## Weak Spots in Global Financial System Could Amplify Shocks

_IMF Blog, April 10, 2019_

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**Canonical URL:** [Weak Spots in Global Financial System Could Amplify Shocks](https://www.imf.org/en/blogs/articles/2019/04/10/weak-spots-in-global-financial-system-could-amplify-shocks)

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## Bibliographic details
- Authors: Tobias Adrian, Fabio Natalucci
- Published: April 10, 2019

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### Overview
- Authors: Tobias Adrian, Fabio Natalucci
- Date: April 10, 2019
- Central message: Vulnerabilities across advanced and emerging market economies are rising and—if they continue to build amid still-easy financial conditions—could amplify shocks to the global economy and raise the odds of a severe economic downturn a few years down the road.
- Short-term risks: "still low by historical standards" but "slightly higher" than in the October 2018 Global Financial Stability Report.
- Medium-term risks: "remain elevated."

### Quantitative framework introduced
- Purpose: Quantify vulnerabilities in the financial system so policymakers can monitor them in real time and take preventive steps.
- Scope: Framework encompasses six sectors—corporates, households, governments, banks, insurance companies, and other financial institutions (including "shadow banks").
- Metrics tracked: Level and pace of change in vulnerabilities, including leverage, maturity and liquidity mismatches of assets and liabilities, and currency exposures.
- Coverage: Aggregates across 29 systemically important countries.

### Key vulnerabilities by region and sector
- Advanced economies:
  - Corporate debt and financial risk-taking have increased.
  - Creditworthiness of borrowers has deteriorated.
  - "The stock of bonds with BBB ratings has quadrupled, and the stock of speculative-grade credits has almost doubled in the United States and the euro area since the crisis."
  - Concern about leveraged loans to highly indebted borrowers.
- Euro area:
  - Fiscal challenges in some countries could drive bond yields sharply higher, causing significant losses for banks with large holdings of government debt.
  - Insurance companies could also face losses.
  - This "sovereign-financial sector nexus" recalls dynamics from the euro crisis in 2011.
  - Mitigants: banks have higher capital ratios today, and policymakers have taken steps to address nonperforming loans.
- China:
  - Declining bank profitability and "capital levels remain low at small and medium-size lenders."
  - This constrains credit to smaller private firms.
  - Further monetary and credit support may increase financial stability risks by making it harder for smaller banks to clean up balance sheets.
- Emerging markets:
  - Overseas portfolio investments increasingly run by managers who seek to match returns of popular indexes.
  - "The value of fixed-income, benchmark-driven investments has quadrupled in the past ten years to $800 billion."
  - Index-driven funds expand the investor base but increase vulnerability to sudden reversals of capital flows.

### Specific statistics and exact phrasings to note
- "The stock of bonds with BBB ratings has quadrupled."
- "The stock of speculative-grade credits has almost doubled in the United States and the euro area since the crisis."
- "The value of fixed-income, benchmark-driven investments has quadrupled in the past ten years to $800 billion."
- Short-term assessment: "short-term risks to global financial stability are still low by historical standards, though they are slightly higher than we found in our October 2018 Global Financial Stability Report."
- Medium-term assessment: "risks remain elevated."

### Policy recommendations and tools
- Macroprudential measures:
  - Use macroprudential tools to cool credit growth and strengthen system resilience.
  - Example: countercyclical capital buffers requiring banks to increase capital when credit is growing.
- Corporate-debt-heavy countries:
  - Develop tools to limit the riskiness of credit to firms, especially credit from nonbank lenders.
- Euro area:
  - Lower the debt-to-GDP ratio among highly indebted governments.
  - Further repair banks' balance sheets, including reducing non-performing loans.
- China:
  - Continue reducing leverage in the financial sector, especially in shadow banking.
  - Ensure lenders build capital buffers.
  - Promptly carry out announced reforms to address risks in investment products.
- Emerging market economies:
  - Limit reliance on short-term overseas debt.
  - Ensure adequate foreign currency reserves and fiscal buffers.
  - Use flexible exchange rates to absorb shocks.
- Monetary policy stance:
  - In some circumstances, countries with strong economies and inflation at or above target can consider using monetary policy to "lean against the wind."
  - Trade-off highlighted: patient monetary policy can accommodate downside risks now, but if financial conditions remain easy for too long, vulnerabilities will continue to build and increase the odds of a sharp drop in economic growth later.

### Risks, trade-offs, and outlook
- Vulnerabilities can amplify sudden shocks such as:
  - Sharper-than-anticipated economic slowdown.
  - Unexpected shift in monetary policy.
  - Escalation of trade tensions.
- Trade-off for policymakers:
  - A patient approach to monetary policy may be warranted to counter slowing growth.
  - But prolonged easy financial conditions risk building vulnerabilities that increase medium-term downside risks.
- Overall assessment: With the right mix of policies, countries "can sustain growth while keeping vulnerabilities in check."

*Source: Tobias Adrian and Fabio Natalucci, April 10, 2019*

---


## References

- [عربي](https://www.imf.org/ar/News/Articles/2019/04/09/blog-gfsr-weak-spots-in-global-financial-system-could-amplify-shocks)
- [日本語](https://www.imf.org/ja/News/Articles/2019/04/09/blog-gfsr-weak-spots-in-global-financial-system-could-amplify-shocks)
- [Português](https://www.imf.org/pt/News/Articles/2019/04/09/blog-gfsr-weak-spots-in-global-financial-system-could-amplify-shocks)
- [Global Financial Stability Report](https://www.imf.org/en/publications/gfsr)
- [World Economic Outlook.](https://blogs.imf.org/2019/04/09/the-global-economy-a-delicate-moment/)
- [https://www.imf.org/wp-content/uploads/2019/04/gfsr-ch1-1.png](https://www.imf.org/wp-content/uploads/2019/04/gfsr-ch1-1.png)
- [Global Financial Stability Report](https://blogs.imf.org/2018/10/09/the-financial-system-is-stronger-but-new-vulnerabilities-have-emerged-in-the-decade-since-the-crisis/)
- [https://www.imf.org/wp-content/uploads/2019/04/gfsrch1-2.png](https://www.imf.org/wp-content/uploads/2019/04/gfsrch1-2.png)
- [https://www.imf.org/wp-content/uploads/2019/04/gfsrch1-3.png](https://www.imf.org/wp-content/uploads/2019/04/gfsrch1-3.png)
- [blog](https://blogs.imf.org/2018/11/15/sounding-the-alarm-on-leveraged-lending/)
- [https://www.imf.org/wp-content/uploads/2019/04/gfsrch1-4.png](https://www.imf.org/wp-content/uploads/2019/04/gfsrch1-4.png)
- [https://www.imf.org/wp-content/uploads/2019/04/gfsrch1-5.png](https://www.imf.org/wp-content/uploads/2019/04/gfsrch1-5.png)
- [Assessing the Risk of the Next Housing Bust](https://blogs.imf.org/2019/04/04/assessing-the-risk-of-the-next-housing-bust/)
- [Risky Business: Reading Credit Flows for Crisis Signals](https://blogs.imf.org/2018/04/10/risky-business-reading-credit-flows-for-crisis-signals/)

_Source: https://www.imf.org/en/blogs/articles/2019/04/10/weak-spots-in-global-financial-system-could-amplify-shocks_