Edited by Huachuang Securities: "reflection on the financial crisis: how far are we from the next crisis?" "

1. increased risk in the medium term, four factors may cause the financial market to suddenly tighten

Global short-term risk has increased slightly, while medium-term risk has increased.Financial conditions in some emerging market economies have tightened since the global financial stability report in April 2018. This tightening is driven by country-specific factors, deteriorating external financing conditions and trade tensions. As a result, the recent risk of financial stability has increased slightly, while the medium-term risk has increased due to high debt levels and increased financial fragility (such as a decline in asset valuations).

2. Financial fragility is still increasing, and high debt is a key challenge.

Debt levels have risen significantly in all countries and industries.Since the global financial crisis, the total non-financial sector debt of governments, non-financial companies and households has grown much faster than the economic growth rate. The total non-financial debt of countries with systemically important financial sectors is currently $167 trillion, or more than 250 per cent of total GDP, compared with $113 trillion (210 per cent of GDP) in 2008. Higher debt makes the non-financial sector more sensitive to changes in interest rates.

In the United States, risk in the public sector continues to increase and the proportion of highly leveraged trading increases.Public sector debt continues to climb and the federal deficit is expected to expand, further exacerbating an already unsustainable debt situation.In the eurozone, corporate and public sector leverage remains high.The share of lower-rated companies has increased, and narrowed spreads have encouraged the accumulation of leverage.

In China, leverage in the non-financial corporate sector has been rising.Although the lending risk ratio (LTV ratio, total mortgages or loans divided by property valuation) is low, the rapid growth of household debt has also raised concerns (household debt levels are in the high echelon in emerging markets).In other major emerging market economies, credit quality is a big risk.

3. The scale of leveraged financing is expanded.

Leveraged financing, which includes high-yield bonds and leveraged loans, has doubled in size since the financial crisis.(figure 11, shaded areas). As a tool for investors to take risks, leveraged financing is pro-cyclical. Looking to the future, with the normalization of monetary policyThe floating interest rate characteristics of leveraged loans may lead to default due to the decrease of borrower's debt coverage ratio (DCRs) and market liquidity risk.。

First, the concentration of BBB borrowers has increased, meaning that the downgrade of BBB borrowers to BB or lower during an economic downturn will cause some investors to sell the bonds. In addition, given that mutual funds are a major buyer, mark-to-market losses could stimulate fund redemptions, trigger fire sales and further depress prices. These developments not only affect investors who hold these loans, but also hinder the flow of money to leveraged credit markets, which in turn affects the economy as a whole.

4. Global impact of global risks and uncertainties

Countries with a higher degree of trade or financial openness are more vulnerable to global shocks. As shown in the chart below, financial openness and trade openness are twice as responsive to global risks and uncertainties as they are at baselines. (below, the blue line represents the average effect, while the red line represents the response of open and integrated countries to financial risks and uncertainties. )

The impact of global risk and uncertainty shocks is related to national vulnerability.Countries with higher comprehensive risk ratings and higher debt levels (especially foreign currency debt) have been hit harder(the figure below is almost twice that of the benchmark). The underdevelopment of the financial sector is also an important factor, which has caused economic activity to decline by about 50 per cent more than the benchmark.

5. Global market structure and the high cost of protectionism

Global trade and financial markets are increasingly linked.Multinational corporations are widely distributed and account for an increasing share of trade. they need a lot of working capital and bear a lot of foreign exchange risks. The financial transactions needed to manage these positions, including derivatives and hedging strategies used to offset currency risk, add complexity.

The relationship between trade and finance is getting closer and closer and will affect the expectations of financial markets.The middle right of the chart below shows the response of the Mexican peso / dollar to its main trade relationship, which weakened (as an upward trend) last year due to the deterioration of expectations of the North American Free Trade Agreement (NAFTA).

Trade protectionism has affected the performance of financial markets.The left chart below shows the share prices of US automakers on July 25, after General Motors Co lowered its forecast and its shares fell sharply, citing rising commodity prices. After that, trade tensions between the two countries eased. Shares of European carmakers rose and the euro rose against the dollar.

Protectionism could lead to a series of negative consequences. If all the factors are combined, we may face a perfect storm.First, consider that banks outside the United States provide most letters of credit denominated in dollars, which account for more than 80% of the sources of trade finance. As non-Bank of America Corporation relies on the financing market for US dollars, it increases the fragility of global finance. Second, trade skirmishes could easily escalate into currency wars; finally, given the heavy borrowing of dollars by non-banks outside the US, which now stands at $11.5 trillion, we must be wary of the long-term knock-on effects of US monetary tightening.