper money markets:
     - FMs should adopt and operationalize interest rate–based frameworks using credible policy instruments and transaction-based reference rates.
     - Developing repo markets is critical; major emerging markets can expand collateral reuse and term repos and facilitate access to NBFIs.
     - Mitigate systemic risks in repo markets with consistent haircuts and margin requirements, enhanced transparency, and other risk management controls.
  b. Issuance strategies:
     - Emphasize predictability and transparency to sustain demand and build benchmark bonds.
     - Align issuance with monetary operations to stabilize systemic liquidity and reduce issuance volatility.
     - Frontier markets should focus on a limited set of standardized benchmarks; emerging markets can consolidate liquidity through greater reopenings and regular use of liability management operations.
  c. Primary dealer frameworks and trading infrastructure:
     - PD obligations should be balanced and tailored to the stage of market development, from indicative quotes in frontier markets to firm quoting obligations in major emerging markets.
     - PD frameworks in frontier markets must balance privileges with obligations; in major emerging markets emphasize enforcing quoting obligations and participation thresholds for PDs.
  d. Market microstructure and systemic safeguards:
     - Implement electronic interdealer trading platforms, publish reliable yield curves, and improve dissemination of pre- and post-trade information.
     - In markets with significant repo activity, consider more robust clearing arrangements; central clearing counterparties could reduce counterparty risks and dealer balance sheet strain.
  e. Prudential treatment of sovereign bonds:
     - Avoid reinforcing the sovereign-bank nexus by gradually reducing incentives for held-to-maturity holdings and aligning liquidity coverage requirements with global standards.
     - Remove legal and structural impediments to secondary market trading and support development of hedging instruments to enable more securities to be held in trading books.
  f. Contractual provisions for domestic sovereign issuance:
     - Incorporate sound contractual provisions relating to the negotiation process and restructuring mechanics to facilitate orderly and predictable resolution if restructuring becomes necessary.
  g. Investor base diversification:
     - Prioritize pension reforms and greater penetration of the life insurance sector to expand the institutional investor base.
     - Align investment mandates, solvency rules, and tax treatment to enhance institutional investor demand in frontier markets.
     - Improve issuance communication to anchor investor expectations and promote pooled investment vehicles like mutual funds and voluntary pensions in large emerging markets.
- Nonresident participation guidance:
  a. Gradual and phased opening:
     - Consider both benefits and risks; where financial development is limited and FX and money markets are shallow and macroeconomic stability is weak, open participation of foreign investment gradually and in phases.
     - Phase out reliance on short-term debt instruments that increase rollover risks and amplify volatility during stress.
     - Improving FX hedging tools can attract longer-term, noncarry-trade flows and mitigate capital outflows.
  b. Managing high nonresident participation:
     - Strong institutions and appropriate FMI systems should support systematic monitoring of nonresident holdings and flows.
     - Periodic assessments of risks associated with nonresident holdings are important for policy responses and buffer-building.
     - As an exception, temporary and narrowly targeted capital flow management measures may be considered in line with the IMF’s Institutional View (IMF 2012).

### Tailored priorities by country grouping (Table 3.1 summarized)
- Major emerging markets:
  - Consolidate benchmark issuance to reduce fragmentation.
  - Deepen institutional investor base by promoting long-term savings institutions.
  - Expand use of interbank repos and encourage larger trading books for PDs and banks.
  - Establish central clearing counterparties where appropriate.
- Other emerging markets:
  - Accelerate benchmark bond issuance and initiate regular liability management operations.
  - Develop domestic institutional investor base.
  - Improve the primary dealer framework.
  - Encourage use of repo contracts based on internationally recognized master agreements.
- Frontier markets:
  - Build benchmark bonds, establish issuance rules and auction discipline, and coordinate with monetary operations.
  - Strengthen government cash management.
  - Reduce overreliance on banks and nurture nascent institutional investors.
  - Implement interest rate–based monetary policy and encourage use of money market reference rates and repos.

*International Monetary Fund | October 2025*

### 4. Cumulative Emerging Market Corporate Loan Issuance

### 4. Cumulative Emerging Market Corporate Loan Issuance

### Overview
- Data are aggregations from almost 90,000 bond and loan issuances for about 14,000 nonfinancial corporations in emerging market and developing economies from 2000 to the third quarter of 2004.
- All shares are computed on a volume basis rather than on a deal count basis.
- Sources: Dealogic; and IMF staff calculations.

### Trends in local-currency corporate debt
- The local currency share of emerging market corporate debt (by volume) increased from 34 percent in 2021 to almost 45 percent in the third quarter of 2024.
- Corporations from emerging Asia were especially active issuing local currency bonds.
  - On a volume basis, Malaysian and Thai corporations have almost exclusively issued bonds in local currency in the 2022 to 2024 period.
- The same qualitative trend is observed for corporate loans, although growth of local currency loans may be attenuated by EMDE corporations bolstering borrowing relationships with banks headquartered in foreign jurisdictions that prefer foreign currency loans.

### Investor composition and resilience to shocks
- Domestic investors in corporate debt increased their holdings following the onsets of the global financial crisis and the pandemic, boosting debt volumes while nonresident investors retraced their holdings notably.
- The empirical finding in the chapter: Higher domestic investor shares in EMDE sovereign bonds attenuate the adverse impacts of global shocks — a pattern that resonates with corporate loan and bond investor flows.

### Case study: Georgia — deepening local-currency bond markets and mitigating sovereign debt portfolio risks
- Government debt averaged around 40 percent of GDP between 2018 and 2024.
- Foreign exchange debt share fell from 81 to 70 percent.
- Tenors extended up to 11 years; benchmark issuance and liability management supported market growth.
- A 2024 switch operation raised the average time to maturity for domestic securities from 2.6 years to 3.5 years (2018–24).
- A 2021 Eurobond ensured refinancing and preserved international market access.
- Market Makers Pilot Program launched in 2020 improved price discovery on benchmark bonds (approximately $1.2 billion), though banks remain dominant investors.
- Transparency enhancements aim to attract more nonbank and foreign investors; diversification remains a priority.

### Case study: Bangladesh — laying foundations for a robust local-currency bond market
- Diagnostic mission in 2023 identified distortions: interest rate caps, central bank participation in auctions, reliance on costly nonmarketable domestic debt in the form of national savings certificates.
- Reforms supported by IMF program conditionality included:
  - Transition to an interest rate–based monetary policy framework.
  - Removal of the lending rate cap.
  - Elimination of central bank government bond purchases.
  - Quarterly issuance calendars and publication of a daily secondary market yield curve.
  - Expanded access through over-the-counter and stock exchange trading.
  - National savings certificate rates linked to market yields from 2025.
  - Primary dealer framework reforms in June 2025 removing underwriting obligations and emphasizing market making activities.
- Outcomes:
  - Nominal stock of marketable bonds doubled between 2019 and 2024.
  - Benchmark bonds exceeding $500 million, securing FTSE Frontier Emerging Market Bond Index inclusion.
  - Remaining challenge: reducing the sovereign-bank nexus despite potential foreign investment attraction.

*International Monetary Fund | Global Financial Stability Report: October 2025*

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