Global Financial Stability Outlook CEPS, Brussels, October 25, 2017 - - PowerPoint PPT Presentation

Global Financial Stability Outlook

CEPS, Brussels, October 25, 2017

Tobias Adrian

Financial Counsellor and Director, Monetary and Capital Markets Department

Near Term Global Financial Stability Risks Improving

Away from center signifies higher risks, easier monetary and financial conditions, or higher risk appetite

Emerging market risks Risk appetite Monetary & financial Market & liquidity risks Credit risks Macroeconomic risks

Risks Conditions

1

Apr 2017 GFSR Oct 2017 GFSR Global Financial Crisis

Core Banking System More Resilient

2

Improving Capital and Liquidity

(Percent)

Improving Resilience but Profitability Challenges Remain

4.0 4.5 5.0 5.5 6.0 6.5 7.0 7.5 110 115 120 125 130 135 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Deposits to Loans Ratio Adjusted Capital / Assets Profitability Challenges Remain

(Percent of Assets)

48 49 36 29 15 52 51 64 71 85 10 20 30 40 50 60 70 80 90 2016 2017E 2018E 2019E Target Banks’ Target

Market Risks Are Rising

3

Gradual Central Bank Balance Sheet Reduction

(Central Bank Outstanding Assets, Trillions of USD)

Monetary Policy Support: Still Needed

Prolonged Low Policy Rates

(Market Implied Policy Rates, Percent)

1.76 0.22 0.03 0.97

• 0.50
• 0.25

0.00 0.25 0.50 0.75 1.00 1.25 1.50 1.75 Current 2017 2018 2019 2020 United States United Kingdom Japan Euro Area 2022 UK

Analysts’ Projections

2 4 6 8 10 12 14 16 2005 2008 2011 2014 2017 2020 Aggregate Japan Euro Area United States

2 4 6 8 10 12 14

• 1 to 0

0 to 1 1 to 2 2 to 3 3 to 4 4 to 5 5 to 6 6 to 7 7 to 8 >8 Yield (Percent)

4

Fewer Yielding Assets…

(Global Investment-Grade Fixed Income Instruments)

But The Search For Yield Is Going Too Far

… Compressing Premiums As Credit Quality Worsens

(Market Risk Premium, Share of IG BBB Bonds)

$16tn $2tn 2007 2017 100 200 300 400 500 600 20 25 30 35 40 45 50 2006 2007 2009 2010 2012 2013 2015 2016

Basis Points Percent

Market Risk Premium Credit Quality

2017

US $tn

5

Low Volatility and Rising Valuations…

(AE Assets, Percentile Rank)

The Volatility Paradox: Low Volatility Breeds Complacency

… Leading to Rising Leverage And Complacency

• 4
• 3
• 2
• 1

1 2 3 4

• 2.0
• 1.5
• 1.0
• 0.5

0.0 0.5 1.0 1.5 2.0

00 02 04 06 08 10 12 14 16 Credit Gap (percentage points) Standard deviations from mean 2000

Credit gap (right scale) Model-based probability

• f default

(left scale) Financing conditions (left scale)

Volatilities Govt bond Corp bond Housing Equities 2017 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

6

Debt Continues To Rise…

(Average Debt-to-GDP Ratios for G20 Economies, Percent)

Higher Leverage And Debt Service Challenges

.. Increasing Debt Service Burdens

(Deviation From Mean, Percentage Points, 2016)

20 30 40 50 60 70 90 92 94 96 98 00 02 04 06 08 10 12 14 16

General Government Non-Financial Companies Households

1990 AUS CAN FRA DEU ITA JPN KOR GBR USA BRA CHN IND IDN MEX RUS ZAF TUR

• 3
• 2
• 1

1 2 3 4 5 6

• 40
• 20

20 40 60 80 100 Debt service ratio Debt-to-GDP

7

Short Term Expansions May Pose Future Risks to Growth

(Growth Effect of a 1 Percent Increase in HH Debt to GDP, Percent)

Rising Household Debt Could Challenge Growth

Macroprudential Policies Can Curb Household Credit Growth

(Impact of a Tightening on Real Household Credit Growth, Percentage Points)

Effective Policies & Institutions Could Mitigate These Risks

(Growth Effect at t+3 of a 1 Percent Increase in HH Debt to GDP, Percent)

• 1.00
• 0.75
• 0.50
• 0.25

0.00 Advanced Economies Emerging Economies

• 0.25
• 0.20
• 0.15
• 0.10
• 0.05

0.00 0.05 0.10 0.15 t t+3 Years Advanced Economies Emerging Economies

• 0.75
• 0.50
• 0.25

0.00 0.25 0.50 Least Effective Average Most Effective

Emerging Markets: Still Waters?

8

Regulatory Tightening of Small and Medium Sized Banks…

(Monthly Change, Three Month Average, Billions of RMB)

China: A Delicate Balancing Act

… Could Impact Credit Growth

(Credit Growth Under Shadow Credit Growth Assumption; Percent)

• 400
• 200

200 400 600 800 1,000 1,200 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Mar-17 Jun-17

On-balance sheet shadow credit Unsecured interbank borrowing

6 8 10 12 14 16 18 20 22 2014 2015 2016 2017

Zero shadow credit growth

2017E

Portfolio Flows Have Rebounded

(Billions of USD, Four-quarter Rolling Sum)

Benign External Conditions, but EM Vulnerabilities Remain

50 150 250 350 450 550 650 750 2002 2005 2008 2011 2014 2017

Risk Premiums Have Compressed

(Market Risk + Term Premium, Basis Points)

• 100

100 200 300 400 2000 2002 2004 2006 2008 2010 2012 2014 2016 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5 2003 2005 2007 2009 2011 2013 2015

75th percentile 25th percentile Mean

Corporate Leverage Remains High

(Total Debt to EBITDA, Multiple) 9

2016

10

Bond Issuance Has Risen Sharply…

Low Income Countries: Benefits and Challenges

… Pushing Up Debt Burdens

(Change From 2012 to 2018)

2 4 6 8 10 12 1 2 3 4 5 6 7 8 9 2009 2010 2011 2012 2013 2014 2015 2016 2017YTD

Africa Asia Latin America Number of issuers (RHS)

20 40 60 80 100 5 10 15 20 25 30 35

Public gross debt (percent of GDP) VNM RWA CIV HND TZA CMR ZMB ETH MOZ GHA NGA Public interest expenses to revenues (percent) KEN

US $bn Number

Is Growth At Risk?

11

Growth-at-Risk

Rising Leverage Foresees a Riskier Outlook

(Probability Density Forecasts for GDP Growth Made One Year Earlier)

Annualized GDP growth (percent) Probability

• 2

2 4 6

• 8
• 6
• 4
• 2

2 4 6 8 2005 2006 2007 2008 2009 2010 2011 2012 2013 Standard Deviations Percent

Median

Downside and upside risks (5th and 95th percentiles)

• 14.5

Lower growth and tighter financial conditions

FCI (RHS)

A Tightening of Global Financial Conditions Suggests An Increase In Global Economy Tail Risks 0.00 0.05 0.10 0.15 0.20 0.25

• 6
• 4
• 2

2 4 6 8

With asset prices With asset prices and leverage Without asset prices and leverage

12

Downside Scenario

Could The Global Recovery Be Derailed?

Output Losses Are Substantial and Broad-Based

(Percent of Countries; Output Loss Relative to the Baseline)

2017-2019 2020-2022

Continued search for yield Spreads compressed Low volatility Increasing leverage Increased risk aversion Credit spreads decompress Volatility shifts higher Debt service pressures mount

High Impact Medium Impact Low Impact

18 30 52 1.7%

Beware Of Complacency

…but vulnerabilities are building underneath… Conditions appear calm

• n the surface…

…that could put growth at risk

13

Policy Recommendations

Beware of complacency and safeguard against a build-up of financial vulnerabilities

• Extend the perimeter of macroprudential policies
• EMs: Enhance financial sector resilience
• China: Rein in shadow credit and lower financial risks
• Ensure proactive oversight of bank business models
• Globally: Complete the financial regulatory reform agenda

14