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Financial Stress and Deleveraging: Macrofinancial

Aug 13, 2015




  • Global Financial Stability Report, October 2008

    Global Financial Stability Report Global Financial Stability Report

    Financial Stress and DeleveragingMacro nancial Implications and Policy

    World Economic and Financia l Surveys

    I N T E R N A T I O N A L M O N E T A R Y F U N D





  • World Economic and Financial Surveys

    Global Financial Stability ReportFinancial Stress and Deleveraging

    Macrofinancial Implications and Policy

    October 2008

    International Monetary FundWashington DC

  • 2008 International Monetary Fund

    Production: IMF Multimedia Services DivisionCover: Jorge Salazar

    Figures: Theodore F. Peters, Jr., Andrew Sylvester

    Typesetting: Julio Prego

    Cataloging-in-Publication Data

    Global financial stability report Washington, DC : International Monetary Fund, 2002

    v. ; cm. (World economic and financial surveys)

    SemiannualSome issues also have thematic titles.ISSN 1729-701X

    1. Capital market Developing countries Periodicals. 2. International finance Periodicals. 3. Economic stabilization Periodicals. I. International Monetary Fund. II. Title. III. World economic and financial surveys.HG4523 .G557

    ISBN: 978-1-58906-757-8

    Please send orders to:International Monetary Fund, Publication Services

    700 19th Street, N.W., Washington, D.C. 20431, U.S.A.Tel.: (202) 623-7430 Fax: (202) 623-7201

    E-mail: publications@imf.orgInternet:

  • iiiiii

    Preface ix

    Executive Summary xi

    Chapter 1. Assessing Risks to Global Financial Stability 1

    Global Financial Stability Map 2The Default Cycle 10Financial System Deleveraging 18Systemic Implications 32Emerging Market Resilience Is Being Tested 44Financial Stability Policies 49Annex 1.1. Global Financial Stability Map: Construction and Methodology 56Annex 1.2. Financial Investment in Commodities Markets 62Annex 1.3. Loss Estimates on U.S. Credit Instruments 66Annex 1.4. Factors Infl uencing the Pace and Level of Bank Capital Rebuilding 69References 71

    Chapter 2. Stress in Bank Funding Markets and Implications for Monetary Policy 73

    The Microstructure of Bank Funding Markets 74The Causes of Elevated Interbank Spreads 78Implications for the Interest Rate Transmission Mechanism of Monetary Policy 85Policy Recommendations 96Conclusions 100Annex 2.1. Empirical Framework: The Causes of High Interbank Spreads 100Annex 2.2. Empirical Framework: Monetary Transmission 103References 105

    Chapter 3. Fair Value Accounting and Procyclicality 109

    Fair Value Accounting Through the Business Cycle 110Modeling Fair Value Accounting Through the Business Cycle Using Simulations 117Conclusions and Policy Recommendations 127Annex 3.1. Data and Modeling Assumptions 131References 133

    Chapter 4. Spillovers to Emerging Equity Markets 135

    Performance of Emerging Market Equity Markets 136Cross-Country Equity Price Correlations 138Determinants of Emerging Market Equity Prices 140Spillovers and Their Impact 144The Role of Local Institutional Investors 145




    Key Results and Conclusions 145Annex 4.1. Panel Estimation Specifi cation and Results 152Annex 4.2. Vector Autoregression Model Results 155References 155

    Glossary 157

    Annex: Summing Up by the Acting Chair 163

    Statistical Appendix 167


    1.1 Recent Financial Market Developments 6 1.2 Measuring Capital Adequacy 21 1.3 Global Bank Writedowns and Capital-Raising 23 1.4 U.S. Government-Sponsored Enterprises and Housing Reform Developments 34 1.5 Impact of Credit Market Turmoil on Hedge Funds 41 1.6 Forecasting Loan Charge-Off Rates 68 2.1 Pricing and Hedging Role of Interbank Deposit-Related Derivatives 75 2.2 Is the LIBOR Fix Broken? 77 2.3 The Federal Reserves Term Auction Facility 82 2.4 Breakdown of the Financial Sector for Monetary Transmission Analysis 88 3.1 Off-Balance-Sheet Entities and Procyclicality 111 3.2 Disclosures Recommended by the Financial Stability Forum 113 3.3 Dealing with Procyclicality in the Basel II Framework 116 3.4 Options Surrounding the Application of Fair Value Accounting to

    Mitigate Procyclicality 119 4.1 Is There a Stock Market Wealth Effect in Emerging Markets? 146 4.2 The Role of Emerging Market Institutional Investors in Emerging Market Equities 148


    1.1 Estimates of Financial Sector Potential Writedowns 15 1.2 Estimates of Potential Losses on Loans 17 1.3 European and U.S. Public Securitization 29 1.4 Sensitivity of Deleveraging to Public Sector Support 32 1.5 Macro and Financial Indicators in Selected Emerging Market Countries 46 1.6 Changes in Risks and Conditions Since the April 2008 Global Financial

    Stability Report 57 1.7 Asset Class Characteristics 63 1.8 Test for Causality Between Commodities Prices and Financial Positions 66 1.9 Comparison of Financial Sector Loss Estimates, October 2008 671.10 Deleveraging Illustration: Key Assumptions 70 2.1 List of Restrictions Used in the Structural Vector Autoregression for

    Each LIBOR and Euribor Spread 84 2.2 Static Vector Error Correction Mechanism (2, 3) Estimation with

    Variable Controls: United States 92



    2.3 Static Vector Error Correction Mechanism (2, 3) Estimation with Variable Controls: Euro Area 93

    2.4 List of Variables Used in the Vector Autoregressions 102 3.1 Balance Sheet of Representative U.S. and European Financial Institutions 118 3.2 Parameter Values for Each Simulation 120 3.3 Equity-to-Assets Ratio Through the Business Cycle 122 3.4 Application of Fair Value by U.S. and European Banks, 2007 123 4.1 Emerging Equity Market Peaks and Troughs: Current and Previous Episodes 139 4.2 Fixed-Effects Panel Least-Squares Estimation of the Determinants of Emerging

    Market Equity PricesMonthly Observations (January 2001May 2008), 30 Countries, First Specifi cation 142

    4.3 Fixed-Effects Panel Least-Squares Estimation of the Determinants of Emerging Market Equity PricesMonthly Observations (January 2001May 2008), 30 Countries, Second Specifi cation 143

    4.4 Unit Root Tests 153 4.5 Pedroni Heterogeneous Panel Cointegration Tests 153


    1.1 Global Financial Stability Map 2 1.2 Heat Map: Developments in Systemic Asset Classes 3 1.3 Systemic Bank Default Risk 4 1.4 Asset Price Volatility and Funding and Market Liquidity 5 1.5 Allocation to Global and Emerging Market Risk Assets 5 1.6 U.S. Loan Charge-Off Rates 11 1.7 U.S. Households Balance Sheets: Net Worth 11 1.8 U.S. Mortgage Delinquencies by Vintage Year 12 1.9 Prices of U.S. Mortgage-Related Securities 131.10 U.S. Residential Real Estate Loan Charge-Off Rates 131.11 U.S. Consumer Loan Charge-Off Rates 141.12 Macroeconomic and Corporate Indicators and Default Rates 141.13 Comparison of Financial Crises 161.14 Financial Sector Losses 171.15 Ratio of Household Debt to Gross Disposable Income 181.16 U.K. Mortgage Foreclosures 191.17 Net Acquisition of Financial Assets by U.S. Financial Firms 201.18 Bank Ratios 201.19 U.S. Banks Price-to-Book Ratios and Risk Exposures 261.20 European Banks Price-to-Book Ratios and European Real Estate Prices 271.21 U.K. Banks Price-to-Book Ratios 281.22 AA Rated Bank Bond Index Spreads Relative to Government Bonds 281.23 European Banks Cross-Border Liabilities, end-2007 291.24 Net Cross-Border U.S. Dollar Claims of European Banks 291.25 Cross-Currency Swaps with U.S. Dollar 301.26 Private Sector Credit Growth 301.27 Euro Area Financial Institution Lending for House Purchase 311.28 Market Capitalization and Equity Book Values of Select Financial Institutions 33



    1.29 Probability of Default Based on Equity Option Prices 381.30 U.S. Equity Index Performance 391.31 Total Assets on Federal Reserves Balance Sheet 441.32 Potential U.S. Commitments and Mortgage Markets 441.33 Sovereign Credit Default Swap Spreads 451.34 Net Foreign Equity Investment in Emerging Economies 451.35 Emerging Market External and U.S. High-Grade Corporate Spreads 471.36 Onshore Emerging Market Dollar Interest Rates 471.37 Credit Default Swap Spreads on Selected Emerging Market Banks,

    January 2007Early October 2008 481.38 Real Policy Rates: Latest Levels and Changes from end-2008 481.39 Break-Even Infl ation Rates 491.40 Baltic States: Real Bank Loan Growth to Nonfi nancial Private Sector 491.41 Global Financial Stability Map: Monetary and Financial Conditions 581.42 Global Financial Stability Map: Risk Appetite 591.43 Global Financial Stability Map: Macroeconomic Risks 601.44 Global Financial Stability Map: Emerging Market Risks 611.45 Global Financial Stability Map: Credit Risks 621.46 Global Financial Stability Map: Market and Liquidity Risks 631.47 Commodity Futures Prices and Financial Positions 65 2.1 Unsecured European Bank Borrowing Volumes 76 2.2 Spread Between Three-Month Uncollateralized Interbank Rates and

    Overnight Index Swaps 79 2.3 Joint Probability of Distress: Selected Financial Institutions Participating in

    Interbank Panels 80 2.4 Three-Month Forex Swap Spreads 81 2.5 Structured VAR Model: Variance Decomposition of LIBOR/Euribor Minus

    Overnight Index Swap (OIS) Spread 85 2.6 Selected Countries: Size of Financial Assets 87 2.7 United States: Structural Changes in Financial Sector Liabilities 87 2.8 United States: Selected Interest Rate Spreads 89 2.9 Euro Area: Selected Interest Rates Spreads 902.10 Dynamic Vector Error Correction Mechanism (VECM) (2,3) Estimation of

    the U.S. Fed Funds Rate and Market RatesUnited States 942.11 Dynamic Vector Error Correction Mechanism (VECM) (2,3) Estimation of

    the EONIA Rate and Market RatesEuro Area 952.12 Summary Chart: Accuracy of ForecastsU.S. Model, 19962008 962.13