Financial Stability Improves, But Rising Vulnerabilities Could Put Growth at Risk

IMF Blog, October 11, 2017

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Article by Tobias Adrian, October 11, 2017.
Global financial system is strengthening due to healthy economic growth, buoyant markets, and low interest rates.
Simultaneously, rising financial vulnerabilities are building and could threaten the recovery if left unchecked.

Big, globally systemic banks have added $1 trillion to their capital buffers since 2009.
Overseas investment into emerging market and low income economies has increased.
The global economic upswing is creating prospects for a sustained recovery and a return of monetary policy to normal settings.

Before the crisis, there were $16 trillion in relatively safe, investment-grade bonds yielding more than 4 percent; that has dwindled to just $2 trillion today.
Excess liquidity and scarce high-yielding safe assets are driving investors into riskier and less liquid assets, increasing potential losses if markets tumble.

Borrowing by governments, households and companies (not including banks) in the Group of 20 exceeds $135 trillion, equivalent to about 235 percent of their combined gross domestic product.
Despite low interest rates, debt servicing burdens have risen in several economies.
Chapter two of the Global Financial Stability Report linked growth in household debt relative to GDP with a greater probability of a banking crisis.

Banking sector assets have risen to 310 percent of GDP, up from 240 percent at the end of 2012, and are nearly three times the emerging-market average.
Rapid credit growth, including “shadow” lending and wealth management products, poses elevated financial stability risks, especially for smaller banks.
Authorities have taken steps to address risks, but broader reform measures are necessary to reduce reliance on rapid credit growth.

Expanded access to international bond markets has financed infrastructure projects, debt refinancing, and repayment of arrears.
This borrowing has been accompanied by an underlying deterioration of debt burdens as measured by the debt service ratio.

Supervisors should scrutinize bank business models to ensure sustainable profitability.
Almost one-third of systemically important banks, with $17 trillion in assets, are estimated to struggle to achieve the profitability needed to ensure resilience to shocks.

Major central banks should avoid creating market turbulence by thoroughly explaining plans to gradually unwind crisis-era policies.
Financial regulators should deploy macroprudential policies, such as limits on loan-to-value ratios for mortgages, for macro critical objectives to discourage riskier lending.
Emerging-market and low income countries should use benign external conditions to reduce vulnerabilities by enhancing underwriting standards, building capital and liquidity buffers, and increasing reserves.
Complete and fully implement the global regulatory reform agenda; global cooperation remains essential.

Benign conditions present an opportunity to address mounting vulnerabilities; policymakers should act now to prevent future shocks from derailing the global economic expansion.

Source: Financial Stability Improves, But Rising Vulnerabilities Could Put Growth at Risk (blog article by Tobias Adrian, October 11, 2017).