How an Extended Period of Low Growth Could Reshape the Financial Industry

IMF Blog, April 6, 2017

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Canonical URL: How an Extended Period of Low Growth Could Reshape the Financial Industry

Publication: April 6, 2017.
Authors: Gaston Gelos, Jay Surti.
Core question: What happens if advanced economies remain stuck in a long-lasting funk marked by tepid growth, low interest rates, aging populations and stagnant productivity?
Historical context noted: interest rates and economic growth have been low since the financial crisis in 2008; uncertainty whether this is temporary or a “new normal.”
Comparative experience: Japan offers an example of the impact on banks.
IMF timing: The IMF will release more analysis from the Global Financial Stability Report on April 19.

The yield curve has flattened (difference between short-term and long-term interest rates).
For banks:
- Banks generally borrow relatively cheaply for short periods and lend for longer periods at higher rates; a flattened yield curve means less revenue.
- Banks typically find it difficult to lower rates on deposits to below zero, so lower rates tend to depress margins.
- Aging populations and slow growth imply a likely decline in demand for credit from households; higher lending volumes can’t compensate for low margins.
- By contrast, demand for fees-based and transactional services can be expected to rise.

Smaller, deposit-funded and less diversified banks will be hurt most in such a scenario.
- They may be pushed to reduce costs to preserve profits, and ultimately into mergers or bankruptcy.
Larger banks:
- Are likely to diversify abroad as they seek new, more profitable outlets in emerging markets.

Life insurance companies:
- Face threats to their profits and solvency.
- Their assets, or investments such as bonds, are often shorter-term than their liabilities, or the policies they write.
- They may have to reinvest maturing assets at lower yields while continuing to make high payouts on their policies.
- As a result, they may be forced to raise more capital.
Pension funds:
- Like life-insurance companies, may need more capital.
- They would also have to reduce benefits in the long term.
- The transition from defined-benefit to defined payment pension plans continues.

Asset managers see their market share grow as more people invest retirement savings in stocks, bonds and mutual funds.
They may also grab business from insurance companies as savers seek alternatives to lower-yielding guaranteed products such as whole-life policies.
Supervision concerns:
- Asset management firms may need closer supervision as their its share of the financial system continues to grow.
- Regulators may need to monitor threats to financial stability posed by the increasing popularity of passive index-linked funds, which may reduce diversity of investments and encourage herd behavior among fund managers.

Make it easier to consolidate or liquidate failing firms, allowing remaining banks to improve their profitability.
Limit incentives for banks to take on excessive financial risk.
Introduce frameworks that recognize the financial conditions of insurance companies and pension funds by consistently evaluating assets and liabilities based on economic value, if they haven’t yet done so.
Consider closer supervision of asset management firms, with particular attention to passive index-linked funds and potential systemic risks from reduced investment diversity and herd behavior.

Source: IMF blog article "How an Extended Period of Low Growth Could Reshape the Financial Industry" (April 6, 2017) by Gaston Gelos and Jay Surti.

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