Global Financial Stability Reports

Global Financial Stability Report October 2017: Is Growth at Risk?

October 2017

Summary

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The October 2017 Global Financial Stability Report (GFSR) finds that the global financial system continues to strengthen in response to extraordinary policy support, regulatory enhancements, and the cyclical upturn in growth. Global bank balance sheets are stronger because of improved capital and liquidity buffers, amid tighter regulation and heightened market scrutiny. However, some banks are still grappling with legacy issues and business model challenges, where progress has been uneven. The environment of continuing monetary accommodation—necessary to support activity and boost inflation—may lead to a continued search for yield where there is too much money chasing too few yielding assets, pushing investors beyond their traditional habitats. As the search for yield intensifies, vulnerabilities are shifting to the nonbank sector and market risks are rising. This may lead to a further compression of risk compensation in markets and higher leverage in the nonfinancial sector. These challenges must be managed carefully to avoid putting growth at risk. Policymakers at both the national and global level will have to strengthen the financial and macroeconomic policy mix. The October 2017 GFSR also includes a chapter that examines the short- and medium-term implications for economic growth and financial stability of the past decades’ rise in household debt. It documents large differences in household debt-to-GDP ratios across countries but a common increasing trajectory that was moderated but not reversed by the global financial crisis. Another chapter develops a new macroeconomic measure of financial stability by linking financial conditions to the probability distribution of future GDP growth and applies it to a set of 21 major advanced and emerging market economies. The chapter shows that changes in financial conditions shift the whole distribution of future GDP growth.

 

Chapter One : Is Growth at Risk?

Chapter 1 finds that the global financial system continues to strengthen in response to extraordinary policy support, regulatory enhancements, and the cyclical upturn in growth. Global bank balance sheets are stronger because of improved capital and liquidity buffers, amid tighter regulation and heightened market scrutiny. However, some banks are still grappling with legacy issues and business model challenges, where progress has been uneven. The environment of continuing monetary accommodation—necessary to support activity and boost inflation—may lead to a continued search for yield where there is too much money chasing too few yielding assets, pushing investors beyond their traditional habitats. As the search for yield intensifies, vulnerabilities are shifting to the nonbank sector and market risks are rising. This may lead to a further compression of risk compensation in markets and higher leverage in the nonfinancial sector. These challenges must be managed carefully to avoid putting growth at risk. Policymakers at both the national and global level will have to strengthen the financial and macroeconomic policy mix. 

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Financial Stability Overview
Large Systemic Banks and Insurers: Adapting to the New Environment
Monetary Policy Normalization: A Two-Sided Risk
Has the Search for Yield Gone Too Far?
The Rise in Leverage 
Could Rising Medium-Term Vulnerabilities Derail the Global Recovery? 

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1.1 Global Financial Stability Map: Risks and Conditions


1.2. Cyberthreats as a Financial Stability Risk
 
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1.1. Global Financial Stability Map: Risks and Conditions
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1.2. Global Financial Stability Map: Assessment of Risks and Conditions
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1.3. Search for Yield, Asset Valuations, and Volatility
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1.4. Global Systemically Important Banks: Significance and Business Model Snapshot
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1.5. Global Systemically Important Banks: Capital, Liquidity, and Legacy Challenges
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1.6. Global Systemically Important Banks: Market Activity
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1.7. Global Systemically Important Banks’ International Activity
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1.8. Global Systemically Important Banks: Financial Performance Gaps       
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1.9. Life Insurance Companies’ Profitability and Capital
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1.10. Changes in Life Insurance Companies’ Business Models

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1.11. Life Insurers’ Market Valuations and Risk Outlook
   
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1.12. Simulated Mark-to-Market Shocks to Assets and Liabilities
   
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Data  1.13. Central Bank Balance Sheets and the Sovereign Sector
   
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1.14. Policy Rates, 10-Year Government Bond Yields, and Term Premiums
   
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1.15. Emerging Market Economy Capital Flows
   
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1.16. Global Fixed Income Markets and US Corporate Credit Investor Base
   
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1.17. Emerging Market Economies: Debt Issuance, Portfolio Flows, and Asset Prices
   
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Data  1.18. Low-Income Country External Borrowing and Vulnerabilities
   
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1.19. US and Emerging Market Corporate Bond Spread Decomposition and Leverage
   
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1.20. Long-Term Drivers of the Low-Volatility Regime
   
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1.21. Leveraged and Volatility-Targeting Strategies
   
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1.22. Vulnerability of the US Corporate Credit Investor Base to Shocks
   
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1.23. Group of Twenty Nonfinancial Sector Credit Trends
   
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1.24. Group of Twenty Nonfinancial Private Sector Borrowing
   
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Data  1.25. Group of Twenty Nonfinancial Private Sector Credit and Debt Service Ratios
   
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Data  1.26. Chinese Banking System Developments
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Data  1.27. China: Regulatory Tightening Has Helped Contain Financial Sector Risks   
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Data  1.28. Chinese Banks: Financial Policy Tightening and Credit Growth Capacity     
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Data  1.29. Bank Profitability and Liquidity Indicators       
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Data  1.30. Global Financial Dislocation Scenario       
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Data  1.31. Emerging Market Economy External Vulnerabilities and Corporate Leverage
     

Chapter Two : Household Debt and Financial Stability

Chapter 2 examines the short- and medium-term implications for economic growth and financial stability of the past decades’ rise in household debt. The chapter documents large differences in household debt-to-GDP ratios across countries but a common increasing trajectory that was moderated but not reversed by the global financial crisis. Among advanced economies, the median household debt-to-GDP ratio rose to 63 percent in 2016 from 52 percent in 2008. Among emerging economies, it increased to 21 percent from 15 percent over the same period. The chapter finds a trade-off between a short-term boost to growth from higher household debt and a medium-term risk to macroeconomic and financial stability that may result in lower growth, consumption, and employment and a greater risk of banking crises. This trade-off is stronger when household debt is higher, but can be significantly attenuated by a combination of good policies, institutions, and regulations. These include appropriate macroprudential and financial sector policies, better financial supervision, less dependence on external financing, flexible exchange rates and lower income inequality.  

 

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Table of Contents and Data  
Summary
Introduction
How Does Household Debt Affect Macroeconomic and Financial Stability
Developments in Household Debt around the World
Financial Stability Risks of Household Debt: Empirical Analysis
Conclusions and Policy Implications

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2.1. Household Debt-to-GDP Ratio in Advanced and Emerging Market Economies
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2.2. First- and Second-Round Effects of the Buildup of Household Debt on Financial Stability
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2.3. Growth and Composition of Household Debt by Region
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2.4. Household Debt: Evidence from Cross-Country Panel Data
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2.5. Effects of Household Debt on GDP Growth and Consumption
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2.6. Effects of Household Debt on GDP Growth: Robustness Tests
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2.7. Micro-Level Evidence Corroborating the Macro Impact
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2.8. Banking Crises and the Role of Household Debt
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2.9. Bank Equity Returns and Household Debt
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2.10. The Impact of Household Debt by Country and Institutional Factors

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2.1. Long-Term Growth and Household Debt
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2.2. Distributional Aspects of Household Debt in China
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2.3. A Comparison of US and Canadian Household Debt
 
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2.4. The Nexus between Household Debt, House Prices, and Output
 
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2.5. The Impact of Macroprudential Policies on Household Credit
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Annex Figure 2.1.1. Loan Characteristics, Rules, and Regulations

Chapter Three : Financial Conditions and Growth at Risk

The global financial crisis showed policymakers that financial conditions can offer valuable information about risks to future growth and provide a basis for targeted preemptive action. Chapter 3 develops a new macroeconomic measure of financial stability by linking financial conditions to the probability distribution of future GDP growth and applies it to a set of 21 major advanced and emerging market economies. The chapter shows that changes in financial conditions shift the whole distribution of future GDP growth. Wider risk spreads, rising asset price volatility, and waning global risk appetite are significant predictors of increased downside risks to growth in the near term, and higher leverage and credit growth provide relevant signals of such risks in the medium term. A retrospective real-time analysis of the global financial crisis shows that forecasting models augmented with financial conditions would have assigned a considerably higher likelihood to the economic contraction that followed than those based on recent growth alone. This confirms that the analytical approach developed in the chapter can be a significant addition to policymakers’ macro-financial surveillance toolkit.  


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Table of Contents and Data
Summary
Introduction
Financial Conditions and Risks to Growth: Conceptual Issues
How Do Changes in Financial Conditions Indicate Risks to Growth?
How Well Do Changes in Financial Conditions Forecast Downside Risks To Growth?
Policy Implications

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3.1. Tighter Financial Conditions Forecast Greater Downside Tail Risk to Global Growth
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3.2. Risk of Severe Recessions Is Especially Sensitive to a Tightening of Financial Conditions in   Major Advanced and Emerging Market Economies
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3.3. In Emerging Market Economies, Changes in Financial Conditions Also Affect Upside Risks
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3.4. Higher Price of Risk Is a Significant Predictor of Downside Growth Risks within One Year
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3.5. Rising Leverage Signals Higher Downside Growth Risks at Longer Time Horizons
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3.6. Waning Global Risk Appetite Signals Imminent Downside Risks to Growth
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3.7. Probability Densities of GDP Growth for the Depths of the Global Financial Crisis
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3.8. In-Sample and Recursive Out-of-Sample Quantile Forecasts: One Quarter Ahead
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3.9. In-Sample and Recursive Out-of-Sample Quantile Forecasts: Four Quarters Ahead
Annex Figures
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3.1 Financial Vulnerabilities and Growth Hysteresis in Structural Models
Data Appendix
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One-Year-Ahead Density Forecasts and Financial Conditions Indicies-All Economies in the Sample

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