Deepening Financial Stability Analysis

Making the global financial system safer is a work in progress.

Spotting Global Risks Through Global Collaboration

Behind The Scenes

Tools for spotting risks

The April 2019 GFSR expands the IMF’s methodology to quantify vulnerabilities in the financial system, so policymakers can monitor them and take preventive steps if needed to mitigate risks. The framework encompasses six sectors: firms, households, governments, banks, insurance companies, and other financial institutions—such as shadow banks.

The framework tracks both the level and the pace of change along a variety of vulnerabilities, including leverage and mismatches in the maturity and liquidity of assets and liabilities, as well as currency mismatches. These vulnerabilities are tracked at regional and global levels, aggregating across 29 systemically important countries.

What types of risks did this framework uncover? In advanced economies, vulnerabilities were detected from rising corporate debt and financial risk taking, coupled with borrowers’ declining creditworthiness. In emerging markets, it was the expansion of benchmark-driven investment inflows, which leaves these countries more vulnerable to sudden reversals of capital flows.

Policymakers often wish they had a crystal ball to help them predict and prevent crises. With the scars of the global financial crisis still with us, the IMF staff and financial specialists have been hard at work to do just that.

The April 2019 Global Financial Stability Report (GFSR) presented a new analytical tool that can help policymakers gauge the likelihood of a housing downturn and take early steps to limit the damage. The tool, dubbed House-Prices-at-Risk, feeds into the growth-at-risk model, which links financial conditions to the danger of a severe economic downturn in the short to medium term. Based on five conditions that affect home prices, such as past price growth and credit booms, the analysis shows that in most advanced economies in the sample, the odds of a big drop in inflation-adjusted house prices were lower at the end of 2017 than 10 years earlier. In most emerging markets, by contrast, riskiness was higher in 2017 than on the eve of the global financial crisis.

The global financial crisis remains one of the defining events of our time. The severe economic and social fallout from the crisis forced a concerted effort toward a global regulatory reform agenda for the financial system. Ten years on, the October 2018 GFSR found that the regulation and supervision of the financial sector had strengthened considerably. Still, the reform agenda is not fully completed, and new risks have emerged, especially in the unregulated part of the financial system known as “shadow banking.” These developments call for regulators around the world to avoid complacency and for countries to replenish their policy arsenal. It is worth remembering that risk tends to rise during good times, and it migrates to new, unexpected corners of the financial system.

Figure 1.2

Risks have risen

Governments and nonfinancial sector vulnerabilities have increased since the global financial crisis.

‍ A bar chart showing the percentage of systemically important countries in sample, by GDP, with high and medium-high vulnerabilities.

Percentage of systemically important countries in sample, by GDP, with high and medium-high vulnerabilities.
Numbers of countries are in parentheses.

Source: IMF staff calculations.

Learn

What is a leveraged loan?

There is a growing segment of the financial world that involves loans, usually arranged by a syndicate of banks, to companies that are heavily indebted or have weak credit ratings. These loans are called “leveraged” because the ratio of the borrower’s debt to assets or earnings significantly exceeds industry norms. The global market for such loans now stands at $1.4 trillion. This has policymakers and analysts sounding an alarm on dangerous deterioration in lending standards.
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Why? Because most of these loans involve weak underwriting standards and less investor protection, and they are less transparent. In addition, companies such as mutual funds and collateralized loan obligations, which are packaged loans that are resold to other investors, now hold a large portion of these leveraged loans, and it is not always clear what link these have with the banking sector. It is therefore crucial for policymakers to develop and deploy new tools to address deteriorating underwriting standards. Having learned a painful lesson a decade ago about unforeseen threats to the financial system, policymakers should not overlook another potential threat.