Global financial stability: the IMF report

Financial stability has been a bubbling topic since 2008--although it never really stopped simmering since the emerging market crises of the 1990s. Over the past year or so, a dominant view seems to be forming that financial instability risks are rising, particularly among some emerging-market countries.

Here's a list of great articles or papers, and one oral presentation, on the topics of financial instability, financial crises, etc. I have perused recently:

• Emerging market macroeconomic resilience to external shocks: today versus pre-global crisis (pdf) by Liliana Rojas-Suárez at the Center for Global Development.
• The mythic quest for early warnings, by Cecchetti and Schoenholtz.
• The coming emerging-market debt squeeze, by Andrés Velasco at Project Syndicate.
• Negative rates and financial intermediation, by Jérémie Cohen-Setton at Bruegel.
• Do eerie parallels presage new crisis? by Satyajit Das at the Financial Times.
• The glaringly obvious guide to the next crash, by James Mackintosh at the Financial Times.
• Getting up to speed on the financial crisis: A one-weekend-reader's guide (pdf), by Gary Gorton and Andrew Metrick.
• New evidence on the impact of financial crises in advanced countries (pdf), by Christina Romer and David Romer.
• Private credit, public debt, and financial crises (30 min lecture), by Òscar Jordà.
• Articles by Jesse Colombo, on Forbes, on why the Philippines, Thailand, Malaysia, and Singapore are heading for trouble. 
• Financial openness and currency crises, by Jon Frost and Ayako Saiki, guest post at Econbrowser. 

Chapter 1 of the IMF's Global Financial Stability Report (pdf), published this week, warns of the main risks to global financial stability. Here's a summary of the report:

1. Financial stability risks have increased since October. Lower growth prospects and disinflation have prompted central banks to respond by loosening policy. The BoJ and the ECB are the most notorious examples, but other central banks have relaxed their monetary policy stances as well.

2. Emerging market financial stability risks have increased. Commodity price declines have hurt commodity exporters, while the corporate sector has increased its foreign currency indebtedness. Lower energy prices have impacted negatively firms in the energy sector. 

3. The fall in nominal yields, and flattening of the yield curve, are a threat to the life insurance and pension fund sectors, especially in Europe.

4. Monetary policy divergence has lead to a sharp increase in volatility in foreign exchange markets amid the appreciation of the U.S. dollar. Term premia are narrow in all three main currencies (dollar, euro, and yen). Asset valuations remain elevated, in part because of persistently loose monetary policy. Market volatility in general has increased.

5. Quantitative easing can boost inflation and growth, but it also encourages greater financial risk taking, so monitoring and addressing financial excesses is necessary. Additional policy measures are necessary to enhance the effectiveness of monetary accommodation.

The report also has special boxes for two sub topics:

• The oil price fallout, explaining the channels through which the abrupt fall of oil prices could spawn financial vulnerabilities.
• Russia's financial risks and potential spillovers.

Here are a few charts from the report that caught my attention. Having a good legal system helps a country de-leverage. According to the chart below, an index of the strength of the legal system explains 45% of the cross-sectional dispersion of de-leveraging:

An increasing number of short- and long-term European government bonds have a negative yield:

QE in the eurozone and Japan could lead to significant portfolio outflows. Eurozone investors might allocate up to €1.3 trillion abroad by the end of 2015, a good chunk of which would go to the U.S. Insurance companies and pension funds in Japan could invest as much as $559 billion, or 12.8% of GDP, in foreign assets by the end of 2017 (that's if announced policies are fully implemented and work to their fullest extent across the three reform arrows): 

Non-performing loans and write-offs are frighteningly high in the eurozone and Japan:

European life insurers are in the unsustainable business of writing long-term policies without assets of a correspondingly long duration, which has resulted in negative duration gaps. Moreover, many policies contain high return guarantees, which are unsustainable in a low-interest-rate environment. Insurers in Sweden and Germany have the largest mismatches: 

Despite the recent round of monetary policy easing in emerging markets, real rates are expected to rise in 2015 in almost all of them:

Debt of the non-financial (private and government) sector of emerging markets has increased dramatically since 2007:

A significant share of debt is owed by firms with poor interest-coverage ratios: