Transcript of Global Financial Stability Report Press Briefing

April 18, 2018

Tobias Adrian, Financial Counsellor and Director for the Monetary and Capital Markets Department, IMF.

Anna Ilyina, Division Chief, Monetary and Capital Markets Department, IMF.

Fabio Natalucci, Deputy Director, Monetary and Capital Markets Department, IMF.

J. Benson Durham, Advisor, Monetary and Capital Markets Department, IMF.

Randa Elnagar, Communications Officer, Communications Department, IMF.

MS. ELNAGAR: Good morning, and welcome to the Spring Meetings. This is the Global Financial Stability Report Press Conference, and I am Randa Elnagar of the IMF Communications Department. We have with us here the IMF’s Financial Counsellor and the Director of the Monetary and Capital Markets Department, Mr. Tobias Adrian; Deputy Director of the Monetary and Capital Markets Department, Fabio Natalucci; Division Chief for the Monetary and Capital Markets Department, Anna Ilyina; and Benson Durham, the Advisor to the Monetary and Capital Markets Department.

Tobias is going to give some opening remarks, and then we are going to take your questions.

MR. ADRIAN: Good morning. As the World Economic Outlook noted yesterday, the global economy continues to show broad-based momentum. Today I will discuss our outlook for financial sustainability. Since our last Global Financial Stability Report, short-term risks to financial stability have increased, and medium-term risks remain elevated. Despite the VIX tantrum in February, the recent volatility in equity markets due to trade policy tensions, still-easy financial conditions continue to support global growth in the short term. But there has been a buildup of medium-term vulnerabilities which have accumulated during years of low interest rates. Vulnerabilities may make the road ahead bumpy and could put growth at risk. Our growth-at-risk analysis, which links financial conditions to the distribution of future global growth, indicates that under a severely adverse scenario, growth could be negative three years from now. This report discusses three main vulnerabilities: stretched valuations across many asset classes, borrowing by emerging markets in low-income countries, and bank dollar liquidity mismatches. I will discuss each of these three vulnerabilities in turn.

The first vulnerability is that valuations of risk assets are stretched across many markets. Some late-stage credit cycle dynamics are emerging. Corporate bond spreads remain at low levels. Issuance of riskier bonds has surged, and leveraged lending hit a record high in 2017. A faster-than-expected pickup in inflation might lead to a more rapid withdrawal of monetary accommodation by some central banks. This could trigger a sudden tightening in financial conditions and a sharp fall in asset prices. The resulting turbulence in financial markets could be amplified by liquidity mismatches and increased use of financial leverage.

The second vulnerability is that emerging markets and low-income countries could face a sudden tightening in global financial conditions. Such an event could lead to a reduction in capital flows. Debt sustainability in low-income countries has deteriorated, and the more complex creditor composition poses challenges for any future debt restructurings.

The third vulnerability is that there is a structural use dollar mismatch among non-US banks, even though banks overall have improved their resilience since the global financial crisis. The international US dollar balance sheets of non-US banks rely on short-term wholesale sources for about 70 percent of their funding. This could leave banks exposed to dollar funding problems in the event of strains in markets.

The report also looks at crypto assets. Some of the technologies behind crypto assets could make the financial market infrastructure, such as payment systems, more efficient; but crypto assets also have been afflicted by fraud, security breaches, and operational failures. Their limited size, now around 3 percent of combined G4 central bank balance sheets, currently implies little risk to financial stability, but they could pose greater risks in the future.

This all suggests that policy actions are needed in several spheres. Central banks should continue to normalize monetary policy gradually, and they should communicate their decisions clearly. Regulators should address financial vulnerabilities by deploying and developing prudential tools. Policymakers should ensure the post-crisis regulatory reform agenda is implemented, and they should resist calls for rolling back reforms.

To sum up: The economic recovery has remained resilient despite market volatility, but investors and policymakers should not take too much comfort from today’s relatively easy financial conditions. They should remain attuned to the risks associated with rising interest rates, elevated market volatility, and an escalation of trade tensions. The road ahead may well turn out to be bumpy.

QUESTION: In the past, you have identified problems with nonperforming loans in the European banking system. I wonder if you could enlarge on where that has got to now, what the scale of the nonperforming loans is at the moment, and whether you are seeing any progress?

MR. ADRIAN: There is some progress in terms of nonperforming loans as the economic recovery is strengthening, but the overall level of nonperforming loans remains high in some countries, and more progress is needed to ensure financial stability going forward.

MR. NATALUCCI: So the idea essentially is there is a need for comprehensive strategy here. So some steps have been taken by national authorities. Banks themselves have taken steps. Of course, growth helps. As the economy recovery grows, it helps bring down the level of nonperforming loans. The proposal at the European level, so the European Commission action plan, the guidance from the ECB, and then the comprehensive strategy obviously needs to include also steps toward simplifying the judicial system, so more expeditious resolving of nonperforming loans, as well as developing the secondary market for banks to dispose of those loans. I believe we have a chart in the report. It should be 900 billion, if I remember correctly.

QUESTION: Thank you. You mentioned trade tensions in your remarks. I am just wondering what kind of risks do you think a trade war between the U.S. and China will impose on the financial stability of the world? Thank you.

MR. ADRIAN: In the press conference by the Chief Economist yesterday, there was extensive discussion of trade issues. Here we are focusing on the financial stability implications of trade tensions. What we have seen in recent weeks is that the discussions around trade, and actions taken around trade policies, have increased investor uncertainty. As a result, financial conditions have tightened somewhat but overall remain easy. So the main effect that we have seen so far is an increase in uncertainty in financial markets.

QUESTION: Two questions if I could. One, you mentioned resisting calls to roll back regulation, so I am wondering if you have had any sense of the steps taken in the U.S. so far proposed by the Trump administration regarding changes to the Dodd-Frank law and whether that rises to the sort of critical level that you think could pose problems down the road?

Secondly, if you would elaborate a little more on inflation. I was sort of surprised to see that come up. I do not think that is on the radar of any major central bank in the world right now, and it seems to imply that this would have to happen to be a problem, A, globally, and, B, would have to also involve a policy mistake of some sort on the part of those central banks to turn it into a financial risk. So if you could maybe attach a probability to that actually happening.

MR. ADRIAN: Let me address the question about regulations. Since the global financial crisis, regulatory reforms around the world have made the financial system safer. Capital and liquidity buffers have strengthened, and resolution regimes have been introduced around the world. We feel that these are very positive steps. Jurisdictions around the world are taking steps to evaluate any unintended consequences of these regulations on market functioning and on credit availability. This is done under the auspices of the Financial Stability Board; and as jurisdictions look at any of these unintended consequences, there might be some adjustments to the regulations as they were implemented in recent years. However, we would warn against any rollbacks of the overall level of capital, the overall level of liquidity, or any rollbacks in terms of the resolution authorities.

MR. NATALUCCI: The only point I would add is under the umbrella of the FSB, I think it is an important point, there is a need for tweaking regulations at the margin; and the fact that it is done at the FSB level, so at the international level, in a coordinated manner, international coordination essentially, that helps to keeping a level playing field, avoid regulatory arbitrage, and so on. So that is an important point.

MR. ADRIAN: Let me address the question about monetary policy as well. What we are flagging in the report is that uncertainty about inflation is very low at the moment. So analysts and investors agree that inflation will likely be low going forward — below target in many jurisdictions. What we are flagging is that at some point we might well see shocks to inflation that might increase inflation uncertainty; and historically when inflation uncertainty increases, that is associated with a rise in long-term interest rates, and that might lead to a sharp tightening of financial conditions.

QUESTION: Mr. Adrian, could you comment a little about in the case that the monetary policy might stay at a faster the pace, more than expected now in the short run, what would be the major risks for the financial stability worldwide?

MR. NATALUCCI: So one of the scenarios that we consider in the report is where there are stronger-than-expected inflation, for example, or there is a repricing on inflation risks in markets, and that brings the central banks to accelerate the pace of normalization, and that would bring in a tightening of financial conditions that would have implications for both central banks that either are starting to normalize or gearing up to normalize. We look at the correlation of yields across major advanced countries, and we see that the correlation has increased, so that could have some spillover effect in other advanced countries, as well as implications for emerging markets. A tightening of financial conditions will probably affect the inflows or will generate a reversal of capital flows that we have seen over the past few years, so it could have spillover effect in other central banks in advanced countries, as well as in emerging markets.

QUESTION: What were the specific findings about Nigeria, and I would like to know if you are comfortable with the stability you have seen in Nigeria’s foreign exchange market and if you are OK with the measures taken so far by the Central Bank of Nigeria. Thank you.

MR. ADRIAN: So we do not go into the details of specific countries in the report. There will be a regional press briefing on Friday that is looking more specifically at different regions, in particular at Sub-Saharan Africa; and specific country questions can be raised at that point. In general, what we see in many emerging and low-income countries is that debt levels are rising and that underwriting standards of foreign debt are deteriorating, and that is a risk for financial stability of those countries.

QUESTION: Good morning. I have a question about crypto. In the report you just seem to essentially observe that there is a variety of approaches to regulations which have been taken around the world and that these can be quite different, so I was wondering whether you have a preference of the different models. And I am also asking because you call for greater harmonization and coordination, and it seems to me to be quite different to have that coordination if countries go with very different models on approaching this subject.

MR. ADRIAN: Absolutely. So what we see at the moment is a wide variety of approaches to the regulation of crypto assets. What many jurisdictions are doing is to apply existing regulations to this new and emerging sector, and that is yielding some results across jurisdictions. What is important is that regulatory approaches are taken that are generating trust in emerging technologies. We have seen a number of cases of fraud and operational failures in this new and emerging sector; and that is, of course, negative for investor confidence and consumer confidence.

Furthermore, we feel that cooperation across jurisdictions is important as investments in crypto assets is very global by nature, and business models in the fintech sector are very often very global by nature; so some coordination across jurisdictions is important.

At the same time, we do note in the report that the sector remains fairly small at the moment, so it does not represent a major financial stability risk for the moment, but that might change going forward. So remaining vigilant and really understanding what is happening in the fintech sector and with emerging technologies in the financial sector is a priority for regulators.

QUESTION: Good morning. I know you have not addressed this in the report, but we have upcoming elections in major countries, major economies, this year, like Brazil itself, Mexico, India, and the U.S. itself. I was wondering if this is also an issue for financial stability, and how do you face these upcoming elections? Thank you.

MR. ADRIAN: Policy uncertainty is certainly a driver of uncertainty in financial markets. We have seen a gradual increase of financial market volatility from very low levels last year to somewhat more average levels this year, and uncertainty about policies is one of the drivers of this development.

MS. ILYINA: One thing that is worth pointing out is that many of the major emerging markets countries have benefited from very favorable external financing conditions. That also created some room for them to strengthen their fundamentals. Many of the larger emerging markets, including Brazil, have managed to narrow their current account deficits, which puts them in a stronger position to deal with any kind of external shocks. But, of course, as Mr. Adrian mentioned, policy uncertainty does create additional volatility; and we have, indeed, seen some increased volatility in many developed-market currencies lately, but of course this could also be related to other sources of uncertainty globally.

MS. ELNAGAR: We are going to go online.

QUESTION: How do you evaluate the deleveraging process in China at this time? Is China improving compared to last year?

MR. ADRIAN: Yes. Thanks so much. In China, regulators have taken decisive steps to tighten the regulatory environment. These steps are very welcome by the IMF. We had a Financial Sector Assessment Program in China that concluded last year and that recommended the tightening of regulations. What we see so far is that the rise in debt levels has slowed down in China; however, the overall level of debt remains fairly elevated in China, and so we would welcome further regulatory tightening going forward.

MR. NATALUCCI: So Chinese authorities made financial stability a top priority. They have taken important steps to address financial stability risks as well as financial vulnerabilities, taken on board key recommendations for the FSAP; and so we welcome these steps. There are, of course, a number of factors and risks that need to be addressed. One of them is nonregulatory factors, for example, so growth target, which have implications for credit growth and leveraging the system. The report looks at the interconnectedness and opacity and complexity of the financial system, so the interaction between the banking sector and the shadow banking and so the assessment in terms of the deleveraging of the financial system is that they are taking important steps. They are going the right direction. There is more that needs to be done.

An important element also we highlight in the report is the existence of implicit guarantees, so it is important that authorities prioritize strengthening the policy framework and the position, the capital and liquidity position, of the institution so they do not inadvertently bring forth the financial stability risk. And so the sequencing and pace of the reforms and steps taken by the Chinese authorities is crucial here.

MS. ELNAGAR: We are going to go online again.

QUESTIONS: To what extent might shadow banks amplify any turbulence in markets?

MR. ADRIAN: The shadow banking system has become safer since the global financial crisis. Ten years ago, shadow banking was one of the major contributors to the turbulences of the 2008 and 2009 global financial crisis. Since then, steps by regulators in the banking system have been taken to sever the ties between the banks and the shadow banks, and that has been successful in many jurisdictions around the world. As a result, we have seen more and more of an emergence of the market-based financial system, which is generally less levered than the shadow bank system from ten years ago. I would point out, however, that shadow banking in China remains prevalent and that it is a large fraction of the financial system there.

QUESTION: Thank you. My question is, what impact will this Global Stability Report have on Africa with regard to the fight against corruption? Thank you.

MR. ADRIAN: The Global Financial Stability Report does not specifically focus on corruption issues. Of course, corruption is an important consideration that the Fund is addressing in other publications, and there is some link to the accumulation of debt. We do see that in some African countries debt is accumulated quickly, and that could pose financial stability problems for those countries in the future.

MS. ELNAGAR: One more online.

QUESTION: The question is about digital currencies, pros and cons, and how can we help emerging economies such as Egypt?

MR. ADRIAN: There is an emergence of digital currencies around the world. There have been over a thousand initial coin offerings that have occurred over the past two years, and this emergence of new currencies might well shape the nature of the financial system going forward. Today it is difficult to say how exactly these new developments are going to shape the financial system, but there are potential benefits. So one potential benefit is on the cost of international payments that might go down in the future at some point, but it is too early to say whether this is really going to take place.

QUESTION: In terms of your Africa outlook debt, there is a fiscal multiplier which the IMF recently started recommending which basically traces the impact of fiscal decisions. Now, is there a more precise way in which the IMF can recommend and trace numerically with facts and figures the debt utility as these countries utilize the debt that they get from the IMF?

MR. ADRIAN: So the IMF is working with country authorities on evaluating fiscal policies, including on estimating fiscal multipliers. That, again, is the subject of the regional and economic outlooks, as well as the Fiscal Monitor, so the Fiscal Monitor is going to be discussed in this room next, and the regional economic outlooks are going to be discussed on Friday.

MS. ILYINA: Let me just add a couple of things. We certainly are very much focused on public-sector debt dynamics in low-income countries, and there has been a rapid accumulation of public debt in the last few years. In fact, the median public debt-to-GDP ratio in low-income countries rose by over 13 percentage points to about 47 percent of GDP, which is a quite dramatic increase in such a short period of time.

Also, this leads to difficulties for some countries in managing and servicing this debt. In fact, over 40 percent now of low-income countries are at high risk of distress, and this is up from about 20 percent in 2013. It is also a rapid increase, so we certainly are very much focused on this. From the point of view of our report, we do track the debt issuance by low-income countries; and we have seen that there was, again, a strong rebound in international bond issuance by low-income countries, by frontier markets last year. And even early this year, despite global market volatility, issuance has been strong from several countries from the region. And the IMF, of course, is trying to provide some technical assistance to these countries on sound debt management, as well as on how to make sure that they can keep track of all the sort of borrowings and that there are as few as possible data gaps, so different ways of addressing data gaps. And also the IMF has recently rolled out the new debt sustainability framework for low-income countries that should help identify more precisely the sources of different debt-related vulnerabilities.

QUESTION: Also, I just wanted to apologize. Perhaps I did not put it in a global context, but it is a global context. Why? Because developed countries are affected, and most correspondent banks that attend to developing nations are from developed countries, so I just wanted to bring that context; it was not meant for low-income. It is a global issue as well.

MR. ADRIAN: In terms of correspondent banking, we have seen a withdrawal of correspondent banking from some jurisdictions. The Fund is working with our membership on addressing a number of AML/CFT shortcomings, and that is starting to show some success in certain jurisdictions, so the number of correspondent banks has actually increased in some countries. And, more generally, the withdrawal of correspondent banking has slowed down in recent months. So it is an issue that we are focused on and that we are monitoring with great detail, and we do work with our membership in a very intense fashion.

QUESTION: Sorry to ask a second question. I was going to address Brexit and the European Union, just one issue in particular. There has been a lot of concern that most of the euro clearing is done through London at the moment and that other jurisdictions across Europe might want to take some of that clearing, and that might weaken the supervision and regulation and safety of those clearing systems, and I wonder if you have any thoughts on that?

MR. NATALUCCI: So derivative is one of the issues that, of course, we pay attention to; and it could be related to possible financial stability risks as it relates to Brexit and whatever long-term agreement is reached. The long-term solution, at this point I am not going to speculate on what the optimal final solution will be. I think an important point to make here is that to manage financial stability risk associated with clearing derivative position, it is very important the cooperation between regulatory authorities on both sides, so the UK side and the European side, that that level of cooperation remain high so that financial stability considerations are brought into consideration to the extent they reach a final agreement.

MR. ADRIAN: Let me just add to that, that from a policy point of view, since the global financial crisis, there has been a push by regulators to centralize clearing; and so around the world we see that in different security markets we have seen an increase of clearing in different CCPs, central clearing counterparties, around the world. And so within the Brexit negotiations, there might be a push to decentralize some of that clearing. So from a policy point of view, there are tradeoffs on the one hand between the efficiency and the financial stability benefits from centralized clearing, and on the other hand, having a more direct regulatory control over your own jurisdiction.

QUESTION: You mentioned in the report that one of the risks are crypto assets markets. Do you have some advice for financial regulators of the countries, how to react on the crypto currency expansion? Is there any traditional regulation or methods that could be achieved in this situation?

MR. ADRIAN: So a number of existing regulations can be applied to crypto assets. Consumer and investor protection laws that are existing should also apply to crypto assets, and security market regulators in many jurisdictions are enforcing those regulations to crypto assets.

Furthermore, there are some infrastructure concerns about crypto assets. We have seen a number of issues relating to operational failures and fraud in markets around the world, and different jurisdictions have addressed that in a variety of ways. In general, we do recommend a cooperative approach to regulatory actions.

MS. ELNAGAR: Thank you very much. We will take one last question and then wrap up.

QUESTION: In which jurisdiction do you expect more of the envisaged negative growth in three years’ time? Thank you.

MR. ADRIAN: So in the report, we are looking at financial stability risks one year and three years into the future. And what we are showing is that in the short term, so at the one-year horizon, financial stability risks have increased, but they remain fairly low. In the medium term, at the three-year horizon, financial stability risks are elevated, and that is because vulnerabilities are building in an environment of easy financial conditions. So our estimate of global growth in a severely adverse scenario, so if negative shocks realize at a horizon of three years into the future, if negative shocks realize, we do expect in a severely adverse scenario to have negative growth in the future. And different countries are going to be exposed to such a negative scenario in different ways, and that really depends on the buildup of vulnerabilities in countries. So countries that are building up higher debt levels, that are exposed more to currency mismatches and liquidity transformation, are going to be exposed more to any adverse developments in terms of global financial conditions.

MS. ELNAGAR: Thank you very much for coming. Thank you to Tobias and the team. We have the Fiscal Monitor later, so please come back for the press conference. Thank you.

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