- International Monetary Fund
- Published Date:
- April 2014
©2014 International Monetary Fund
Joint Bank-Fund Library
Global financial stability report–Washington, DC: International Monetary Fund, 2002–
v.; cm. – (World economic and financial surveys, 0258-7440)
Some issues also have thematic titles.
1. Capital market—Development countries—Periodicals. 2. International finance—Periodicals. 3. Economic stabilization—Periodicals. I. International Monetary Fund. II. Series: World economic and financial surveys.
ISBN 978-1-48435-746-0 (paper)
Disclaimer: The analysis and policy considerations expressed in this publication are those of the IMF staff and do not represent official IMF policy or the views of the IMF Executive Directors or their national authorities.
Recommended citation: International Monetary Fund, Global Financial Stability Report—Moving from Liquidity- to Growth-Driven Markets (Washington, April 2014).
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- Assumptions and Conventions
- Executive Summary
- Chapter 1 Making the Transition from Liquidity- to Growth-Driven Markets
- Financial Stability Overview
- Normalizing U.S. Monetary Policy—A “Goldilocks” Exit?
- Box 1.1. Deleveraging Trends in Selected Advanced Economies
- Box 1.2. Is the Japanese Financial System Rebalancing, and What Are the Financial Stability Implications?
- Box 1.3 Recent Periods of Turbulence in Emerging Market Economies Emerging Markets: External Risks and Transition Challenges
- Box 1.4. Macroprudential Policy in the United States Improving Euro Area Bank Asset Quality to Support Credit
- Box 1.5. Financial Regulatory Reform: Can We Make It to the Finish Line?
- Box 1.6. Rollout of Banking Union Is Progressing, but Challenges Remain
- Box 1.7. European Union Bank Deleveraging
- Annex 1.1. Constructing Term Premium Estimates for Major Advanced Economies
- Annex 1.2. Emerging Market Corporate Sensitivity Analysis
- Annex 1.3. Exploring the Relationship between Bank Capital Buffers, Credit, and Asset Quality
- Chapter 2 How Do Changes in the Investor Base and Financial Deepening Affect Emerging Market Economies?
- Box 2.1. A Primer on Mutual Funds
- Evolving Emerging Market Assets and Their Investor Bases
- Box 2.2: Financial Deepening in Emerging Markets
- Identifying the Financial Stability Effects of Changes in the Investor Base and in Local Financial Systems
- Box 2.3: Investment Strategies of Institutional Investors
- Box 2.4: Are Investors Differentiating among Emerging Markets during Stress Episodes?
- Box 2.5. Measuring Herding
- Policy Implications and Conclusions
- Annex 2.1: Data, Main Empirical Framework, and Additional Analyses
- Chapter 3 How Big Is the Implicit Subsidy for Banks Considered Too Important To Fail?
- Is the Too-Important-to-Fail Problem Growing?
- Estimating Subsidy Values
- Box 3.1. Cross-Border Banking Linkages
- Box 3.2. Benefits and Risks of Large Banks
- Box 3.3. Estimating Implicit Too-Important-to-Fail Subsidies
- The Effects of Specific Reforms
- Policy Discussion
- Box 3.4. Banks and Sovereign Linkages
- Box 3.5. Recent Policy Initiatives Addressing the Too-Important-to-Fail Issue
- Box 3.6. Higher Loss Absorbency for Systemically Important Banks in Australia
- Annex 3.1. The Contingent Claims Analysis Approach
- Annex 3.2. The Ratings-Based Approach
- Annex: IMF Executive Board Discussion Summary
- Statistical Appendix
- 1.1.1. Indebtedness and Leverage in Selected Advanced Economies
- 1.1.2. Reduction in Gross Debt Levels in Selected Advanced Economies from the 2009–13 Peak
- 1.1. Issuance Trends for U.S. High-Yield Bonds and Loans
- 1.2. Change in 10-Year Government Bond Yields
- 1.3. Correlation and Beta between the U.S. Term Premium in the United States and other Major Advanced Economies
- 1.4. Debt, Leverage, and Credit in Selected Emerging Market Economies
- 1.5. Change in Gross Debt Levels in Selected Emerging Market Economies
- 1.6. Summary of Indicators
- 1.7.1. Large European Union Bank Deleveraging
- 1.7. Yield Curve Data Sources
- 1.8. Correlation of Term Premium Estimates
- 1.9. Sensitivity to the U.S. Term Premium
- 1.10. Granger Causality
- 1.11. Coverage of Firms by S&P Capital IQ
- 1.12. Credit Variables Used in the Vector Autoregression Exercise
- 2.1.1. Key Fund Characteristics
- 2.1.2. Shares of Types of Mutual Funds
- 2.3.1. Investment Constraints of Institutional Investors
- 2.1. Size of Global and Local Institutional Investors and Mutual Funds
- 2.2. Role of Financial Deepening in Dampening the Impact of Global Financial Shocks on Asset Prices
- 2.3. Summary of Methods and Results
- 2.4. Sample Economies
- 2.5. Definition of Variables Used in Estimations
- 2.6. Local Macroeconomic Factors and Global Financial Shocks—The Effect on Asset Prices and Portfolio Flows
- 3.1. Summary of the Estimates of Implicit Subsidies
- 3.2. Event Study
- 3.3. Summary of Policy Measures
- 3.4. Sample of Systemically Important Banks (as of 2012)
- 3.5. Benchmark Credit-Rating Estimation Results to Explain the Overall Ratings
- 3.6. Unit Rating Uplift: Robustness for Different Samples
- 1.1. Global Financial Stability Map
- 1.2. Global Financial Stability Map: Assessment of Risks and Conditions
- 1.1.1. Trends in Indebtedness in Selected Advanced Economies since the Crisis
- 1.2.1. Japanese Financial System
- 1.3.1. Asset Class Performance
- 1.3. Federal Reserve Lending Survey and Institute for Supply Management New Orders: Green Shoots?
- 1.4. U.S. Nonfinancial Corporations: Credit Cycle Indicators
- 1.5. U.S. Nonfinancial Corporations: Key Financial Indicators
- 1.6. S&P 500: Price-to-Earnings Ratio
- 1.7. Decomposition of Equity Market Performance
- 1.8. U.S. High-Yield Bond and Leveraged Loan Issuance with Lower Standards
- 1.9. Leveraged Loans: Debt-to-EBITDA Ratio for Highly Leveraged Loans
- 1.10. U.S. Nonfinancial Corporations: Market-Based Financing
- 1.11. Federal Reserve Guidance Gaining Credibility?
- 1.12. Ten-Year U.S. Treasury Rate Projections Based on Exit Scenarios
- 1.13. Global Interest Rate Scenarios
- 1.14. Bond Flows to Emerging Market Economies and Domestic Credit in the Face of Tighter External Conditions
- 1.15. Private Sector Gross Debt and Credit in Selected Emerging Market Economies
- 1.16. Current Account Balance and Real Rates Now and Before the Financial Crisis
- 1.17. Policy Space
- 1.18. Ratio of International Reserves to 2014 External Financing Requirements
- 1.19. Coverage of Current Account by Foreign Direct Investment
- 1.20. Corporate Debt in Emerging Markets
- 1.21. Emerging Market Bank Resilience
- 1.22. China: Wealth Management Products and Trusts
- 1.23. China: Selected Financial Sector Developments
- 1.24. Total and Retail Portfolio Flows to Selected Emerging Market and Other Economies
- 1.25. Share of Nonresidential Holdings of Local Currency Government Debt and Market Liquidity
- 1.26. Summary of Selected Emerging Market Policy Actions since May 2013
- 1.27. Bank Credit and Market Indicators
- 1.28. Euro Area Bank Asset Quality
- 1.7.1. Change in Large European Union Bank Core Tier 1 Capital Ratios
- 1.7.2 Changes in European Union Bank Exposures, 2010:Q4–2013:Q2
- 1.29. Euro Area Bank Profitability, Buffers, and Interest Rates
- 1.30. Assets of Banks in the Euro Area
- 1.31. Simulated Cumulative Response of Bank Corporate Credit
- 1.32. Euro Area Write-Down Potential
- 1.33. Strength of Insolvency Procedures and Nonperforming Loans in Advanced Economies, 2013
- 1.34. Sources of Nonfinancial Corporate Credit, 2013:Q3
- 1.35. Term Premium Estimates under Alternative Affine Models
- 1.36. CEMBI Model Quarterly Spreads and Model Fits
- 1.37. Vector Autoregression Model Residuals
- 1.38. Comparing the Effects on Credit of One-Time Shocks: Cumulative Impulse Response Functions
- 2.1. Investor Base for Bonds in Emerging Markets
- 2.2 Trends in Capital Flows to Emerging Markets
- 2.3. Transformation of Investment Options in Emerging Markets
- 2.4. Emerging Markets: Shares in Economic Activities and Financial Markets
- 2.2.1. Financial Deepening in Emerging Markets
- 2.3.1. Investments of Institutional Investors in Emerging Markets
- 2.5. Allocation to Emerging Market Assets
- 2.6. Integration of Emerging Market Assets into Global Markets
- 2.7. Herding among Equity and Bond Funds Investing in Emerging Markets
- 2.4.1 Role of Macroeconomic Fundamentals over Time
- 2.8. Mutual Fund and Institutional Investor Flows
- 2.9. Cumulative Monthly Portfolio Flows to Emerging Markets from Different Types of Investors during Distress Episodes
- 2.10. Flow Sensitivity to Global Financial Conditions by Fund Characteristics
- 2.11. Drivers of Global and Dedicated Funds’ Flows into Emerging Markets around the Global Financial Crisis
- 2.12. The Effects of Financial Deepening on the Sensitivities of Asset Returns to Global Risk Factor
- 2.13. Sensitivity of Local Yields to Portfolio Flows and Decline in Global Market Making
- 3.1. Effects of Too-Important-to-Fail Protection on a Simplified Bank Balance Sheet
- 3.2. Changes in the Number of Banks and the Size of the Banking Sector
- 3.3. Total Assets of Large Banks
- 3.4. Concentration in the Banking Sector
- 3.1.1. Cross-Border Banking Linkages
- 3.1.2. Global Banking Network: Core Countries
- 3.5. Bond Spread Differential between Systemically Important Banks and Other Banks
- 3.6. U.S. Banks’ Average Bond Duration
- 3.7. Bond Spread Differential for U.S. Banks with Similar Leverage
- 3.8. Mean Implicit Subsidy for Systemically Important Banks Estimated with the Contingent Claims Analysis Approach
- 3.9. Implicit Subsidy by Type of Bank in the United States
- 3.10. Average Subsidies Derived from Credit Ratings
- 3.11. Subsidies Derived from Credit Ratings for a Bank Just Below Investment Grade
- 3.12. Implicit Subsidy Values for Global Systemically Important Banks
- 3.13. Event Tree of Government Policies to Deal with Systemically Important Banks
- 3.6.1. Additional Tier 1 Capital Requirements for Systemic Banks
Assumptions and Conventions
The following conventions are used throughout the Global Financial Stability Report (GFSR):
- … to indicate that data are not available or not applicable;
- – between years or months (for example, 2013–14 or January–June) to indicate the years or months covered, including the beginning and ending years or months;
- / between years or months (for example, 2013/14) to indicate a fiscal or financial year.
“Billion” means a thousand million.
“Trillion” means a thousand billion.
“Basis points” refer to hundredths of 1 percentage point (for example, 25 basis points are equivalent to ¼ of 1 percentage point).
If no source is listed on tables and figures, data are based on IMF staff estimates or calculations.
Minor discrepancies between sums of constituent figures and totals shown reflect rounding.
As used in this report, the terms “country” and “economy” do not in all cases refer to a territorial entity that is a state as understood by international law and practice. As used here, the term also covers some territorial entities that are not states but for which statistical data are maintained on a separate and independent basis.
Further Information and Data
The data and analysis appearing in the GFSR are compiled by the IMF staff at the time of publication. Every effort is made to ensure, but not guarantee, their timeliness, accuracy, and completeness. When errors are discovered, there is a concerted effort to correct them as appropriate and feasible. Corrections and revisions made after publication are incorporated into the electronic editions available from the IMF eLibrary (www.elibrary.imf.org) and on the IMF website (www.imf.org). All substantive changes are listed in detail in the online tables of contents.
For details on the terms and conditions for usage of the contents of this publication, please refer to the IMF Copyright and Usage website, www.imf.org/external/terms.htm.
The Global Financial Stability Report (GFSR) assesses key risks facing the global financial system. In normal times, the report seeks to play a role in preventing crises by highlighting policies that may mitigate systemic risks, thereby contributing to global financial stability and the sustained economic growth of the IMF’s member countries. The global financial system is currently undergoing a number of challenging transitions on the path to greater stability. These transitions are far from complete, and stability conditions are far from normal. For advanced and emerging market economies alike, a successful shift from liquidity-driven to growth-driven markets requires a number of elements. The current report discusses these elements, including a normalization of U.S. monetary policy that avoids financial stability risks; financial rebalancing in emerging market economies amid tighter external financial conditions; further progress in the euro area’s transition from fragmentation to robust integration; and the successful implementation of Abenomics in Japan to deliver sustained growth and stable inflation. The report also examines how changes in the investor base and financial deepening affect the stability of portfolio flows and asset prices in emerging market economies. The findings suggest that changes in the composition of investors are likely to make portfolio flows to emerging market economies more sensitive to global financial conditions; however, strengthening local financial systems reduces the sensitivity of domestic financial asset prices to global financial shocks. Last, the report looks at the issue of institutions deemed too important to fail and provides new estimates of the implicit funding subsidy received by systemically important banks. The report finds that this subsidy is still sizable and calls for a strengthening of financial reforms.
The analysis in this report has been coordinated by the Monetary and Capital Markets (MCM) Department under the general direction of José Viñals, Financial Counsellor and Director. The project has been directed by Jan Brockmeijer and Peter Dattels, both Deputy Directors, as well as by Gaston Gelos and Matthew Jones, both Division Chiefs. It has benefited from comments and suggestions from the senior staff in the MCM Department.
Individual contributors to the report are Isabella Araujo Ribeiro, Nicolás Arregui, Serkan Arslanalp, Sofiya Avramova, Luis Brandao-Marques, Eugenio Cerutti, Yingyuan Chen, Julian Chow, Fabio Cortes, Pragyan Deb, Reinout De Bock, Marc Dobler, Martin Edmonds, Johannes Ehrentraud, Jennifer Elliott, Michaela Erbenova, Luc Everaert, Xiangming Fang, Florian Gimbel, Brenda González-Hermosillo, Dale Gray, Pierpaolo Grippa, Sanjay Hazarika, Geoffrey Heenan, Hibiki Ichiue, Bradley Jones, David Jones, William Kerry, Oksana Khadarina, Yoon Sook Kim, Koralai Kirabaeva, Frederic Lambert, Paul Mills, Camelia Minoiu, Prachi Mishra, Kenji Moriyama, Papa N’Diaye, Oana Nedelescu, Lam Nguyen, Erlend Nier, S. Erik Oppers, Hiroko Oura, Evan Papageorgiou, Vladimir Pillonca, Jean Portier, Shaun Roache, Luigi Ruggerone, Narayan Suryakumar, Shamir Tanna, Kenichi Ueda, Constant Verkoren, Chris Walker, Christopher Wilson, Tao Wu, and Xiaoyong Wu. Magally Bernal, Carol Franco, Juan Rigat, and Adriana Rota were responsible for wordprocessing. Joe Procopio and Linda Griffin Kean from the Communications Department edited the manuscript and managed production of the publication with assistance from Lucy Scott Morales and Linda Long.
This particular edition of the GFSR draws in part on a series of discussions with banks, securities firms, asset management companies, hedge funds, standards setters, financial consultants, pension funds, central banks, national treasuries, and academic researchers.
This GFSR reflects information available as of March 24, 2014. The report benefited from comments and suggestions from staff in other IMF departments, as well as from Executive Directors following their discussion of the Global Financial Stability Report on March 21, 2014. However, the analysis and policy considerations are those of the contributing staff and should not be attributed to the IMF, its Executive Directors, or their national authorities.
The global financial system is undergoing a number of challenging transitions on the path to greater stability. As the economic recovery in the United States gains footing, U.S. monetary policy has begun to normalize. Emerging market economies are transitioning to more sustainable growth in the financial sector, while addressing macroeconomic vulnerabilities amid a less favorable external financial environment. The euro area is strengthening bank capital positions as it moves from fragmentation to a more robust framework for integration.
These transitions are far from complete, and stability conditions are far from normal. Since October, bouts of financial turbulence have highlighted the substantial adjustment that lies ahead. In advanced economies, financial markets continue to be supported by extraordinary monetary accommodation and easy liquidity conditions. They will need to transition away from these supports if they are to create an environment of self-sustaining growth, marked by increased corporate investment and growing employment.
For advanced and emerging market economies alike, a successful shift from “liquidity-driven” to “growth-driven” markets requires a number of elements, including a normalization of U.S. monetary policy that avoids financial stability risks; financial rebalancing in emerging market economies amid tighter external financial conditions; further progress in the euro area’s transition from fragmentation to robust integration; and the successful implementation of “Abenomics” to deliver sustained growth and stable inflation in Japan.
Transition from Liquidity- to Growth-Driven Markets
The gradual shift to self-sustaining growth is most advanced in the United States, where green shoots are evident from the economic recovery under way, as noted in the April 2014 World Economic Outlook. The U.S. transition presents several challenges to financial stability. The “search for yield” is becoming increasingly extended, with rising leverage in the corporate sector and weakening underwriting standards in some pockets of U.S. credit markets. Weaker market liquidity and the rapid growth of investment vehicles that are vulnerable to redemption risk could amplify financial or economic shocks. In this transitional period, the reduction in U.S. monetary accommodation could have important spillovers to advanced and emerging market economies alike as portfolios adjust and risks are repriced.
Amid this shifting global environment, emerging market economies face their own transition challenges, but with substantial differences across economies. Private and public balance sheets have become more leveraged since the beginning of the crisis and thus are more sensitive to changes in domestic and external conditions. Macroeconomic imbalances have increased in a number of economies in the past few years, while the increased participation of foreign investors in domestic bond markets exposes some economies to an additional source of market volatility and pressure on capital flows.
These developments have created a “systemic liquidity mismatch,” that is, a disjunction between the potential scale of capital outflows and the capacity of local institutions and market makers (in particular, international banks) to intermediate them. This bottleneck could magnify the impact of any shocks emanating from other economies and broaden the impact on asset prices, particularly if asset managers seek to hedge exposures by taking positions in more liquid but unrelated markets. The mismatch could create circumstances where authorities may have to provide liquidity to particular distressed markets to keep local bond and money markets working and contain spillovers across economies.
In the corporate sector of emerging market economies, this report suggests companies in many cases have sufficient buffers to withstand normal domestic or international shocks, although some vulnerabilities are evident. In a severe and adverse scenario where borrowing costs escalate and earnings deteriorate significantly, the debt at risk held by weaker, highly leveraged firms could increase by $740 billion, rising on average to 35 percent of total corporate debt in the sample of firms. In most emerging market economies, reported bank capital buffers and profitability generally remain high and should be sufficient to absorb moderate shocks to nonfinancial companies. Nonetheless, in several economies, weak provisioning and lower levels of bank capital could present difficulties in the event of further balance sheet deterioration in the corporate sector.
In China, the challenge for policymakers is to manage an orderly transition toward more market discipline in the financial system, including the removal of implicit guarantees. In this process, investors and lenders will have to bear some costs of previous financial excesses, and market prices will need to adjust to more accurately reflect risks. Pace is important. If the adjustment is too fast, it risks creating turmoil; if too slow, it will allow vulnerabilities to continue building. Other keys to the success of an orderly transition include upgrading the central bank’s ability to address unpredictable shifts in liquidity demand, timely implementation of deposit insurance and interest rate liberalization, and strengthening the resolution framework for failed financial institutions.
In the euro area, policies implemented at both the national and European levels are supporting the transition to a more robust framework for integration, but important challenges remain. The restructuring of the debt-burdened euro area corporate sector has been stalled by the unfinished repair of bank balance sheets. Moreover, credit conditions remain difficult in stressed euro area economies. Although market sentiment regarding stressed euro area banks and sovereigns has improved markedly, it may be running ahead of the necessary balance-sheet repair. Thus, European policymakers must push ahead with a rigorous and transparent assessment of the current health of the banking system, followed by a determined cleansing of balance sheets and the removal of banks that are no longer viable. Additional measures to improve nonbank credit and equity channels are also required. The resulting tangible strengthening of balance sheets will help reinforce the improved optimism in financial markets.
In Japan, continued monetary accommodation is necessary but not sufficient for renewed economic dynamism to take root. The transition to higher sustained growth and lower debt-related risks requires the enactment of persuasive structural reforms. The first stages of Abenomics have been largely successful in altering deflationary expectations, but consolidating these gains in financial stability and expanding them will require continued efforts.
More broadly, maintaining the momentum and impetus for reform and good policies may prove challenging, amid a crowded electoral calendar in many countries. Geopolitical risks related to Ukraine could also pose a more serious threat to financial stability if they were to escalate. Greater spillovers to activity beyond neighboring trading partners could emerge if further turmoil leads to a renewed bout of increased risk aversion in global financial markets, or from disruptions to trade and finance. Against this backdrop, there is a need for strengthened and cooperative policy actions to help reduce risks of renewed turmoil in the global economy, both by reducing external imbalances and their associated internal distortions and by improving market confidence. Furthermore, an enhanced dialog between supervisors in advanced and emerging market economies should help ensure that cross-border liquidity and credit are not disrupted.
Chapter 2 discusses the evolving landscape of portfolio investment in emerging market economies over the past 15 years. Their financial markets have deepened and become more globalized. Greater direct participation by global investors has stimulated the development of new asset class segments, including local currency sovereign debt markets. The mix of global investors has also changed, and bond funds have become more prominent—especially local currency funds, open-end funds with easy redemption options, and funds investing only opportunistically in emerging market economies. Chapter 2 draws on a variety of methods and relatively unexploited data to examine the implications of these changes for the stability of portfolio flows and asset prices in emerging market economies.
It finds that changes in the composition of global portfolio investors are likely to make overall portfolio flows more sensitive to global financial shocks. The share of more volatile bond flows has risen, and larger foreign participation in local markets can transmit new instability. The growing activity of institutional investors is potentially more stable, but when facing an extreme shock, they can pull back even more strongly and persistently than other asset managers. While domestic macroeconomic conditions matter, herd behavior among global funds continues, and there are few signs that differentiation along local macroeconomic fundamentals during crises has increased over the past 15 years.
However, the progress made so far by emerging market economies in promoting a larger local investor base, deepening their banking sectors and capital markets, and improving their institutions has reduced their sensitivity to global financial shocks. A continuation of these efforts can help emerging market economies reap benefits from financial globalization while minimizing its potential costs.
Chapter 3 looks at how implicit funding subsidies for banks considered too important to fail (TITF) have changed over the past few years. Government protection for TITF banks creates a variety of problems: an uneven playing field, excessive risk taking, and large costs for the public sector. Because creditors of TITF institutions do not bear the full cost of failure, they are willing to provide funding without paying much attention to the banks’ risk profiles, thereby encouraging leverage and risk taking. During the global financial crisis, governments intervened with large amounts of funds to support distressed banks and safeguard financial stability, leaving little uncertainty about their willingness to bail out failing TITF institutions. These developments have further reinforced incentives for banks to become large, and indeed, the concentration of the banking sector in many economies has increased. In response, policymakers have undertaken ambitious financial reforms to make the financial system safer, including addressing the TITF problem.
Chapter 3 assesses whether these policy efforts are sufficient to alleviate the TITF issue. In particular, it investigates the evolution of the funding cost advantages enjoyed by systemically important banks (SIBs). The expectation of government support in case of distress represents an implicit public subsidy to those banks. This subsidy rose in all economies during the crisis. Although it has declined in most economies since then, it remains elevated, especially in the euro area, likely reflecting different speeds of balance-sheet repair as well as differences in the policy response to the problems in the banking sector. Nonetheless, the expected probability that SIBs will be bailed out in case of distress has remained high in all regions.
Although not all measures have been implemented yet, there is still scope for a further strengthening of reforms. These reforms include enhancing capital requirements for SIBs or imposing a financial stability contribution based on the size of the liabilities of banks. Progress is also needed in facilitating the supervision and resolution of cross-border financial institutions. In these areas, international coordination is critical to avoid new distortions and negative cross-country spillovers, which may have become even more important because of country-specific policy reforms.