Transcript of the Press Conference on the Release of the October 2017 Global Financial Stability Report

October 13, 2017


Mr. Adrian, Financial Counsellor and Director, Monetary and Capital Markets Department, IMF
Mr. Dattels, Deputy Director, Monetary and Capital Markets Department, IMF
Mr. Jones, Assistant Director, Monetary and Capital Markets Department, IMF
Mr. Al‑Eyd, Deputy Division Chief, Monetary and Capital Markets Department, IMF
Ms. Zucchini, Senior Communications Officer, Communications Department, IMF

MS. ZUCCHINI: Good morning, ladies and gentlemen, and welcome to the press conference for the launch of the Global Financial Stability Report, October 2017 edition entitled: Is growth at risk?

I am Silvia Zucchini from the IMF's Communications Department. And I am joined on stage today by: Tobias Adrian, IMF Financial Counselor and Director of the Monetary and Capital Markets Department; Peter Dattels, Deputy Director of the Monetary and Capital Markets Department; Matthew Jones, Division Chief in the Global Markets Analysis Division of MCM; and Ali Al‑Eyd, Deputy Division Chief in the Global Markets Analysis Division of the Monetary and Capital Markets Department.

Before we take your questions, let me just give the floor to Tobias Adrian for his opening remarks.

MR. ADRIAN: Good morning, ladies and gentlemen.

Since our last report, global financial stability has continued to improve as the economic recovery broadens and global markets are buoyant. But while waters seem calm, vulnerabilities are building under the surface. If left unattended, these could derail the global recovery, putting growth at risk. This is the theme of this Global Financial Stability Report.

Let me start with the good news. As the economic counselor outlined yesterday at the launch of the World Economic Outlook, the upswing in global activity has gained further steam. This is laying hopes for a sustained recovery and allowing for the eventual normalization of monetary policy.

The core of the global financial system is stronger. Systemically important banks and insurers continue to enhance their resilience. They are raising capital, addressing legacy issues, and adapting their business models to the evolving regulatory and market environment.

In emerging markets, capital flows are rebounding. The cost of financing is low, and the currencies and equity prices have strongly appreciated this year.

Globally, supportive financing conditions and buoyant markets have helped foster and repair balance sheets.

Despite these favorable conditions, the recovery is not yet complete. Monetary accommodation remains necessary to support activity and boost inflation. Markets expect a prolonged period of accommodation before policies will be fully normalized after years of unconventional support following the crisis.

This environment is breeding complacency. Complacency is spawning financial excesses and is allowing vulnerabilities to build on several fronts. Let me emphasize five vulnerabilities:

First, market risk is rising. The search for yield may have gone too far. There is simply too much money chasing too few yielding assets. There is less than $2 trillion of investment‑grade bonds yielding over 4 percent compared with $16 trillion pre-crisis. Despite deteriorating health of corporate balance sheets, credit spreads are close to historic lows. Institutional investors are being drawn out of their natural habitats in a search for yield. This exposes the balance sheets to increased credit maturity and liquidity risks.

Second, debt levels are increasing in G‑20 economies. Leverage in the private sector is now higher than prior to the financial crisis. And despite low yields, debt service burdens have increased in several major economies. This poses greater risks over time from sharp increases in interest rates.

Third, external borrowing in emerging markets and low‑income countries has also increased. Portfolio inflows to emerging market economies are on track to reach $300 billion in 2017, more than twice the total over the past two years. This is broadly good news, supporting growth prospects in these countries, but this greater reliance on foreign borrowing may at some point become a vulnerability, particularly for low‑income countries, if those resources are not put to good use.

Fourth, in China, the size, complexity, and pace of expansion of credit in the financial system, particularly shadow credit, point to elevated risks to financial stability.

Finally, with volatility extremely low across asset classes, markets appear complacent about a host of potential shocks. These include: geopolitical risks, upside inflation surprises, a snapback in long‑term interest rates, and downside risks to economic growth. These growing vulnerabilities could derail the recovery, putting growth at risk. This is illustrated in our downside scenario, where risk premiums rise, equity in housing prices fall, and $100 billion in portfolios flows are pulled from emerging markets. In this scenario, losses to global output could be about one‑third of that of the global financial crisis.

The key challenge policymakers face is to continue providing the appropriate monetary policy support while containing the buildup of underlying financial vulnerabilities. This calls for policy actions on several fronts:

Major central banks should ensure a smooth normalization of monetary policy. Well‑communicated plans for unwinding unconventional monetary policies remain crucial to ward off market turbulence. Financial regulators should deploy macroprudential policies and consider extending the boundary of such tools to curb rising leverage and growing stability risks. Supervisors will need to put increased focus on business models of major banks. Some banks are still struggling to adapt their business models to the new environment.

We estimate nearly one‑third of systemically important global banks, representing 17 trillion in assets, will struggle to achieve sustainable profitability to ensure ongoing resilience.

Emerging market countries need to take advantage of benign financing conditions to address imbalances, continuing to reduce private sector leverage where it is high, and managing external sovereign debt exposures. Chinese policymakers should continue to address vulnerabilities and should take broader reform measures to make the economy less reliant on rapid credit growth.

The global regulatory reform framework, developed in the aftermath of the financial crisis, must be completed and fully implemented. Global cooperation remains essential.

To summarize, our key message is that this is no time for complacency. Action is required now because vulnerabilities are building. These vulnerabilities could put growth at risk in the future.

We are happy to take your questions.

MS. ZUCCHINI: Thank you, Tobias. Yes, questions from the floor?

QUESTIONER: In the past, you have made a number of points about the nonperforming loans in the European banking system. I wonder if you could give us a current assessment of those nonperforming loans, which countries have made progress? And what is the scale of those nonperforming loans now, particularly in Italy and Greece?

MR. DATTELS: The latest official number we have on nonperforming loans is a stock of €988 billion. This is still a very high number. But some recent developments are more encouraging, and we can expect a decline to about €900 billion by the end of the year.

It is expected that Italian banks will be able to sell €65 billion in nonperforming loans this year, and this is reflecting some €18 billion from UniCredit, €26 billion from Monte dei Paschi di Siena after its precautionary recapitalization, and some of the smaller banks.

Sales of nonperforming loans in Spain account for a further 30 billion in euros. All this time, the underlying recovery in these economies is helping reduce the flow of new nonperforming loans.

Elsewhere, levels of nonperforming loans are still very high. In Portugal, they have peaked last year at around 18 percent of corporate loans, and they are down to about 15.5 percent in the second quarter. And particularly, this highlights the nonfinancial corporate sector, where there is still a considerable debt overhang, something of 20‑27 percent of corporate loans.

QUESTIONER: I would like you to talk a little bit more about Sub‑Saharan Africa, the trend in Sub‑Saharan Africa, Nigeria, South Africa, and the rest, but more specifically about the French‑speaking countries in Africa. As you know, half of the countries in Sub‑Saharan Africa do not have / are not allowed to have their own currencies since independence.

Do you think that without their own currencies, Cameroon Chad and all those countries, do you think they can aspire to even any financial stability? What would be your recommendation for those countries? And do you think that if those countries have their own currencies, do they achieve more financial stability?

MR. ADRIAN: Financing conditions are easy globally. And funding for countries, including Sub‑Saharan African countries, including francophone countries have very favorable funding conditions. In fact, issuance, debt issuance in Sub‑Saharan Africa has been at very high levels compared to historical standards.

From a financial stability point of view, the key question is: How are those funds used by those countries? Are countries using the funding responsibly in order to ensure financial stability and a sustainable fiscal outlook going forward?

MS. ZUCCHINI: Thank you.

There is also a press conference from the African Department on Friday, and those specific questions can be asked there.

QUESTIONER: Thank you. I have two questions. I am from the Austrian paper (inaudible).

If I would give my readers one figure or a way to see this mispricing, one simple figure which they could hopefully understand, which one would you pick in the bond market or the government market?

And my second question is: The Economist had a very interesting article this week, saying, actually, this time is somewhat different because there is a mispricing everywhere, not just bond markets but also real estate. Could you elaborate on that? Does that make a difference?

MR. ADRIAN: We have one very nice chart in the Global Financial Stability Report that is a heat map that gives asset valuations across different markets, and it also provides a gauge of the level of volatility. And it is really the low level of market volatility, together with a compression of the prices of risks, such as credit spreads or interest rate term spreads, that is particularly striking at the moment.

It is true that the elevated asset valuations are present globally across different regions, and across different asset classes. So, the one number that I find the most telling is that term spreads—that is the risk premium embedded in longer‑term government securities—are negative in many jurisdictions. So basically, the way to think about it is that investors are paying to hold interest rate risk. So normally you are compensated to hold risk, but these term premia in longer‑term government securities are actually negative, and that is true across several markets around the world.

QUESTIONER: Hi, Tobias. I was just wondering if you could give your thoughts on the prospect of the rollback of financial regulations in the U.S. You know, the President has indicated that he would like to choose a Fed Chair who is perhaps a little less hawkish on regulation. There are proposals in Congress to do so. As somebody who has been at the New York Fed, what are your thoughts on what the implications of that would be?

MR. ADRIAN: The Fund is strongly endorsing the higher level of capital and liquidity and the resolution regimes that have been introduced since the global financial crisis.

Capital, liquidity and resolution are making the core banking system much more resilient and much more stable. At the same time, there might be some unintended consequences of those regulations. And internationally, regulators are starting to evaluate the impacts of the regulatory reforms on credit supply and liquidity. So there might be some scope for either streamlining or simplifying some aspects of the reforms without rolling back the overall high level of capital and high level of liquidity that we feel is very important for financial stability.

QUESTIONER: You just mentioned the expansion of credit in China's financial market. So I am wondering: How serious is the issue now? And what do you think of the current situation compared with that in April?

MR. JONES: We think the rapid rise in nonfinancial sector leverage in China along with, as Tobias said, the size, complexity, and pace of growth in the financial system does point to elevated financial stability risks. For example, in the report we cite that banking sector assets are now 310 percent of GDP, up from 240 percent in 2012. That is a significant growth in the past five years.

The rapid growth of intra‑financial system credit, funded with more fragile wholesale funding structures, is a particular issue that we are concerned about in small and medium banks.

Regulators in China have taken a number of measures in the past 12 months with better coordination across agencies to address many of these risks. This is very welcome because it is had a significant impact on slowing down some of the shadow banking growth and reduce reliance on wholesale funding. But these vulnerabilities overall will be difficult to address without slower credit growth.

In the report, we point to a number of broader reforms that we think are necessary. To be successful, this sort of regulatory tightening must really be accompanied by broader reforms that reduce the economy's reliance on rapid credit growth: for example, reducing corporate leverage, resolving nonviable firms, improving credit efficiency through reform of state‑owned enterprise. We think the authorities have taken a number of measures that are helpful, but the stronger growth outlook really does provide a window of opportunity for the ability to address these rising vulnerabilities, and we think it will be very helpful for financial stability if that opportunity is taken.

QUESTIONER: Regarding the role of the big central banks, do you think the current course toward normalizing is the correct one? The Fed, the ECB. Why or why not?

MR. ADRIAN: We do feel that the current stance on monetary policy in the major economies is appropriate. In the U.S., the euro area, and Japan, inflation remains below target. And in some of those economies, there are some other signs of slack. Further accommodative monetary policy is the right stance.

Of course, as we are pointing out in the Global Financial Stability Report, this accommodative stance on monetary policy is also fueling a reaching for yield, and our recommendation is to use macroprudential policy tools to address the buildup of financial vulnerabilities.

QUESTIONER: Could you be more precise and specific about the risks of the banks in Portugal, please?

MR. DATTELS: In Portugal, we have the Novo Banco sale—and a key condition was met last week with the completion of the debt buyback. Two formal steps now are remaining for the completion of the sale, that is the approval by the EC's competition authorities and the ECB, and these are expected to be granted. So that process is moving forward. There is potential for an additional contingent capital injection, but the contingencies are fully in place should that be necessary.

Regarding the nonperforming loan situation I mentioned earlier, there needs to be further progress, and more broadly throughout the euro area. The platform from which to address the NPL overhang in those countries which have high levels, is first stronger supervision.

We welcome the recent measures by the ECB and the Single Supervisory Mechanism, to agree to targets with individual banks to reduce the stock of NPL. We believe these targets should be time‑bound and guidance should be applied in a proportionate way across the credit institutions and followed with strict supervisory oversight. In addition, looking forward, the ECB has introduced a public consultation for looking at provisioning for new nonperforming loans. Again, we believe this is a positive step forward, and we support these measures.

Second, in addition to enhanced supervision, these measures should be complemented by a continued harmonization and modernization of national, corporate, and insolvency frameworks.

And thirdly, the generation of an active secondary market for disposal and sales of distressed assets. And these things are all in play.

QUESTIONER: I wanted to ask you a question about the Catalan crisis and its implications for financial stability in Spain and the euro zone.

I guess probably a nightmare scenario, generally speaking, for financial markets is when a shock event is announced and then delayed three months. Yesterday, the President of the Catalan Government announced unilateral independence and then delayed it. So there has been a small bank run on some of the Catalan banks. ECB liquidity operations have shot up in some of the Spanish banks.

I wonder if you could just give me ‑‑ you know, evaluate. Sometimes this is seen as a bit of a game, but I wonder if you could just evaluate the risks of credit spreads going up permanently or this causing serious damage to financial stability for Spain.

MR. ADRIAN: We have just completed a Financial Sector Assessment Program in Spain [at the end of the summer]. And we have generally found the Spanish banking system to be resilient and to be strong, having addressed most of its legacy issues. So, furthermore, the outlook for the Spanish economy is strong, and the basic fundamentals of the country are favorable for financial stability.

QUESTIONER: You have spoken about emerging economies. Let me talk about India. We are facing a huge banking sector problem with bad loans. And there is also a debate on trade‑offs in monetary policy when you talk about inflation and growth.

MR. AL‑EYD: We conducted an extensive analysis of emerging economy banks in our previous report. And we found that the Indian banking system, in particular, was vulnerable, given that large segments have low profitability, large problem loans, and inadequate buffers. We also found that Indian corporates remain highly leveraged and have high debt at risk.

So the combination of weak banks and weak corporate leaves India vulnerable to a tightening in global financial conditions. We welcome the measures that have been taken through the asset quality review to address the problems in banks, but more needs to be done to ensure that there is adequate capitalization in public sector banks, and also to implement further public sector banking reform. As you know, the Financial Sector Assessment Program will have more to say on this in the coming months.

QUESTIONER: Can I just come back to Catalonia and Spain? You did not really answer the question that was put to you from my colleague.

Are you saying there is absolutely no risk to the Spanish banking system from independence from Catalonia? And if you are saying that, are not you being guilty of the complacency that you, yourself, have warned against in this report?

MR. JONES: The situation remains fluid, so we will not speculate. But we do hope that the situation can be resolved smoothly and in a timely manner.

From a financial stability perspective, Tobias has given the summary of the recent Financial Sector Assessment Program results from Spain. That is all we have to offer on the Catalan situation.

QUESTIONER: I wondered if you could discuss a little bit more the way the report identified specific global financial institutions that look like they are unlikely to be able to achieve a reasonable kind of threshold of profitability in the next few years by 2019. Specifically, do the regulators in the countries for the banks need to take much more aggressive steps to get them into a profitable position by 2019, including either, you know, doing steps to increase their profitability to that threshold or to shrink themselves so that they are no longer this globally important?

MR. ADRIAN: What we are doing is to compare the return on equity of the banks, of the 30 the global systemically important banks. And we also collect the return on equity targets that the banks, themselves, are setting. So we go to the annual reports and basically ask: What are the return-on-equity targets that the institutions set themselves as a goal post?

One thing we do is to just compare: What is return on equity? What is the forecasted return on equity? So here, we use analyst forecasts for how earnings are going to evolve over coming years. And we ask: Are banks meeting their own return-on-equity targets?

There is one chart in the Global Financial Stability Report that shows that many of the banks are meeting their own targets, but some banks are very far off from their own targets. This is one aspect.

Then the second aspect is an analysis based on the market valuation formulas. We basically ask: given the fundamentals, given the balance sheets and the earnings of the banks, what is sort of required return by the marketplace for this type of institution? And we ask whether the institutions are meeting this required market return. That is another angle on the same type of question.

And broadly, our conclusion is that, globally systemic important banks overall are very strong, and they are expected to increase their profitability in coming years. But, in 2019 we still expect roughly a third of banks to have relatively weak returns. Half of those institutions might not even meet their own profitability return on equity targets.

So broadly, the G‑SIBs are doing very well; they are profitable. But there is a pocket of challenged institutions. And for those institutions, our policy advice is for supervisors to take actions in terms of business model, you know, helping the institutions to restructure their business models to become profitable.

Of course, the market environment and the regulatory environment has changed dramatically in recent years, and some institutions have been able to adapt to that, but others have not done so well.

This is our recommendation because we feel that institutions that are not profitable might not be able to generate enough capital in the future, should adverse shocks hit. So it might become a financial stability risk not to be profitable. There is a tight linkage between risk and return in some sense.

QUESTIONER: (Interpreted) I would like to know what is your assessment of public debt in north Africa. It is going up all the time in Morocco, for instance. Should we be concerned? And do you have any particular recommendations for that region?

MR. ADRIAN: I will repeat the question in English. The question was whether in North Africa, the rising debt is representing a vulnerability and what should be done about it.

In some North African countries, debt levels are increasing. And in today's market environment of very high risk appetite and very compressed prices of risk and some indications of a deterioration of underwriting standards, the main risk that we see is that countries continue to build up their debt because it is cheap. They can roll over existing debt, and they can take on further debt. But that might generate financial stability problems in the future, and it might generate debt sustainability problems in the future.

I do not want to talk about specific countries in North Africa. But we do present a scenario in the report where these kinds of buoyant financial conditions continue to exist for another two years and where then an adverse shock hits. And some countries are hit particularly hard by these adverse developments because of the buildup of leverage that then makes them vulnerable to adverse developments in global financial conditions.

MS. ZUCCHINI: I think we are going to wrap up with this question. Tobias, do you want to just give us some concluding words?

MR. ADRIAN: Yes. Before we close, I would like to note that this is the last press conference for Pete Dattels who is retiring later this year.

Pete has contributed to 27 Global Financial Stability Reports, starting in September 2004. He has led the work of Chapter 1, which is the chapter we are presenting today, for the past 11 years, through the depths of the crisis, covering 22 reports.

So, Pete, thank you for your contributions, and thanks for being a great colleague, a great friend, and for having done fantastic work over so many years.

MR. DATTELS: Thank you! This is Great team, and a Great new Director.

MS. ZUCCHINI: With these words, we wrap up our press conference today. Thank you very much.

[Briefing ends]

IMF Communications Department

PRESS OFFICER: Silvia Zucchini

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