Global Financial Stability Report October 2016

Chapter 1: Financial Stability Challenges in a Low-Growth, Low-Rate Era

Chapter 1 finds that short-term risks to global financial stability have abated since April 2016, but that medium-term risks continue to build. Financial institutions in advanced economies face a number of cyclical and structural challenges and need to adapt to low growth and low interest rates, as well as to an evolving market and regulatory environment. Weak profitability could erode banks’ buffers over time and undermine their ability to support growth. A cyclical recovery will not resolve the problem of low profitability. More deep-rooted reforms and systemic management are needed, especially for European banks. The solvency of many life insurance companies and pension funds is threatened by a prolonged period of low interest rates. Corporate leverage in emerging market economies remains elevated in some countries, but the current favorable external environment presents an opportunity for overly indebted firms to restructure their balance sheets. The political climate is unsettled in many countries. A lack of income growth and a rise in inequality have opened the door for populist, inward-looking policies. These factors make it even harder to tackle legacy problems and further expose economies and markets to shocks. A potent and more balanced policy mix is needed to deliver a stronger path for growth and financial stability, and avoid slipping into a state of financial and economic stagnation.

Chapter 2: Monetary Policy and the Rise of Nonbank Finance

Chapter 2 studies how nonbank financial institutions may shape the transmission of monetary policy. It finds that nonbanks, if anything, have strengthened the transmission of monetary policy. Nonbanks may amplify the effects of monetary policy on real economic activity because their incentives to take risks are particularly sensitive to changes in monetary policy. However, banks still matter for the transmission of monetary policy because even large firms have limited ability to move away from bank loans and into bond financing after a monetary contraction. Policymakers must continue to adapt the conduct of monetary policy to changes in the composition of financial systems and to be mindful of the implications of monetary policy on financial stability. In this context, the provision of data on nonbank financial intermediaries needs to continue to be enhanced.

Chapter 3: Corporate Governance, Investor Protection, and Financial Stability in Emerging Markets

Chapter 3 focuses on the links between corporate governance, investor protection, and financial stability across emerging market economies. The chapter finds that corporate governance and investor protection have generally improved in emerging market economies over the past two decades. The analysis supports the notion that stronger corporate governance and investor protection frameworks enhance the resilience of emerging market economies to global financial shocks. The results show that corporate governance improvements foster deeper and more liquid capital markets, allowing them to absorb shocks better. Corporate governance improvements also enhance stock market efficiency, thereby making equity prices less sensitive to external shocks and less prone to crashes. Emerging market economies with better corporate governance and investor protections generally have stronger corporate balance sheets. The financial stability benefits associated with improved corporate governance strengthen the case for further reform. Policies to further bolster the rights of outside investors (especially minority shareholders), bring disclosure requirements fully in line with international best practice, and promote greater board independence are likely to yield financial stability benefits.