In a previous article, we explored a paper from Americans for Financial Reform outlining key reforms needed to prevent and stabilize a future financial crisis. In April, the International Monetary Fund released the Global Financial Stability Report: Vulnerabilities in a Maturing Credit Cycle.

The global financial sector continues as “accommodative” as shocks at the end of 2018 did not accumulate to cause meaningful damage in the financial sector. Nevertheless, the global credit cycle is maturing and causing alarm for policymakers.

Key risks in 2019

  • Corporate sector debt in advanced economies.
  • Europe’s, specifically Italy, troubled sovereign-financial debt.
  • Chinese decline impacting the world economy.
  • Benchmark indices impacted by instability in emerging markets.
  • Housing market correction.

The major risk echoed in global financial reports focuses on corporate debt. The risk of elevated corporate debt occurs in countries that account for 70% of the world’s GDP. In a previous article, the risk of corporate debt could cause firms to restructure, but the risk of widespread financial contagion remains low.  

The report outlines numerous indicators that the IMF is monitoring around each of the risk areas. One indicator identifies the channels of contagion in the sovereign-financial sector. The below graphic depicts a significant strain on insurers and an impact on companies and households that includes higher interest rates and an economic slowdown.

Policy Recommendations

The report lists policy recommendations to contain financial vulnerabilities including:

  • Capital requirements to cool credit growth.
  • Establish stress tests and debt mitigation tools for highly leveraged corporates.
  • Review of underwriting policy at critical banks.
  • Ensure financial stability in non-bank housing lenders.
  • Establish a framework for preventing contagion in the insurance industry.
  • Establish stress tests and policies to calculate and manage leverage for asset managers.

The report also lists specific policies to address the sovereign-bank nexus and increase resiliency in emerging markets and China.