Transcript of a Press Conference on the Global Financial Stability Report by Jaime Caruana, Director of the IMF's Monetary and Capital Markets Department, and Hung Tran, Deputy Director of the Monetary and Capital Markets Department

IMF News, April 10, 2007

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Canonical URL: Transcript of a Press Conference on the Global Financial Stability Report by Jaime Caruana, Director of the IMF's Monetary and Capital Markets Department, and Hung Tran, Deputy Director of the Monetary and Capital Markets Department

Global financial stability remains underpinned by the favorable economic outlook.
Despite solid global growth, risks have risen in some areas since the September Global Financial Stability Report.
Macroeconomic risks and those faced by emerging markets sovereign borrowers have eased somewhat since September, while market risk and credit risks have risen.
The recent market turbulence is a reminder that downside risks persist, even though it did not lead to a fundamental reassessment of the global growth and inflation outlook.
Volatility across many asset classes is close to historic lows; credit spreads on a variety of instruments have tightened; risk appetite has increased.

U.S. subprime mortgage market
- Subprime market is still only about 14 percent of the U.S. mortgage market.
- Credit deterioration is also discernible in the next riskiest mortgage segment, the Alternative-A.
- Deterioration in subprime credit quality has translated into wider spreads on securities collateralized by them, affecting a wide range of investors, including some international investors.
Market turbulence
- Recent corrections (including late February and early March, and May–June of the prior year) are viewed as reminders of downside risks; corrections have been relatively short-lived and markets have shown resilience.
Emerging market pockets of vulnerability
- Heavy issuance of foreign exchange–denominated debt by emerging market banks and corporations, sometimes at increasingly lower credit ratings.
- Large flows into previously low-interest countries (including new frontiers in sub-Saharan Africa) could pose challenges, especially where countries run current account deficits.
- Increased investor risk appetite has encouraged entry into local-currency markets in many emerging markets; this is broadly positive but can cause “indigestion” in small, illiquid local markets and lead to volatility on investor exit.

Rapid growth in private equity and leveraged buyouts raises concerns despite supportive drivers (long-term interest rates and healthy corporate balance sheets).
Risks highlighted:
- Rising leverage in target firms.
- Weakening lending standards in syndicated loans used to finance deals.
- Relaxation of credit standards and due diligence in financing for LBOs and dividend-related financing.
- Growth of so-called government light loans.
Observations on scope and regional focus:
- Concern centers on deal-level standards and exposures rather than a single region; the current wave features larger-sized LBOs than in prior waves.
Policy recommendation:
- Regulators in major markets should ensure lenders and investors exercise due diligence and maintain credit standards.

Cross-border financial asset accumulation has tripled over the last decade (see Chapter II).
Three trends affecting cross-border flows:
- Rapid growth under management of institutional investors.
- Changes in asset allocation behavior of those investors.
- Broadening global investor base, including an increasing role of emerging market official sector and sovereign wealth funds.
Stability implications:
- A wider variety of cross-border investors can enhance financial stability by diversifying investment behaviors and horizons.
- Rapid acceleration of flows to some emerging markets presents management challenges and has in past episodes led to abrupt reversals.
Globalization of institutions:
- Positive relationship found between globalization of individual financial institutions (mostly banks) and their accounting and market performance.
- System-wide benefits of diversification are less clear; when many banks diversify internationally, systems may become more correlated and vulnerable to large common shocks, complicating severe crises.

Shift from international foreign currency–denominated borrowing toward domestic local-currency funding by sovereigns and increased entry of international investors into local-currency markets is viewed as a positive structural development.
Risks and caveats:
- Small, illiquid local markets that attract large international investor flows can experience price “indigestion” and volatility on sudden outflows.
- Countries should strengthen market infrastructure and develop local institutional investor bases to mitigate volatile flow risks.
- No free lunch: reduced sovereign FX exposure can shift volatility sources to foreign investor behavior in local markets.
Example cited: foreign banks account for 75 percent of assets in Mexico’s banking industry (used as an illustration of foreign bank penetration).

Improvements in market infrastructure, risk management, and more discriminating market participants have enhanced resilience, particularly in emerging markets.
The financial system has become more complex and interlinked; growth in credit risk transfer markets has been dramatic and not yet fully tested by a sustained shock.
Data and supervisory gaps:
- Insufficient data on types and sources of capital flows entering countries.
- Limited visibility on where risks embedded in increasingly complex structured products are housed.
- Need to address gaps in data collection, cross-border oversight, and crisis resolution frameworks.
Policy implication:
- The benign economic environment provides an opportunity for policymakers to strengthen regulation, data collection, cross-border oversight, market infrastructure, and crisis resolution arrangements.

U.S. housing/subprime risk channels:
- Subprime deterioration is expected to reduce U.S. growth but not to cause a fundamental change in outlook, provided income and employment remain strong.
- A possible transmission channel is tightening of lending conditions, which could reinforce weakness in home sales and housing activity.
Market corrections and investor behavior:
- February–March correction characterized as short-lived and a reminder of complacency risks; markets may become more data-dependent and focused on economic news.
- Reappraisal of risk could lead to a re-establishment of risk premia and tighter financial conditions if corrections deepen.

Transcript of a Press Conference on the Global Financial Stability Report by Jaime Caruana and Hung Tran, April 10, 2007.