Global Financial Stability Reports

Global Financial Stability Report April 2018: A Bumpy Road Ahead

April 2018

Summary

Full Text  

The April 2018 Global Financial Stability Report (GFSR) finds that short-term risks to financial stability have increased somewhat since the previous GFSR.  Medium-term risks are still elevated as financial vulnerabilities, which have built up during the years of accommodative policies, could mean a bumpy road ahead and put growth at risk. Higher inflation may lead central banks to respond more aggressively than currently expected, which could lead to a sharp tightening of financial conditions. Valuations of risky assets are still stretched, and liquidity mismatches, leverage, and other factors could amplify asset price moves and their impact on the financial system. Emerging markets have generally improving fundamentals, but could be vulnerable to sudden tightening of global financial conditions. Banks have strengthened their balance sheets since the crisis, but parts of the system face a structural US dollar liquidity mismatch that could be a vulnerability. Crypto assets have features that may improve market efficiency, but they could also pose risks if used with leverage or without appropriate safeguards. Policymakers and investors must remain attuned to the risks of rising interest rates and higher market volatility. Central banks should continue to normalize policy gradually and communicate clearly, while policymakers should address vulnerabilities by deploying and developing macroprudential tools. This GFSR also examines the short- and medium-term implications for downside risks to growth and financial stability of the riskiness of corporate credit allocation. It documents the cyclical nature of the riskiness of corporate credit allocation at the global and country levels and its sensitivity to financial conditions, lending standards, and policy and institutional settings. Another chapter analyzes whether and how house prices move in tandem across countries and major cities around the world—that is, global house price synchronicity. The chapter finds a striking increase in house price synchronization across the countries and cities. It also finds that global financial conditions contribute to this synchronization, which suggests that policymakers should be alert to the possibility that shocks to house prices elsewhere may affect housing markets at home. 

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Chapter 1: A Bumpy Road Ahead

The April 2018 Global Financial Stability Report (GFSR) finds that short-term risks to financial stability have increased somewhat since the previous GFSR. Medium-term risks are still elevated as financial vulnerabilities, which have built up during the years of accommodative policies, could mean a bumpy road ahead and put growth at risk. Higher inflation may lead central banks to respond more aggressively than currently expected, which could lead to a sharp tightening of financial conditions. Valuations of risky assets are still stretched, and liquidity mismatches, leverage, and other factors could amplify asset price moves and their impact on the financial system. Emerging market have generally improving fundamentals, but could be vulnerable to sudden tightening of global financial conditions. Banks have strengthened their balance sheets since the crisis, but parts of the system face a structural US dollar liquidity mismatch that could be a vulnerability. Crypto assets have features that may improve market efficiency, but they could also pose risks if used with leverage or without appropriate safeguards. Policymakers and investors must remain attuned to the risks of rising interest rates and higher market volatility. Central banks should continue to normalize policy gradually and communicate clearly, and policymakers should address vulnerabilities by deploying and developing macroprudential tools.

Full Text    Summary   Blog
Outlook for Financial Stability
Monetary Policy Normalization in Advanced Economies
Reach for Yield or Overreach in Risky Assets?
Crypto Assets: New Coin on the Block, Reach for Yield, or Asset Price Bubble?
Vulnerabilities in Emerging Markets, Low-Income Countries, and China
Funding Challenges of Internationally Active Banks

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1.1. Global Financial Conditions
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1.2. Growth-at-Risk 
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1.3. Nonfinancial Private Sector Debt
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1.4. Market Interest Rates, Central Bank Balance Sheets, and US Financial Indicators
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1.5. Regulatory Reform – Tying Up the Loose Ends
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1.6. Term Premium Correlations, Spillovers, and Exchange Rate Relationships
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1.7. Valuations of Global Equities
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1.8. Valuations of Corporate Bonds
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1.9. Leveraged Loan Issuance, Quality, and Developments after Regulatory Guidance

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1.10. Correlations and Interconnectedness   
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1.11. Measures of Leverage and Investment Funds with Derivatives-Embedded Leverage   
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1.12. Strong Inflows into Exchange-Traded Funds Pose Challenges for the Less Liquid Fixed-Income Markets   
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1.13. Crypto Assets: Size, Price Appreciation, Realized Volatility, and Sharpe Ratio 

 
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1.14. Share of Trading Volumes across Exchanges, Crypto Assets, and Fiat Currencies   
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1.15. Improving Fundamentals, Increased Foreign Currency Issuance   
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1.16. Creditor Base and External Financing Vulnerabilities 

 
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1.17. Rising Vulnerabilities and More Complex Creditor Composition   
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1.18. Stylized Map of Linkages within China’s Financial System   
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1.19. Chinese Banking System and Financial Market Developments and Liabilities   
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1.20. Risks and Adjustment Challenges in Chinese Investment Products   
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1.21. Chinese Insurers   
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1.22. Advanced Economy Bank Health   
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1.23. US Dollar Credit Aggregates and Bank Intragroup Funding Structures   
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1.24. Non-US Banks’ International Dollar Balance Sheets   
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1.25. Non-US Banks’ International US Dollar Liquidity Ratios   
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1.26. Foreign Exchange Swap and Short-Term Bank Funding Markets
 
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1.1. The VIX Tantrum
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1.2. An Econometric Lens on What Drives Term Premiums   
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1.3. The Changing Investor Base in the US Leveraged Loan Market   


1.4. Central Bank Digital Currencies   


1.5. Regulatory Reform—Stitching Up the Loose Ends   
Online Annexes
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1.1. Option-Implied Volatility: The Quantity and Price of Risk for Stocks and Bonds
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1.2. Bank International Dollar Funding Methodology 

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Chapter 2: The Riskiness of Credit Allocation: A Source of Financial Vulnerability?

Chapter 2 takes a comprehensive look at the riskiness of corporate credit allocationthe extent to which riskier firms receive credit relative to less risky firms, its relationship to the size of credit expansions, and its relevance to financial stability analysis. It constructs four measures of the riskiness of credit allocation across a broad set of advanced and emerging market economies. The riskiness of credit allocation is cyclical at the global and country levels and rises when financial conditions and lending standards are looser. Taking it into account helps better predict full-blown banking crises, financial sector stress, and downside risks to growth at horizons up to three years. Because it is a source of vulnerability and may threaten financial stability, policymakers and supervisors should keep close watch on its evolution. This chapter also finds that a period of credit expansion is less likely to be associated with a riskier credit allocation if macroprudential policy has been tightened, the banking supervisor is more independent, the government has a smaller footprint in the nonfinancial corporate sector, and minority shareholder protection is greater.

 

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Table of Contents and Data  

Summary
Introduction
The Riskiness of Credit Allocation: Conceptual Framework  
The Riskiness of Credit Allocation and Its Evolution across Countries
The Riskiness of Credit Allocation and Macro-Financial Stability

The Role of Policy and Structural Factors  
Conclusions and Policy Implications

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2.1. Financial Conditions Have Been Loose in Recent Years
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2.2. Low-Rated Nonfinancial Corporate Bond Issuance Has Been High in Some Advanced Economies
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2.3. Key Drivers of the Riskiness of Credit Allocation
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2.4. The Riskiness of Credit Allocation Is Cyclical at the Global Level
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2.5. Selected Economies: Riskiness of Credit Allocation, 1995–2016
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2.6. The Riskiness of Credit Allocation Rises When a Credit Expansion Is Stronger
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2.7. The Association between the Size of a Credit Expansion and the Riskiness of Credit Allocation Is Greater When Lending Standards and Financial Conditions Are Looser
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2.8. The Riskiness of Credit Allocation Rises to a High Level Before a Financial Crisis, and Falls to a Low Level Thereafter
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2.9. Higher Riskiness of Credit Allocation Signals Greater Risk of a Systemic Banking Crisis
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2.10. Higher Riskiness of Credit Allocation Signals Greater Risk of Banking Sector Stress
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2.11. Higher Riskiness of Credit Allocation Signals Higher Downside Risks to GDP Growth
   
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2.12. The Association of the Riskiness of Credit Allocation with Downside Risks to GDP Growth Depends on the Size of Credit Expansion
     
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2.13. The Association of a Credit Expansion with the Riskiness of Credit Allocation Depends on Policy and Institutional Settings       
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2.1. Measuring the Riskiness of Credit Allocation
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2.2. Credit Allocation in China: Is Credit Flowing to the Most Profitable Firms?
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2.3. The Joint Dynamics of the Riskiness of Credit Allocation, Financial Conditions, Credit Expansions, and GDP Growth
 
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2.4. The High-Yield Share during a Credit Boom and Output Growth
 

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Chapter 3: House Price Synchronization: What Role for Financial Factors?

Chapter 3 analyzes whether and how house prices move in tandem across countries and major cities around the world—that is, the synchronicity of global house prices. The chapter finds an increase in house price synchronization, on balance, for 40 advanced and emerging market economies and 44 major cities. Countries’ and cities’ exposure to global financial conditions may explain rising house price synchronization. Moreover, cities in advanced economies may be particularly exposed to global financial conditions, perhaps because they are integrated with global financial markets or are attractive to global investors searching for yield or safe assets. Policymakers cannot ignore the possibility that shocks to house prices elsewhere will affect markets at home. House price synchronization in and of itself may not warrant policy intervention, but the chapter finds that heightened synchronicity can signal a downside tail risk to real economic activity. Macroprudential policies seem to have some ability to influence local house price developments, even in countries with highly synchronized housing markets, and these measures may also be able to reduce a country’s house price synchronization. Such unintended effects are worth considering when evaluating the trade-offs of implementing macroprudential and other policies.

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Table of Contents and Data

Summary
Introduction
House Price Synchronicity: A Conceptual Framework

House Price Synchronization in Countries and Cities

Analyzing Contributors to House Price Synchronization


House Price Synchronization and Risks to Growth

Policy Discussion





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3.1. House Price Gains in Selected Cities and Countries Have Been Widespread
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3.2. Widespread House Price Gains Have Accompanied Accommodative Financial Conditions (Diffusion Index of House Price Growth and Global Financial Conditions)
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3.3. Institutional Investor Participation Has Been on the Rise
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3.4. Global Financial Conditions, Portfolio Channels, and Expectations Contribute to House Price Synchronization, as Do Supply Constraints and Local Policy
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3.5. Synchronization Has Steadily Increased across Countries and Cities
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3.6. The Relative Contribution of the Global Factor Has Grown
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3.7. Instantaneous Quasi Correlation of House Price Gaps Shows Financial Cycle Properties
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3.8. Relative Contribution of the Global Factor Varies across Regions
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3.9. Economies Differ in Their House Price Interconnectedness
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3.10. Interconnectedness among Cities’ House Prices Varies 

 
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3.11. Average Country-Level Housing Market Spillovers Have Increased   
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3.12. Bilateral Links between Countries Are Associated with House Price Synchronization 

 
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3.13. Greater Financial Openness Is Associated with Higher House Price Synchronization   
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3.14. On Average, the Global Factor for House Prices Has Increased along with That for Equities   
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3.15. Global Financial Conditions, as Proxied by Global Liquidity, Have Different Associations with House Price Synchronization across Countries and Cities   
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3.16. House Price Synchronization Predicts a Downside Risk to Economic Growth at Short Horizons 

 
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3.1. Global Investors, House Price Dispersion, and Synchronicity
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Data Data 3.2. Housing as a Financial Asset
 
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  3.3. The Globalization of Farmland
 
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3.4.House Price Gap Synchronicity and Macroprudential Policies
 

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