Transcript of the Press Conference on the Release of April 2017 Global Financial Stability Report

IMF News, April 20, 2017

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Published: April 20, 2017

Global assessment and risks

Global financial stability has improved in the last six months; economic activity has gained momentum and hopes for reflation have risen.
Monetary and financial conditions remain highly accommodative and investor optimism over new policies has boosted asset prices.
Key downside risks if the policy mix is wrong:
- U.S. policies could increase fiscal imbalances and push up interest rates and global risk premia.
- A global shift toward protectionism could drag down trade and growth, triggering capital outflows from emerging markets.
- Loss of global cooperation on regulatory reforms could reverse gains in financial system safety.
Policy focus summarized as “Getting the policy mix right.”

United States — corporate sector vulnerabilities and policy implications

Investment spending has been languishing for over 15 years.
Positive policy drivers: corporate tax reform, infrastructure spending, reductions in regulatory burdens could boost investment.
Vulnerabilities:
- Sectors accounting for almost half of U.S. investment—energy, utilities, and real estate—are already highly levered.
- A sharp rise in interest rates could push corporate debt servicing capacity to its weakest level since the crisis.
- Under a stress scenario, corporates with some $4 trillion of assets may find servicing their debt challenging (about a quarter of assets captured in the IMF analysis).
- Leverage in the U.S. corporate sector is at historically high levels; there is a “tail” of vulnerable firms with low interest coverage ratios.
Policy recommendations:
- U.S. policies should aim to increase economic growth while avoiding creating fiscal imbalances and negative global spillovers.
- Corporate tax reform should translate into more capital expenditure (economic risk‑taking) rather than financial risk‑taking (shareholder payouts, acquisitions of financial assets, increased leverage).
- Authorities should be vigilant and consider tax policy elements that reduce incentives for debt finance and financial risk‑taking.

Emerging markets — spillovers and corporate debt at risk

With the right policy mix, stronger global growth and fading deflation risks can benefit emerging markets even as monetary policies normalize.
Political and policy uncertainty in advanced economies opens channels for negative spillovers to emerging markets.
IMF estimates:
- Debt held by the weakest firms in emerging markets could rise to $230 billion under a global protectionism scenario.
- Current debt at risk is about $590 billion (firms with weak debt‑servicing capacity).
- Scenario breakdowns:
- Tightening of global financial conditions and risk premia: increase in debt at risk of about $135 billion (on the $590 billion base).
- Rising global protectionism: increase in debt at risk of about $230 billion (on the $590 billion base).
Recommendations for emerging market policymakers:
- Address external and domestic imbalances.
- Improve corporate restructuring mechanisms and monitoring of corporate vulnerabilities.
- Ensure banks have healthy buffers of capital and provisions.

China — rapid credit growth and vulnerabilities

Credit in relation to China’s economy has more than doubled in less than a decade, to over 200 percent.
Large and prolonged credit booms increase danger as they grow; the longer and larger the boom, the more dangerous.
Authorities are adjusting policies to limit banking and shadow banking system growth, showing some success, but more needs to be done to slow credit growth and reduce vulnerabilities.
IMF view:
- China has sufficient buffers to weather changes in global financial conditions but should shift policy focus toward reducing financial vulnerabilities rather than emphasizing specific growth targets.
- Strengthen supervisory attention on banks’ emerging risks, especially rapid asset growth in small, unlisted local banks, increased reliance on wholesale funding, and risks packaged into shadow products.

Europe — banking profitability, NPLs, and structural challenges

European banks: analysis covers many banks representing $35 trillion of assets.
Banking groups divided into three categories: global, European‑focused, and domestic.
- Domestic banks face the greatest profitability challenges; almost three quarters of them had very weak returns in 2016.
Overbanking is a common challenge; forms include weak banks with low buffers, too many regionally focused banks, or excessive branch networks with low efficiency.
Profitability issue:
- Weak profitability limits banks’ ability to retain capital, constraining shock absorption and increasing systemic risk.
- Return on equity cutoff used in analysis: 8 percent; roughly 75 percent of domestically‑focused banks have return on equity below 8 percent.
- The 8 percent cutoff is somewhat arbitrary; choosing 6 or 7 percent would not materially change the message.
Nonperforming loans (NPLs) in the euro area:
- NPLs have come down only about EUR 120 billion over the past two years and are still hovering around the EUR 1 trillion mark.
- In Italy, about 70 percent of NPLs are in the court system.
Five critical areas of action to address NPLs:

1. Supervisory enforcement (SSM guidance, ambitious reduction targets, forcing sale of NPLs in some recap plans). 2. Building bank buffers so banks can absorb capital hits and remove NPLs from balance sheets. 3. Harmonizing corporate insolvency laws across the euro area. 4. Careful consideration of national asset management companies given heterogeneous loan types and bank structures. 5. Developing secondary markets for NPLs, which requires high‑quality information, data, legal documentation, and authorities’ efforts to kick‑start these markets.

IMF actions:
- An FSAP (financial sector assessment) of the euro area is beginning to take a close look at the functioning of the SSM.
- Encouragement of Asset Quality Reviews (AQRs) for smaller banks to assess asset quality and support clean‑up efforts.
Policy recommendations for Europe:
- Remove system‑wide impediments to profitability: promote bank consolidation and branch rationalization, reform bank business models, address NPLs, and strengthen capital buffers.
- Manage transition challenges from potential Brexit outcomes to minimize disruption to financial services and supervisory complexity.

Regulatory reform and global cooperation

Successful completion of the Regulatory Reform Agenda, especially adoption of the Basel III enhancements, is vital.
Continued multilateral cooperation and coordination are required to ensure the global financial system remains safe and supportive of growth.

Quantitative and key figures cited

Investment spending has been languishing for over 15 years.
Corporates with some $4 trillion of assets may struggle to service debt under a sharp‑rate‑rise scenario (almost a quarter of assets captured in analysis).
Debt held by weakest firms in emerging markets could rise to $230 billion under global protectionism scenario.
Credit in relation to China’s economy: over 200 percent.
European banks analyzed represent $35 trillion of assets.
Almost three quarters of domestic banks had very weak returns in 2016.
NPLs in the euro area have fallen by about EUR 120 billion over two years and remain near EUR 1 trillion.
In Italy, about 70 percent of NPLs are in the court system.
Corporate cash balances overseas: over $1 trillion.
Current debt at risk for weak firms: about $590 billion.
Scenario increases in debt at risk: about $135 billion (financial tightening) and about $230 billion (protectionism), both on the $590 billion base.
Return on equity cutoff used: 8 percent; roughly 75 percent of domestically‑focused banks below this threshold.

Transcript of the Press Conference on the Release of April 2017 Global Financial Stability Report — April 19, 2017