- International Monetary Fund. Monetary and Capital Markets Department
- Published Date:
- September 2011
©2011 International Monetary Fund
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.
- ISSN 1729-701X
1. Capital market – Developing countries – Periodicals.
2. International finance – Periodicals. 3. Economic stabilization – Periodicals. I. International Monetary Fund. II. Series: World economic and financial surveys.
Please send orders to:
International Monetary Fund, Publication Services
P.O. Box 92780, Washington, D.C. 20090, U.S.A.
Tel.: (202) 623-7430 Fax: (202) 623-7201
- Executive Summary
- Chapter 1 Overcoming Political Risks and Crisis Legades
- Chapter 2 Long-Term Investors and Their Asset Allocation: Where Are They Now?
- Longer-Term Trends in Global Asset Allocation
- Determinants of Private Asset Allocation
- Conclusions and Policy Implications
- Annex 2.1. Asset Allocation: Theory and Practice
- Annex 2.2. Results of the IMF Survey on Global Asset Allocation
- Annex 2.3. Defining Foreign Exchange Reserves and Sovereign Wealth Funds
- Annex 2.4. Theoretical Foundation of the Regression Specification and Detailed Regression Results
- Chapter 3 Toward Operationalizing Macroprudential Policies: When to Act?
- From Sources of Risk to Systemic Risk Indicators: Helpful Hints from a Structural Macro-Financial Model
- The Quest for Leading Indicators of Financial Sector Distress
- Macroprudential Indicators and Policies: Stitching Them Together
- Conclusions and Practical Guidelines
- Annex 3.1. Description of the Structural Model
- Annex 3.2. Predicting the Probability of a Banking Crisis
- Annex 3.3. Finding a Robust Set of Near-Coincident Indicators
- Annex: Summing Up by the Acting Chair
- Statistical Appendix
- [Available online at www.imf.org/external/pubs/ft/gfsr/2011/02/pdf/statappx.pdf]
- 1.1. Market Confidence Deteriorates amid Policy Uncertainty
- 1.2. How Concerned Are Markets about U.S. Sovereign Risks?
- 1.3. Quantifying Spillovers from High-Spread Euro Area Sovereigns to the European Union Banking Sector
- 1.4. Why Do U.S. Money Market Funds Hold So Much European Bank Debt?
- 1.5. Gauging Financial Stability Risks in China
- 1.6. Can Macroprudential Policies Contain the Property Boom?
- 1.7. Euro Area Developments in Crisis Management
- 1.8. The Status of Regulatory Reform
- 2.1. Asset Allocation of Reserve Managers
- 2.2. A New Asset Allocation Framework Using Risk Factors
- 2.3. The Low Interest Rate Environment and Pension Funds
- 2.4. Sovereign Asset Management and the Global Financial Crisis
- 3.1. Monitoring and Policy Tools at New U.S., U.K., and EU Macroprudential Authorities
- 3.2. Extracting Information from Credit Aggregates to Forecast Financial Crisis
- 3.3. Risk Materialization: The Search for Near-Coincident Indicators of Financial System Stress
- 3.4. An Empirical Analysis of the Effectiveness of Macroprudential Instruments
- 1.1. Indebtedness and Leverage in Selected Advanced Economies
- 1.2. Sovereign Debt: Market and Vulnerability Indicators
- 1.3. Emerging Market Banks: Sensitivity to Macroeconomic and Funding Shocks
- 1.4. Macroeconomic and Financial Indicators for Selected Emerging Economies
- 2.1. Assets under Management by Institutional Investors
- 2.2. Assets of Selected Sovereign Wealth Funds
- 2.3. Asset Managers’ Assets under Management: Origin of Funds
- 2.4. Summary of Panel Regression Results on Equity and Bond Flows
- 2.5. Simulated Effects of Shocks on Regional Flows: Emerging Markets
- 2.6. Evaluating the Economic Significance of Crisis Indicator Coefficients
- 2.7. Expected Period before Policy Rate Rise
- 2.8. Top Five Factors Considered in Cross-Border Investment since End-2006
- 2.9. Regional Allocation
- 2.10. Asset Allocation by Asset Class
- 2.11. Survey Participants’ Assets under Management
- 2.12. Asset Managers’ Assets under Management: Origin of Funds
- 2.13. Asset Allocation by Asset Class
- 2.14. Regional Allocation
- 2.15. Top 10 Investment Destinations
- 2.16. Top Five Factors Considered in Country Allocation
- 2.17. Top Five Factors Considered in Cross-Border Investment since End-2006
- 2.18. Experience and Expectations of Portfolio Risk Exposures and Returns
- 2.19. Expected Period before Policy Rate Rise
- 2.20. Use of Hedging Instruments
- 2.21. Use of Derivatives to Enhance Yields
- 2.22. Survey Participants
- 2.23. Sovereign Wealth Fund Classification
- 2.24. Determinants of Equity and Bond Flows: Panel Regression Results
- 3.1. Noise-to-Signal Ratios for Different Credit Indicators
- 3.2. Predictive Power of Various Indicators “X” Years before the Crisis
- 3.3. Long-Run Steady-State Volatilities, by Type of Capital Requirement
- 3.4. Determinants of Systemic Banking Crises: Single-Indicator Probit Model
- 3.5. Determinants of Systemic Banking Crises: Two-Indicator Probit Model
- 3.6. Granger Causality of Systemic Risk Measure to the Event Indicator
- 3.7. Forecastability of Extreme Events: Logit Regressions
- 3.8. Turning Points: Quandt-Andrews Breakpoint Test on Persistence and Level
- 3.9. Total Score
- 1.1. Phases of the Crisis
- 1.2. Global Financial Stability Map
- 1.3. Global Financial Stability Map: Assessment of Risks and Conditions
- 1.4. Asset Price Performance since the April 2011 GFSR
- 1.5. Sovereign Vulnerabilities and Market Pressures
- 1.6. Historical Volatility in One-Month Treasury Bills during Debt Ceiling Negotiations
- 1.7. Change in Advanced Economy Government Bond Yields around Sovereign Debt Downgrades
- 1.8. Developments in Sovereign Credit Default Swap Spreads, 2011
- 1.9. Debt Dynamics
- 1.10. Changes in the Sovereign Investor Base
- 1.11. Bond Market Volatility
- 1.12. Financing Sensitivity to an Interest Rate Shock
- 1.13. Size of High-Spread Euro Area Government Bond Markets
- 1.14. European Credit Risks and Market Capitalization
- 1.15. Spreads on Bank Five-Year Credit Default Swaps
- 1.16. Bank Debt Issuance as a Percent of Maturing Debt, 2011
- 1.17. Cumulative Spillovers from High-Spread Euro Area Sovereigns to the European Union Banking System
- 1.18. Spillovers from High-Spread Euro Area Sovereigns to Country Banking Systems
- 1.19. Distribution of Spillovers from High-Spread Euro Area Sovereigns to European Banks
- 1.20. Spillovers from High-Spread Euro Area Sovereigns to Insurers
- 1.21. Advanced Economy Bank Funding by Source, 2011:Q1
- 1.22. U.S. Prime Money Market Fund Exposures to Banks
- 1.23. Deposit Growth in High-Spread Euro Area Countries
- 1.24. Contributions to Change in Bank Balance Sheets since End-2009
- 1.25. Deleveraging Scenario: Change in High-Spread Euro Area Bank Credit to the Nonfinancial Private Sector
- 1.26. Sovereign Credit Default Swaps: Gross Outstanding Amount
- 1.27. European Bank Core Tier 1 Ratios
- 1.28. Phases of the Credit Cycle
- 1.29. U.S. Household Debt, and Mortgage Delinquencies at Banks
- 1.30. Bank Lending Conditions for Nonfinancial Corporations
- 1.31. U.S. BBB-Rated Corporate Credit Spreads versus Real Federal Funds Rate
- 1.32. Current versus Past U.S. Credit and Economic Cycles: Federal Funds Rate, BBB-Rated Corporate Spreads, and Real Cumulative GDP Growth
- 1.33. Global Securitized and Structured Products Issuance
- 1.34. Hedge Fund Assets under Management
- 1.35. Financing by U.S. Nonfinancial Corporations
- 1.36. High-Yield Gross Issuance and Leveraged Loan Covenants
- 1.37. Emerging Markets: Capital Flows, Credit, and Equity Prices
- 1.38. Net Capital Flows by Region
- 1.39. Emerging Market Corporate External Issuance
- 1.40. Emerging Market Corporate versus U.S. High-Yield Debt: Yields, Leverage, Returns
- 1.41. Emerging Markets External Corporate Issuance, by Sector
- 1.42. Emerging Markets: Total Credit to the Nonbanking Sector
- 1.43. Model Prediction for NPL Ratios in 2011 and 2012 Based on 2010 Values
- 1.44. Impact when Net Capital Flows Decline
- 1.45. Impact when Terms of Trade Decline
- 1.46. Change in Capital Adequacy Ratios under Combined Macro Shocks
- 1.47. Available Set of Policy Choices Is Shrinking
- 1.48. Impulse Responses: Model Specification 1
- 1.49. Impulse Responses: Model Specification 2
- 1.50. Macro Scenarios under Combined Shocks
- 2.1. Asset Allocation of Institutional Investors
- 2.2. Assets of Institutional Investors by Country
- 2.3. Assets under Management by Type of Institutional Investor
- 2.4. Global Asset Allocation of Institutional Investors by Selected Country
- 2.5. Assets under Management by Type of Institutional Investor and Selected Country, 2009
- 2.6. Foreign Exchange Reserves, Excluding Gold
- 2.7. Selected Sovereign Wealth Funds: Asset Allocation by Type of Fund, December 2010
- 2.8. Simulated Effects of Shocks on Regional Flows: Emerging Markets
- 2.9. Regional Distribution of Equity and Bond Mutual Fund Investments
- 2.10. Minimum Variance Frontier
- 3.1. Road Map of the Chapter
- 3.2. Behavior of Four Indicators under Three Shock Scenarios
- 3.3. Event Study Results: Aggregate Indicators Three Years before to Two Years after Crises
- 3.4. Probability of a Systemic Banking Crisis
- 3.5. Estimated Probability of a Systemic Banking Crisis in the United States: Effect of Changes in Credit
- 3.6. Effects of Macroprudential Policy: Time-Varying Capital Requirements for an Asset-Price Stock
- 3.7. Effects of Productivity Shock and Time-Varying Capital Requirements on Real GDP
- 3.8. Marginal Effect on Probability of Crisis of Change in Ratio of Credit to GDP
The Global Financial Stability Report (GFSR) assesses key risks facing the global financial system with a view to identifying those that represent systemic vulnerabilities. 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. Against the background of the weak economic recovery and slippage in global financial stability, the current report highlights how risks have changed over the last six months, traces the sources and channels of financial distress, with an emphasis on sovereign vulnerabilities and contagion risks, notes the pressures arising from growing investor search for yield, discusses the implications of changes to global asset allocation patterns, and provides considerations on operationalizing macroprudential policies.
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 Robert Sheehy, both Deputy Directors; Peter Dattels and Laura Kodres, Assistant Directors; and Matthew Jones and Chris Walker, Deputy Division Chiefs. It has benefited from comments and suggestions from the senior staff in the MCM department.
Contributors to this report also include Ruchir Agarwal, Sergei Antoshin, Serkan Arslanalp, Jaromír Beneš, Ken Chikada, Julian Chow, Francesco Columba, Alejo Costa, R. Sean Craig, Reinout De Bock, Morgane de Tollenaere, Alexander Demyanets, Joseph Di Censo, Michaela Erbenova, Luc Everaert, Pascal Farahmand, Vincenzo Guzzo, Kristian Hartelius, Sanjay Hazarika, Cheng Hoon Lim, Changchun Hua, Anna Ilyina, Gregorio Impavido, Silvia Iorgova, Michael Kamya, William Kerry, Peter Lindner, Estelle Xue Liu, Yinqiu Lu, Kasper Lund-Jensen, Rebecca McCaughrin, André Meier, Paul Mills, Srobona Mitra, Aditya Narain, Erlend Nier, Mohamed Norat, S. Erik Oppers, Samer Saab, Marta Sánchez Saché, Christian Schmieder, Tiago Severo, Tao Sun, Narayan Suryakumar, Takahiro Tsuda, Han van der Hoorn, and Ann-Margret Westin. Ivailo Arsov, Martin Edmonds, Oksana Khadarina, and Yoon Sook Kim provided analytical support. Gerald Gloria, Nirma-leen Jayawardane, Juan Rigat, and Ramanjeet Singh were responsible for word processing. Joanne Blake and Gregg Forte, of the External Relations Department, and Florian Gimbel, of MCM, edited the manuscript. The External Relations Department coordinated production of the publication.
This particular issue draws, in part, on a series of discussions with banks, clearing organizations, securities firms, asset management companies, hedge funds, standards setters, financial consultants, central bank reserve managers, sovereign wealth funds, and academic researchers. The report reflects information available up to August 31, 2011.
The report benefited from comments and suggestions from staff in other IMF departments, as well as from Executive Directors following their discussion of the GFSR on August 31, 2011. However, the analysis and policy considerations are those of the contributing staff and should not be attributed to the Executive Directors, their national authorities, or the IMF.
The following symbols have been used throughout this volume:
- … to indicate that data are not available;
- — to indicate that the figure is zero or less than half the final digit shown, or that the item does not exist;
- - between years or months (for example, 2008–09 or January–June) to indicate the years or months covered, including the beginning and ending years or months;
- / between years (for example, 2008/09) 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 1/4 of 1 percentage point).
“n.a.” means not applicable.
Minor discrepancies between constituent figures and totals are due to rounding.
As used in this volume the term “country” does 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.
The boundaries, colors, denominations, and other information shown on the maps do not imply, on the part of the International Monetary Fund, any judgment on the legal status of any territory or any endorsement or acceptance of such boundaries.
Financial stability risks have increased substantially over the past few months. Weaker growth prospects adversely affect both public and private balance sheets and heighten the challenge of coping with heavy debt burdens. Public balance sheets in many advanced economies are highly vulnerable to rising financing costs, in part owing to the transfer of private risk to the public sector. Strained public finances force policymakers to exercise particular care in the use of fiscal policy to support economic activity, while monetary policy has only limited room to provide additional stimulus. Against this backdrop, the crisis—now in its fifth year—has moved into a new, more political phase (Figure 1.1). In the euro area, important steps have been taken to address current problems, but political differences within economies undergoing adjustment and among economies providing support have impeded achievement of a lasting solution. Meanwhile, the United States is faced with growing doubts over the ability of the political process to achieve a necessary consensus regarding medium-term fiscal adjustment, which is critically important for global stability. As political leaders in these advanced economies have not yet commanded broad political support for sufficiently strengthening macro-financial stability and for implementing growth-enhancing reforms, markets have begun to question their ability to take needed actions. This environment of financial and political weakness elevates concerns about default risk and demands a coherent strategy to address contagion and strengthen financial systems.
Figure 1.1.Phases of the Crisis
Indeed, a series of shocks have recently buffeted the global financial system: fresh market turbulence emanating from the euro area periphery, the credit downgrade of the United States, and signs of an economic slowdown. In the euro area, sovereign pressures threaten to reignite an adverse feedback loop between the banking system and the real economy. The euro area sovereign credit strain from high-spread countries is estimated to have had a direct impact of about €200 billion on banks in the European Union since the outbreak of the sovereign debt crisis in 2010. This estimate does not measure the capital needs of banks, which would require a full assessment of bank balance sheets and income positions. Rather, it seeks to approximate the increase in sovereign credit risk experienced by banks over the past two years. These effects are amplified through the network of highly interconnected and leveraged financial institutions; when including interbank exposures to the same countries, the size of spillovers increases by about one half. Banks in some economies have already lost access to private funding markets. This raises the risk of more severe deleveraging, credit contraction, and economic drag unless adequate actions are taken to deal with the sources of sovereign risk—through credible fiscal consolidation strategies—and to address the potential consequences for the financial system—through enhancing the robustness of banks.
This Global Financial Stability Report cautions that low policy rates, although necessary under current conditions, can carry longer-term threats to financial stability. With growth remaining sluggish in the advanced economies, low rates are appropriate as a natural policy response to weak economic activity. Nevertheless, in many advanced economies some sectors are still trapped in the repair-and-recovery phase of the credit cycle because balance sheet repair has been incomplete, while a search for yield is pushing some other segments to become more leveraged and hence vulnerable again. Moreover, low rates are diverting credit creation into more opaque channels, such as the shadow banking system. These conditions increase the potential for a sharper and more powerful turn in the credit cycle, risking greater deterioration in asset quality in the event of new shocks. Stepped-up balance sheet repair and appropriate macroprudential policies can help contain these risks.
Emerging market economies are at a more advanced phase in the credit cycle. Brighter growth prospects and stronger fundamentals, combined with low interest rates in advanced economies, have been attracting capital inflows. These flows have helped to fuel expansions in domestic liquidity and credit, boosting balance sheet leverage and asset prices. Especially where domestic policies are loose, the result could be overheating pressures, a gradual buildup of financial imbalances, and a deterioration in credit quality, as nonperforming loans are projected to increase significantly in some regions. At the same time, emerging markets face the risk of sharp reversals prompted by weaker global growth, sudden capital outflows, or a rise in funding costs that could weaken domestic banks. This report finds that the capital adequacy of banks in emerging markets could be reduced by up to 6 percentage points in a severe scenario combining several shocks. Banks in Latin America are more vulnerable to terms-of-trade shocks, while banks in Asia and emerging Europe are more sensitive to increases in funding costs.
Risks are elevated, and time is running out to tackle vulnerabilities that threaten the global financial system and the ongoing economic recovery. The priorities in advanced economies are to address the legacy of the crisis and conclude financial regulatory reforms as soon as possible in order to improve the resilience of the system. Emerging markets must limit the buildup of financial imbalances while laying the foundations of a more robust financial framework. In particular:
- Coherent policy solutions are needed to reduce sovereign risks in advanced economies and prevent contagion. The euro area summit of July 21 and subsequent announcements by the European Central Bank are substantial steps to enhance the crisis management framework of the euro area. However, it is paramount to ensure swift implementation of the agreed steps and to consider further enhancements in the economic and financial governance framework of the euro area. The United States and Japan must address sovereign risk through strategies that consolidate fiscal policy over the medium term, particularly given the many adverse global economic and financial repercussions that would follow from failure to adequately deal with U.S. fiscal problems.
- Credible efforts are required to strengthen the resilience of the financial system and guard against excesses. Appropriate fiscal action, combined with measures to strengthen banks through balance sheet repair and adequate capital buffers, can help break the link between sovereign risk and banks. If a country’s fiscal measures are successful in restoring the long-term sustainability of its public finances, its sovereign risk premium will come down, and this will reduce pressures on banks. Nevertheless, in view of the heightened risks and uncertainties—and the need to convince markets—some banks, especially those heavily reliant on wholesale funding and exposed to riskier public debt, may also need more capital. Additionally, the amount of new capital needed would also depend, in part, on the credibility of the macroeconomic policies pursued to address the roots of sovereign risk. Building capital buffers would also help support lending to the private sector. Weak banks would have to be either restructured or resolved. Any capital needs should be covered from private sources wherever possible, but in some cases public injections may be necessary and appropriate for viable banks. Stronger macroprudential measures may be required to contain risks associated with a prolonged period of low interest rates and credit cycle risks.
- Emerging market policymakers need to guard against overheating and a buildup of financial imbalances through adequate macroeconomic and financial policies. Stress tests show that there is a case for further strengthening bank balance sheets across many emerging markets.
- The financial reform agenda needs to be completed as soon as possible and implemented internationally in a consistent manner. This includes the finalization of Basel III, the treatment of systemically important financial institutions, and addressing the challenges posed by the shadow banking sector.
Chapter 2 of this report, “Long-Term Investors and Their Asset Allocation: Where Are They Now?” looks at the forces driving the global asset allocations of long-term, real-money institutional investors and the potentially lasting effects of the crisis on their investment behavior. Public and private pension funds, insurance companies, and the asset managers who assist them are found to have altered their behavior during the crisis by pulling away from risky, illiquid assets. The chapter cautions that the generalized move to safer, more liquid securities may limit the stabilizing role that long-horizon investors can play in global markets.
The chapter finds an acceleration of the long-term trend toward emerging market assets. The main determinants are strong prospects for domestic economic growth and lower perceived country risk rather than interest rate differentials. Outflows from emerging market debt and equity funds could be large—in some cases larger than in the crisis itself—if the fundamental factors that drive these flows were to change. For these economies, that threat underscores the importance of policies aimed at maintaining strong and stable growth as well as financial system resiliency.
Chapter 3, “Toward Operationalizing Macroprudential Policies: When to Act?” searches for variables that can serve as indicators of systemic events. It finds that, among credit variables, annual growth of the credit-to-GDP ratio above 5 percentage points can signal increased risk of a financial crisis about two years in advance. This is especially so if credit includes direct cross-border loans from foreign financial institutions. Importantly, credit-based indicators are far more effective if combined with other variables, as this allows for a better understanding of the underlying cause of the increase in credit. This reduces the risk of inappropriate use of macroprudential policies when the expansion of credit is supporting healthy economic growth.
Lastly, the chapter sheds light on the application of policy instruments to mitigate the buildup of systemic risks. It examines how countercyclical capital buffers, a key macroprudential tool, can prevent destabilizing cycles. Interestingly, the ability of countercyclical capital requirements to mitigate systemic risk is unaffected by exchange rate regimes. This suggests that such a tool may be widely effective across a number of different types of economies. Overall, the chapter takes a step forward in the design and operation of macroprudential frameworks—a topic under intense discussion in many countries following the crisis.