Global Financial Stability Report

Global Financial Stability Report: Lower for Longer

October 2019

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Full Report and Executive Summary

The October 2019 Global Financial Stability Report (GFSR) identifies the current key vulnerabilities in the global financial system as the rise in corporate debt burdens, increasing holdings of riskier and more illiquid assets by institutional investors, and growing reliance on external borrowing by emerging and frontier market economies. The report proposes that policymakers mitigate these risks through stricter supervisory and macroprudential oversight of firms, strengthened oversight and disclosure for institutional investors, and the implementation of prudent sovereign debt management practices and frameworks for emerging and frontier market economies.

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Chapter 1: Global Financial Stability Overview: Lower for Longer

Chapter 1 assesses overall global financial stability. Financial markets have been buffeted by the twists and turns of trade disputes and growing investor concern about the global economic outlook. Financial conditions have eased further and appear to be premised on expectations of additional monetary policy accommodation across the globe. Large interest rate declines have created further incentives for investors to search for yield, leading to stretched valuations in some asset markets. Accommodative conditions have fueled a buildup of financial vulnerabilities. Against this backdrop, medium-term risks to global growth and financial stability are still firmly skewed to the downside. Policymakers urgently need to tackle financial vulnerabilities that could exacerbate the next economic downturn.

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Chapter 2: Global Corporate Vulnerabilities: Riskier Business

Accommodative monetary policy supports the economy in the near term, but easy financial conditions encourage more financial risk-taking and may fuel a further buildup of vulnerabilities in some sectors and countries. This chapter shows that corporate sector vulnerabilities are already high in several systemically important economies as a result of rising debt burdens and weakening debt service capacity. In a material economic slowdown scenario, half as severe as the global financial crisis, corporate debt-at-risk (debt owed by firms that cannot cover their interest expenses with their earnings) could rise to $19 trillion—or nearly 40 percent of total corporate debt in major economies, and above postcrisis levels.

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Chapter 3: Institutional Investors: Falling Rates, Rising Risks

Lower-for-longer yields may prompt institutional investors to seek riskier and more illiquid investments to earn their targeted return. This increased risk-taking may lead to a further buildup of vulnerabilities among investment funds, pension funds, and life insurers. Low yields promote greater portfolio similarities among investment funds, which may amplify market sell-offs if there is an adverse shock. The need to satisfy contingent calls arising from pension funds’ illiquid investments could constrain the traditional role they play in stabilizing markets during periods of stress. High return guarantees and duration mismatches are driving an increase in cross-border investments by some life insurers, leading in some cases to large concentrated exposures and increasing the risk of spillovers of shocks across borders. These vulnerabilities could amplify shocks and should be closely monitored and carefully managed.

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Chapter 4: Emerging and Frontier Markets: Mind the Debt

Favorable external financing conditions, such as falling global interest rates, supported debt portfolio flows to emerging markets and contributed to the decline of emerging market credit spreads. Equity flows have suffered the most from the twists and turns of trade disputes, and further escalation remains a serious risk for emerging and frontier markets. With private and public debt already high in some countries, easy financing conditions may encourage excessive buildup of debt, raising rollover and debt sustainability risks. Overindebted state-owned enterprises may face difficulties in accessing funding markets and servicing their debt without sovereign support. Frontier market economies’ ever greater reliance on external debt may increase the risk of debt distress. These risks should be addressed through prudent sovereign debt management practices and frameworks.

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Chapter 5: Banks' Dollar Funding: A Source of Financial Vulnerability

Chapter 5 assesses global non-US banks’ US dollar funding fragility and provides metrics for monitoring it. The chapter shows that rising US dollar funding costs are associated with financial stress in the home economies of global non-US banks and with cutbacks in the supply of loans to countries that borrow in US dollars. Such negative effects are amplified when US dollar funding is fragile and the share of US dollar assets in total assets is high. Emerging markets borrowing in US dollars are particularly vulnerable to cutbacks in cross-border lending, because their ability to substitute into alternative funds in US dollars or even other currencies is limited. The chapter discusses central bank swap line arrangements as well as international reserves in the home economies of global non-US banks as possible mitigation tools.

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Chapter 6: Sustainable Finance: Looking Farther

Chapter 6 reports on the incorporation of environmental, social, and governance (ESG) principles into finance. ESG issues may materially affect corporate performance and give rise to financial stability risks via exposure of financial institutions and large losses from climate change. Investor interest in ESG factors has continued to rise in recent years, but sustainable finance needs to deal with challenges, such as lack of standardization. ESG-related disclosure remains fragmented and sparse—in part because of associated costs, the often voluntary nature of disclosure, and lack of standardization. Policymakers have a role to play in developing standards, fostering disclosure and transparency, and promoting integration of sustainability considerations into investments and business decisions.