Global Financial Stability OutlookCEPS, Brussels, October 25, 2017

Tobias AdrianFinancial Counsellor and Director, Monetary and Capital Markets Department

Near Term Global Financial Stability Risks Improving

Away from center signifies higher risks, easier monetary and financial conditions, or higher risk appetite

Emerging market risks

Risk appetiteMonetary & financial

Market & liquidity risks

Credit risks

Macroeconomicrisks

Risks

Conditions1

Apr 2017 GFSROct 2017 GFSRGlobal Financial Crisis

Core Banking System More Resilient

2

Improving Capital and Liquidity(Percent)

Improving Resilience but Profitability Challenges Remain

4.0

4.5

5.0

5.5

6.0

6.5

7.0

7.5

110

115

120

125

130

135

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

Deposits to Loans Ratio

Adjusted Capital / Assets

Profitability Challenges Remain(Percent of Assets)

48 49

36 29

15

52 51

64 71

85

0

10

20

30

40

50

60

70

80

90

2016 2017E 2018E 2019E TargetBanks’ Target

Market Risks Are Rising

3

Gradual Central Bank Balance Sheet Reduction(Central Bank Outstanding Assets, Trillions of USD)

Monetary Policy Support: Still Needed

Prolonged Low Policy Rates(Market Implied Policy Rates, Percent)

1.76

0.22

0.03

0.97

-0.50

-0.25

0.00

0.25

0.50

0.75

1.00

1.25

1.50

1.75

Curr

ent

2017

2018

2019

2020

United States

United Kingdom

Japan

Euro Area

2022

UK

Analysts’ Projections

0

2

4

6

8

10

12

14

16

2005

2008

2011

2014

2017

2020

Aggregate Japan

Euro Area

United States

0

2

4

6

8

10

12

14

-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

Yield (Percent)

4

Fewer Yielding Assets…(Global Investment-Grade Fixed Income Instruments)

But The Search For Yield Is Going Too Far… Compressing Premiums As Credit Quality Worsens

(Market Risk Premium, Share of IG BBB Bonds)

$16tn

$2tn

2007

2017

0

100

200

300

400

500

600

20

25

30

35

40

45

50

2006

2007

2009

2010

2012

2013

2015

2016

Basi

s Po

ints

Perc

ent

Market Risk Premium

Credit Quality

2017

US $tn

5

Low Volatility and Rising Valuations…(AE Assets, Percentile Rank)

The Volatility Paradox: Low Volatility Breeds Complacency… Leading to Rising Leverage And Complacency

-4

-3

-2

-1

0

1

2

3

4

-2.0

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

00 02 04 06 08 10 12 14 16

Cred

it G

ap (p

erce

ntag

e po

ints

)

Stan

dard

dev

iatio

ns fr

om m

ean

2000

Credit gap(right scale)

Model-basedprobabilityof default(left scale)

Financingconditions(left scale)

Volatilities

Govt bond

Corp bond

Housing

Equities

2017

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

6

Debt Continues To Rise…(Average Debt-to-GDP Ratios for G20 Economies, Percent)

Higher Leverage And Debt Service Challenges.. Increasing Debt Service Burdens(Deviation From Mean, Percentage Points, 2016)

20

30

40

50

60

70

90 92 94 96 98 00 02 04 06 08 10 12 14 16

General Government

Non-Financial Companies

Households

1990

AUS

CAN

FRA

DEU

ITA

JPN

KOR

GBRUSA

BRA

CHN

IND

IDNMEX

RUS

ZAF

TUR

-3-2-10123456

-40 -20 0 20 40 60 80 100

Debt service ratio

Debt-to-GDP

7

Short Term Expansions May Pose Future Risks to Growth(Growth Effect of a 1 Percent Increase

in HH Debt to GDP, Percent)

Rising Household Debt Could Challenge GrowthMacroprudential Policies Can

Curb Household Credit Growth(Impact of a Tightening on Real Household

Credit Growth, Percentage Points)

Effective Policies & Institutions Could Mitigate These Risks

(Growth Effect at t+3 of a 1 Percent Increase in HH Debt to GDP, Percent)

-1.00

-0.75

-0.50

-0.25

0.00

AdvancedEconomies

EmergingEconomies

-0.25

-0.20

-0.15

-0.10

-0.05

0.00

0.05

0.10

0.15

t t+3Years

Advanced EconomiesEmerging Economies

-0.75

-0.50

-0.25

0.00

0.25

0.50

LeastEffective Average

MostEffective

Emerging Markets: Still Waters?

8

Regulatory Tightening of Small and Medium Sized Banks…(Monthly Change, Three Month Average, Billions of RMB)

China: A Delicate Balancing Act… Could Impact Credit Growth

(Credit Growth Under Shadow Credit Growth Assumption; Percent)

-400

-200

0

200

400

600

800

1,000

1,200

Dec

-15

Mar

-16

Jun-

16

Sep-

16

Dec

-16

Mar

-17

Jun-

17

On-balance sheetshadow credit

Unsecuredinterbank borrowing 6

8

10

12

14

16

18

20

22

2014 2015 2016 2017

Zero shadow credit growth

2017E

Portfolio Flows Have Rebounded(Billions of USD, Four-quarter Rolling Sum)

Benign External Conditions, but EM Vulnerabilities Remain

50

150

250

350

450

550

650

750

2002

2005

2008

2011

2014

2017

Risk Premiums Have Compressed(Market Risk + Term Premium, Basis Points)

-100

0

100

200

300

400

2000

2002

2004

2006

2008

2010

2012

2014

2016

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

2003

2005

2007

2009

2011

2013

2015

75th percentile

25th percentile

Mean

Corporate Leverage Remains High(Total Debt to EBITDA, Multiple)

9

2016

10

Bond Issuance Has Risen Sharply…

Low Income Countries: Benefits and Challenges… Pushing Up Debt Burdens

(Change From 2012 to 2018)

0

2

4

6

8

10

12

0

1

2

3

4

5

6

7

8

9

2009

2010

2011

2012

2013

2014

2015

2016

2017

YTD

AfricaAsiaLatin America

Number of issuers (RHS)

0

20

40

60

80

100

0 5 10 15 20 25 30 35

Publ

ic g

ross

deb

t (pe

rcen

t of G

DP)

VNM

RWA

CIVHND

TZA

CMR

ZMBETH

MOZ

GHA

NGA

Public interest expenses to revenues (percent)

KEN

US $bn Number

Is Growth At Risk?

11

Growth-at-RiskRising Leverage Foresees a Riskier Outlook

(Probability Density Forecasts for GDP Growth Made One Year Earlier)

Annualized GDP growth (percent)

Prob

abili

ty

-2

0

2

4

6-8

-6

-4

-2

0

2

4

6

8

2005

2006

2007

2008

2009

2010

2011

2012

2013

Stan

dard

Dev

iatio

ns

Perc

ent

Median

Downside and upside risks (5th and 95th percentiles)

-14.5

Lower growth and tighter financial conditions

FCI (RHS)

A Tightening of Global Financial Conditions Suggests An Increase In Global Economy Tail Risks

0.00

0.05

0.10

0.15

0.20

0.25

-6 -4 -2 0 2 4 6 8

With asset prices

With asset prices and leverage

Without asset prices and leverage

12

Downside Scenario

Could The Global Recovery Be Derailed?Output Losses Are Substantial and Broad-Based

(Percent of Countries; Output Loss Relative to the Baseline)

2017-2019 2020-2022

Continued search for yield

Spreads compressed

Low volatility

Increasing leverage

Increased risk aversion

Credit spreads decompress

Volatility shifts higher

Debt service pressures mount

High Impact Medium Impact Low Impact

18

30

52 1.7%

Beware Of Complacency

…but vulnerabilitiesare building

underneath…

Conditions appear calmon the surface…

…that could putgrowth 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