The Quest for Lasting Financial StabilityCentre International d'Etudes Monétaires et Bancaires

José ViñalsFinancial Counsellor

International Monetary Fund

May 8, 2012

EM Risks

Deleveraging Scenarios

Policies

Global Situation

Global Financial Risk Indicators Have ImprovedGlobal Financial Risk Indicators Have Improved

Oct

-06

Oct

-07

Oct

-08

Jun-

09

Oct

-09

Apr-1

0

Oct

-10

Oct

-11

Apr-1

20

1

2

3

4

5

6

7

8

Lehman

Improve-ment

Oc

Oc

Oc

Jun-

09 Oc

Ap Oc

Oc

Ap0

1

2

3

4

5

6

7

8

9

10 Credit

Market andLiquidity

Lehman

Improvement

Risk Indicators Risk Appetite

1

-80

-60

-40

-20

0

20

40

60

Euribor-OIS Spread(negative)

Peripheral Bank Equi-

ties

But Markets Are Volatile And Stability Is FragileBut Markets Are Volatile And Stability Is Fragile

Peripheral Sovereign

CDS(negative)

-30

-25

-20

-15

-10

-5

0

5

10

15

European Equities

EM Equities

2

(September 2011 = 0)

VIX(negative)

Not Out Of The Crisis Yet

Sovereign and Bank Spreads (in basis points)

3

Buildup of Stress

Crisis Begins

Policy Response

Relief

Political Resistance and/or Complacency

2007 2008 2009 2010 2011 20120

50

100

150

200

250

300

350

400European Financial CDS (left scale)

High Yield Euro-Area Sovereign Bond Spreads (right scale)

Post-Lehman

Greece Program/ SMP

Ireland Program

Cur-rent

Bear Stearns

Global Situation Deleveraging Scenarios

EM Risks Policies

Further Efforts Needed To Achieve Lasting Stability

In The Euro Area And Avoid Downside Risks

Further Efforts Needed To Achieve Lasting Stability

In The Euro Area And Avoid Downside Risks

WeakPolicies

CurrentPolicies

• Escalating funding pressures• Credit crunch• Falling growth• Global contagion

• Funding markets normalize

• Smooth deleveraging

• Higher growth

CompletePolicies

• Market funding strains• Credit squeeze• Home bias• Low growth • Negative spillovers

4

Structural

Shed Legacy Assets

Better Capitalization

Reduce Reliance on Wholesale Funding

Cyclical

Earnings Pressures

Funding Pressures

Drivers of Bank Deleveraging Drivers of Bank Deleveraging

5

European Banks Need To Reduce Leverage And Shrink Balance Sheets

European Banks Need To Reduce Leverage And Shrink Balance Sheets

0

5

10

15

20

25

30

35

40

Euro area

United Kingdom

United States

60

70

80

90

100

110

120

130

140

150

Euro area

United Kingdom

United States

Bank Leverage (Adjusted tangible assets to Tier 1 common capital)

Bank Loan-to-Deposit Ratios(Loans as a percentage of deposits)

6

Series1

Bank Assets in EU BanksCredit Supply in Euro AreaEconomic Growth in Euro Area

Series1-12

-10

-8

-6

-4

-2

0

2

Series1

What Are The Effects Of Deleveraging On The Region…

What Are The Effects Of Deleveraging On The Region…

7

2012-2013(in percent of end-2011 stock, deviation from baseline growth)

-1.4%

-4.4%

-$3.8 tn

-1.7%

-$2.6 tn

0.0%

-$2.2 tn

-0.6%

+0.6

%

Current Policies Complete Policies

Weak Policies

..And On Credit In The Rest Of The World? ..And On Credit In The Rest Of The World?

-5

-4

-3

-2

-1

0

Weak Policies

Current Policies

Complete Policies

8

Impact of EU Bank Deleveraging On Global Bank Lending Supply

(in percent of total bank credit)

U.S./Japan Public Debt: Latent Risk To StabilityU.S./Japan Public Debt: Latent Risk To Stability

0 2 4 6 8 10 12 14 16 18 200

1

2

3

4

5

6

7

BelgiumFrance

Germany

ItalySpain

U.K.

Canada

Avera

ge 1

0-y

ear

Sovere

ign B

ond Y

ield

in

Apri

l 2012 (

in p

erc

ent)

Required Fiscal Adjustment, 2011-2020 (in percent of nominal GDP)

Required Fiscal Adjustment and Interest Rate

9

U.S.

Japan

0

2

4

6

8

10

12

14

16

18

Historical Volatility in One-Month U.S. Treasury Bills During Debt Ceiling

Negotiations(in percent)

Global Situation

EM Risks

Deleveraging Scenarios

Policies

Jan-

10

Apr-1

0

Jul-1

0

Oct-1

0

Jan-

11

Apr-1

1

Jul-1

1

Oct-1

1

Jan-

12

Apr-1

2-3

-2

-1

0

1

2

3

4

5

Emerging Market Portfolio Flows(in billions of U.S. dollars, 3-month moving average)

Emerging Market Asset Performance(January 1, 2010=100)

10

Capital Flows Have Become More Volatile And Less Predictable

Capital Flows Have Become More Volatile And Less Predictable

80

85

90

95

100

105

110

115

120 40

60

80

100

120

140

160

180

EM equities (left scale)

EM currencies (left scale)

Pola

nd

Turk

ey

Kore

a

Mexic

o

Bra

zil

South

Afr

ica

Peru

India

Indonesi

a

Chin

a

Russ

ia

-7.5

-5.0

-2.5

0.0

% Points

What Happens If Bank And Portfolio Flows Reverse?What Happens If Bank And Portfolio Flows Reverse?

11Credit to GDP Ratio

GDP Growth Rate

Fiscal Policy Room

Monetary Policy Room

Credit Policy Room

12

HungaryPolandRussiaTurkeySouth AfricaChinaIndiaIndonesiaKoreaBrazilMexicoPeru

EMs Have Policy Room To Buffer Shocks But Homegrown Vulnerabilities RemainEMs Have Policy Room To Buffer Shocks But Homegrown Vulnerabilities Remain

10.7368405

36.57098271

39.78204563

23.29249406

23.5610262

30.28578836

63.97290738

21.60017491

3.1

6.11615086

5.5

3.5

8.549267935

3.2

5.003352744

3.345152851

2.499537501

-0.794832851

7.027696688

9.433981925

11.03613394

4.465779187

7.12925671

EM Risks

Global SituationDeleveraging

Scenarios

Policies

Policy: The Quest For Lasting StabilityPolicy: The Quest For Lasting Stability

Euro Area Breathing Space Limited And Shrinking; Use It Wisely

National:

Banking:

“More & Better Europe”:

13

• Implementation key

•Recap/restructure/resolve; use public money if needed

• Roadmap to further integration: - Financial: Pan-European supervision and resolution - Fiscal: Ex-ante risk sharing (central financing mechanism)

Policy: The Quest For Lasting StabilityPolicy: The Quest For Lasting Stability

U.S., Japan Start Addressing Medium-Term Challenges Now

• Keep sovereign bonds safe: Fiscal consolidation strategies

Emerging Markets

Do Not Take Stability For Granted

• Preserve policy space and buffers• Macro + prudential + liquidity instruments

Global The World Needs More Collaboration

• IMF resources• Regulatory reform

14

Together:Strong, Sustainable,

Balanced Global Growth

Advanced Economies:

Achieve Lasting Stability for Stronger Growth

Emerging Markets:Maintain

Stability for Continued

Growth

No Time to Pause or Relax: This Time Must Be Different

No Time to Pause or Relax: This Time Must Be Different

FinancialStability

15