Loose Financial Conditions, Rising Leverage, and Risks to Macro-Financial Stability

IMF Working Papers, August 20, 2021

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Canonical URL: Loose Financial Conditions, Rising Leverage, and Risks to Macro-Financial Stability

Authors: Adolfo Barajas, Woon Gyu Choi, Ken Zhi Gan, Pierre Guérin, Samuel Mann, Manchun Wang, Yizhi Xu
Published: August 20, 2021
Series: IMF Working Papers
DOI: https://doi.org/10.5089/9781513591483.001

Authors: Adolfo Barajas, Woon Gyu Choi, Ken Zhi Gan, Pierre Guérin, Samuel Mann, Manchun Wang, Yizhi Xu
Date: August 20, 2021
Short description: After a steady increase following the global financial crisis, private nonfinancial sector leverage rose further during the COVID-19 on the back of easy financial conditions induced by unprecedented policy support. The paper investigates empirical relationships between increased leverage, financial conditions, and macro-financial stability in a sample of major advanced and emerging market economies.

Loose financial conditions contribute to leverage buildups.
There is an intertemporal tradeoff:
- Financial stability risk is lessened in the near term.
- Financial stability risk is exacerbated in the medium term.
The intertemporal tradeoff is amplified under certain conditions:
- During credit booms.
- When debt service burdens are particularly high.
- When the share of foreign currency debt is high in emerging markets.
Selected macroprudential tools can arrest leverage buildups and mitigate the intertemporal tradeoff.

Credit booms amplify the tradeoff between near-term easing of stability risk and medium-term exacerbation.
High debt service burdens increase medium-term macro-financial stability risk.
A high share of foreign currency debt in emerging markets raises vulnerability and amplifies the tradeoff.

Recognize the intertemporal nature of loose financial conditions: near-term stability gains may mask medium-term risks.
Use selected macroprudential tools proactively to:
- Arrest leverage buildups.
- Mitigate the intertemporal tradeoff between near-term and medium-term financial stability.
Pay special attention to episodes of credit booms, elevated debt service burdens, and high shares of foreign currency debt in emerging markets when designing macroprudential responses.