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 Risks Emerging market risks Credit risks Apr 2017 GFSR Oct 2017 GFSR Global Financial Crisis Macroeconomic Market & liquidity risks risks Away from center signifies higher risks, easier monetary and financial conditions, or higher risk appetite Monetary & financial Risk appetite Conditions 1
Core Banking System More Resilient
Improving Resilience but Profitability Challenges Remain Profitability Challenges Remain Improving Capital and Liquidity (Percent of Assets) (Percent) 135 7.5 90 85 80 7.0 130 70 Deposits to 71 6.5 Loans Ratio 60 64 125 6.0 50 52 Adjusted 49 48 40 Capital / 5.5 51 120 Assets 36 30 5.0 29 20 115 4.5 10 15 110 4.0 0 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Banks’ 2016 2017E 2018E 2019E Target Target 2
Market Risks Are Rising
Monetary Policy Support: Still Needed Gradual Central Bank Balance Sheet Reduction Prolonged Low Policy Rates ( Central Bank Outstanding Assets, Trillions of USD) (Market Implied Policy Rates, Percent) Analysts’ 16 1.75 Projections 1.76 1.50 14 United States 1.25 12 Aggregate Japan 0.97 1.00 10 United Kingdom 0.75 8 0.50 Euro Area 0.22 6 0.25 Euro Area 4 0.00 UK 0.03 Japan -0.25 2 United States -0.50 0 Current 2017 2018 2019 2020 2005 2008 2011 2014 2017 2020 2022 3
But The Search For Yield Is Going Too Far … Compressing Premiums Fewer Yielding Assets… (Global Investment-Grade Fixed Income Instruments) As Credit Quality Worsens (Market Risk Premium, Share of IG BBB Bonds) US $tn 50 600 2017 14 45 500 12 Credit Quality 10 40 400 2007 Basis Points 8 35 300 Percent 6 30 200 4 $16tn 2 25 100 Market $2tn Risk Premium 0 20 0 -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 2017 2006 2007 2009 2010 2012 2013 2015 2016 Yield (Percent) 4
The Volatility Paradox: Low Volatility Breeds Complacency Low Volatility and Rising Valuations… … Leading to Rising Leverage And Complacency (AE Assets, Percentile Rank) 4 2.0 Model-based probability Financing of default 3 Volatilities 1.5 Standard deviations from mean Credit Gap (percentage points) conditions (left scale) (left scale) 2 1.0 Govt bond 1 0.5 Corp bond 0 0.0 -1 -0.5 Housing -2 -1.0 Equities Credit gap -3 -1.5 (right scale) 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 -4 -2.0 2000 00 02 04 06 08 10 12 14 16 5
Higher Leverage And Debt Service Challenges Debt Continues To Rise… .. Increasing Debt Service Burdens (Average Debt-to-GDP Ratios for G20 Economies, Percent) (Deviation From Mean, Percentage Points, 2016) Debt service ratio 70 General Government CHN 6 TUR 5 60 4 RUS CAN 3 BRA 50 2 FRA AUS Non-Financial Companies IND 1 KOR MEX 40 0 IDN ITA ZAF -1 30 GBR -2 Households USA DEU JPN -3 20 -40 -20 0 20 40 60 80 100 1990 90 92 94 96 98 00 02 04 06 08 10 12 14 16 Debt-to-GDP 6
Rising Household Debt Could Challenge Growth Short Term Expansions May Effective Policies & Institutions Macroprudential Policies Can Pose Future Risks to Growth Could Mitigate These Risks Curb Household Credit Growth (Growth Effect of a 1 Percent Increase (Growth Effect at t+3 of a 1 Percent Increase (Impact of a Tightening on Real Household in HH Debt to GDP, Percent) in HH Debt to GDP, Percent) Credit Growth, Percentage Points) Advanced Emerging Advanced Economies Least Most 0.15 Economies Economies Effective Average Effective Emerging Economies 0.00 0.50 0.10 0.05 0.25 0.00 -0.25 -0.05 0.00 -0.10 -0.50 -0.25 -0.15 -0.20 -0.50 -0.75 -0.25 t t+3 -0.75 Years -1.00 7
Emerging Markets: Still Waters?
China: A Delicate Balancing Act Regulatory Tightening of Small and Medium Sized Banks… … Could Impact Credit Growth (Monthly Change, Three Month Average, Billions of RMB) (Credit Growth Under Shadow Credit Growth Assumption; Percent) 1,200 22 On-balance sheet 1,000 20 shadow credit 800 18 600 16 400 14 200 12 Zero shadow 10 0 credit Unsecured 8 -200 growth interbank borrowing 6 -400 2017E 2014 2015 2016 2017 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Mar-17 Jun-17 8
Benign External Conditions, but EM Vulnerabilities Remain Risk Premiums Have Compressed Portfolio Flows Have Rebounded Corporate Leverage Remains High (Market Risk + Term Premium, Basis Points) (Billions of USD, Four-quarter Rolling Sum) (Total Debt to EBITDA, Multiple) 750 400 4.5 75 th percentile 650 4.0 300 550 3.5 200 450 Mean 3.0 350 2.5 100 250 2.0 0 150 1.5 25 th percentile 50 1.0 -100 2002 2005 2008 2011 2014 2017 2003 2005 2007 2009 2011 2013 2015 2000 2002 2004 2006 2008 2010 2012 2014 2016 2016 9
Low Income Countries: Benefits and Challenges Bond Issuance Has Risen Sharply… … Pushing Up Debt Burdens (Change From 2012 to 2018) US $bn Number 9 12 Africa 100 Asia 8 MOZ Public gross debt (percent of GDP) 10 Latin America 7 80 6 8 GHA VNM ZMB 5 KEN 60 ETH 6 HND 4 Number of CIV 40 3 4 issuers (RHS) RWA 2 NGA 2 TZA 20 1 CMR 0 0 0 2009 2010 2011 2012 2013 2014 2015 2016 2017YTD 0 5 10 15 20 25 30 35 Public interest expenses to revenues (percent) 10
Is Growth At Risk?
Growth-at-Risk A Tightening of Global Financial Conditions Suggests Rising Leverage Foresees a Riskier Outlook An Increase In Global Economy Tail Risks (Probability Density Forecasts for GDP Growth Made One Year Earlier) 8 Downside and upside risks -2 0.25 FCI (RHS) (5 th and 95 th percentiles) With asset prices Without asset 6 and leverage prices and 0.20 leverage 4 0 Standard Deviations 2 0.15 Probability Percent Median With asset 0 2 prices 0.10 -2 -4 4 Lower growth 0.05 and tighter -6 financial conditions -14.5 0.00 -8 6 -6 -4 -2 0 2 4 6 8 2005 2006 2007 2008 2009 2010 2011 2012 2013 Annualized GDP growth (percent) 11
Could The Global Recovery Be Derailed? Output Losses Are Substantial and Broad-Based Downside Scenario (Percent of Countries; Output Loss Relative to the Baseline) 2020-2022 2017-2019 18 1.7% 52 30 Continued search for yield Increased risk aversion High Impact Medium Impact Low Impact Spreads compressed Credit spreads decompress Low volatility Volatility shifts higher Increasing leverage Debt service pressures mount 12
Beware Of Complacency Conditions appear calm on the surface… …but vulnerabilities are building underneath… …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
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