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Global Financial Stability Report
Global Financial Stability Report, April 2021: Preempting a Legacy of Vulnerabilities
April 2021
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April 2021
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Extraordinary policy measures have eased financial conditions and supported the economy, helping to contain financial stability risks. Chapter 1 warns that there is a pressing need to act to avoid a legacy of vulnerabilities while avoiding a broad tightening of financial conditions. Actions taken during the pandemic may have unintended consequences such as stretched valuations and rising financial vulnerabilities. The recovery is also expected to be asynchronous and divergent between advanced and emerging market economies. Given large external financing needs, several emerging markets face challenges, especially if a persistent rise in US rates brings about a repricing of risk and tighter financial conditions. The corporate sector in many countries is emerging from the pandemic overindebted, with notable differences depending on firm size and sector. Concerns about the credit quality of hard-hit borrowers and profitability are likely to weigh on the risk appetite of banks. Chapter 2 studies leverage in the nonfinancial private sector before and during the COVID-19 crisis, pointing out that policymakers face a trade-off between boosting growth in the short term by facilitating an easing of financial conditions and containing future downside risks. This trade-off may be amplified by the existing high and rapidly building leverage, increasing downside risks to future growth. The appropriate timing for deployment of macroprudential tools should be country-specific, depending on the pace of recovery, vulnerabilities, and policy tools available. Chapter 3 turns to the impact of the COVID-19 crisis on the commercial real estate sector. While there is little evidence of large price misalignments at the onset of the pandemic, signs of overvaluation have now emerged in some economies. Misalignments in commercial real estate prices, especially if they interact with other vulnerabilities, increase downside risks to future growth due to the possibility of sharp price corrections.
Thanks to extraordinary policy support and progress on vaccination, the global economy is beginning to emerge from the worst phases of the pandemic, albeit with prospects diverging starkly across countries. The measures may have unintended consequences on stretched valuations and rising financial vulnerabilities. Given large external financing needs, many emerging markets face challenges, especially if a persistent rise in US rates brings about a repricing of risk and tighter financial conditions. The corporate sector in many countries is emerging from the pandemic overindebted, with notable differences depending on firm size and sector. Concerns about the credit quality of hard-hit borrowers and profitability are likely to weigh on the risk appetite of banks. Therefore, ongoing support remains necessary, but there is a pressing need to act to avoid a legacy of vulnerabilities while avoiding a broad tightening of financial conditions. Policymakers should support balance sheet repair, by strengthening management of nonperforming assets. Rebuilding buffers in emerging markets should also be a priority to prepare for a possible repricing of risk and a reversal of capital flows.
Nonfinancial firms and households came into the coronavirus disease (COVID-19) crisis with historically high levels of leverage on the back of relatively loose financial conditions prevailing since the global financial crisis. The extraordinary policy support that helped to cushion the impact of the COVID-19 shock also contributed to a further increase in nonfinancial sector leverage. This chapter focuses on major advanced and emerging market economies to examine the risks of high and rapidly rising leverage for macro-financial stability. The analysis finds that an easing of financial conditions tends to accelerate buildups in leverage. This further complicates the challenging intertemporal policy trade-off that arises because loose financial conditions, while providing a short-term boost to growth, also accentuate downside risks to growth in the medium term. Macroprudential policy can temper leverage buildups and strengthen resilience, thus mitigating future financial stability risks. While policy support remains necessary in the near term to aid economic recovery, policymakers should be mindful of the increasing macro-financial stability risks resulting from high leverage and consider taking early action to tighten selected macroprudential tools to address rising nonfinancial sector vulnerabilities. As the nonbank financial sector expands its role in providing financing to the nonfinancial sector, urgent efforts should be made to develop the toolkit for this sector.
The coronavirus disease (COVID-19) crisis has hit the commercial real estate sector hard. Containment measures implemented in response to the pandemic severely affected economic activity and reduced the demand for commercial property. Part of the adverse impact—particularly on the retail, office, and hotel segments—could be permanent, as some activities may continue to take place virtually in the future and others may relocate outside of large cities. The large size of the commercial real estate sector and its heavy reliance on debt funding suggest that these developments may have potentially significant implications for financial stability. Against this backdrop, this chapter attempts to identify and quantify financial stability risks arising from the commercial real estate market and discusses policy tools available to mitigate such risks. While the path of recovery in this sector will depend inherently on the structural shifts induced by the pandemic, continued policy support remains warranted at the current juncture to keep financial conditions easy and stimulate aggregate demand to aid the sector’s recovery. However, easy financial conditions may contribute to an increase in financial vulnerabilities and persistent price misalignment. Targeted macroprudential policy tools should be swiftly deployed to address such vulnerabilities. Efforts should also focus on broadening the reach of macroprudential policy to cover nonbank financial institutions, which are important players in commercial real estate funding markets.
