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Credit Suisse Research Institute publishes comprehensive study on global debt

The Credit Suisse Research Institute (CSRI) has today published a comprehensive study assessing the potential risks arising from the surge in global debt over recent years. The study concludes that while there are various pockets of risk that need to be carefully monitored, the likelihood of a systemic crisis such as occurred in 2008 seems contained. 

Does the historically high level of debt relative to GDP imply that we are heading for a renewed disruptive crisis in key countries or even globally? The report by the Credit Suisse Research Institute attempts to assess this risk by analyzing debt dynamics from a broad range of angles, investigating debt in the major economies, regions and sectors. A general finding is that differences in the evolution of debt are very significant, with the strongest rise in debt concentrated in a relatively small number of countries and sectors. 

Specific findings include

  • High government or quasi-government debt in advanced economies as well as China is worrying because it decreases policy flexibility. However, low real interest rates increase debt sustainability, for now. Should they rise in the context of stronger growth, this would not be problematic, but a rise due to reduced savings would generate stress globally
  • In the Eurozone, fiscal metrics are better than sometimes portrayed. Sustainability is threatened by an incomplete monetary union and, more importantly, due to political "tail risk"
  • China has been a major contributor to debt growth since 2008. Debt in China is likely sustainable given still considerable growth potential, but only at the cost of continued "financial repression"
  • Defaults are likely to rise in segments of the corporate debt markets once economic growth weakens more markedly or if monetary policy tightens further; in such a situation, an unwinding of positions could generate significant market stress due to illiquidity
  • Leverage on the fringes of the banking system has once again increased in recent years. While China's authorities have recently clamped down on “shadow bank” lending, real estate related lending by lightly regulated entities may pose some risks in the US market. The gains in market share by unleveraged entities such as insurance companies and pension funds do not seem to pose systemic risks
  • The risk of debt-related stress has declined considerably in the majority of emerging markets relative to the late 1990s, not least due to more flexible monetary and currency policy. But countries with weak fiscal discipline or significant foreign-currency denominated corporate debt exposure need to be monitored carefully
  • While a number of real estate markets, not least Switzerland's, have overheated in the post-crisis period due to very low interest rates and would be at risk of setbacks in case of an economic downturn, real-estate related debt is less of a concern due to more robust financial products
  • The main reason for a more sanguine view of systemic stability is reduced leverage in the global banking system


Michael O’Sullivan, Regional Chief Investment Officer EMEA, Credit Suisse, said: “The report’s key conclusion is that there are a number of specific pockets of risk but that acute “systemic” instability seems less likely than often perceived. One of the key reasons is that leverage in global banking has receded markedly since the crisis, although there are some new areas of heightened financial sector leverage outside the formal banking system.” 

Oliver Adler, Chief Economist, Credit Suisse Switzerland, said: "The surge in government or government-related debt since the financial crisis is worrying because it reduces policy flexibility. While low real interest rates increase debt sustainability, a reduction in global savings poses a risk. US government debt is on an unhealthy trajectory due to recent tax cuts. Fiscal metrics are somewhat better in most of Europe, but uncertainty over the central bank backstop coupled with political risks adds to uncertainty." 

«Assessing Global Debt» (PDF)  

Detailed findings

Advanced economy government debt in part on an unsustainable trajectory
The authors point out that the increase in debt has been far from uniform across countries and sectors. In advanced economies overall leverage has in fact been stable since 2009, but government debt has increased sharply in most countries which raises the question of debt sustainability. On current projections, the trajectory of government debt looks most worrying for the United States debt; this is largely due to the recent significant tax cuts. To return to sustainability, a significant adjustment of fiscal policy would be required which looks unlikely given the current political alignment. While a default by the US government seems very unlikely, the fiscal-cum-current account deficit raises the specter of a sharper USD correction.

High savings rates sustaining Japanese debt, Italian debt subject to political risk
Meanwhile, government debt in Japan remains on an unstable trajectory as well but is, for now, being sustained by Bank of Japan purchases and high private sector demand for low yielding assets; moreover, efforts are underway to further limit deficits. Within the Eurozone, the fiscal position is generally somewhat more stable, but the role of the central bank in maintaining debt sustainability is more constrained ("QE inequality"); this implies that debt is subject to greater political risks, as demonstrated recently in Italy.

Managing an exit from China's high quasi-government debt will continue to require some "financial repression"
By far the biggest driver of the global debt expansion in the post-crisis years has been the rise in the debt of China's state-owned enterprises; this is effectively also public sector debt. The authors conclude that China’s growth potential should suffice for leverage to be kept in check, albeit at the cost of continued “financial repression.” Actions of the Chinese government since 2016 have initiated deleveraging, but so far mostly in the area of private sector debt; this has depressed corporate investment and economic growth. A significant reduction in the household savings rate in China would pose risks to debt sustainability in China as well as globally.

Fiscal discipline better in most other major emerging markets
Overall debt ratios in emerging markets (EM) declined in the decade following the EM crises of the late 1990s. However, government as well as private sector debt has increased again in most countries over the past ten years or so. Nevertheless, the risk of crises and contagion is more limited, not least because the quality of monetary policy has generally improved, allowing countries to better deal with external shocks. Importantly, currencies are not pegged to the USD any longer. High foreign currency denominated corporate debt represents a pocket of risk in some countries.

High US corporate debt a potential pressure point
While the trend for overall non-financial private sector leverage, as measured e.g. by the so-called credit gap, has improved in most advanced economies since the financial crisis, there are pockets of risk here as well. After an initial phase of deleveraging, corporate debt has, in particular, been rising significantly since 2014, especially in the USA; the surge in M&A activity has been one of the contributing factors. Measures of credit quality have worsened within the investment grade bond segment, with vulnerabilities concentrated in some highly indebted "old economy" companies which are under significant competitive pressure. While financial discipline has improved in the high yield area since 2015 non-capital market financing in the form of lower quality leveraged loans has surged. Should the economy slow significantly and/or interest rates rise substantially, default rates are likely to increase markedly. In such a situation, an unwinding of positions could generate significant market stress due to illiquidity. The limited exposure of banks to leveraged loans limits systemic risks, however.

Some real estate markets have overheated on the back of cheap debt
"Toxic" mortgage debt which financed overpriced real estate lay at the heart of the financial crisis. While the crisis markets such as the USA have rebalanced and households have deleveraged, a number of real estate markets, including Australia, Canada, Sweden and Switzerland have been heading for a boom since the financial crisis as declining interest rates encouraged borrowing and real estate investment. Due to high valuations, some of these markets are quite vulnerable to setbacks, in the view of the authors. That said, financing structures have generally become less risky in both private as well as commercial real estate, limiting systemic risks.

Reduced bank leverage is the key reason for reduced systemic risks
Ten years ago, the shortage of capital and low quality "toxic" assets combined to bring the banking system in the United States and Europe to the brink of collapse. Deleveraging in combination with a moderated overall risk profile of banks' balance sheets has since reduced systemic risk in key countries. However, some new areas of risk have emerged, in part on the fringes of the formal banking sector. In the past years, both the USA and China have witnessed a new wave of “shadow bank” lending, in part to finance real estate investments. While the Chinese authorities have in the meantime clamped down on shadow banks, greater regulatory focus may be required elsewhere. Meanwhile, some off-balance sheet areas of financial institutions such as “pledged collateral” may also require greater attention.

About the Credit Suisse Research Institute 

The Credit Suisse Research Institute is Credit Suisse's in-house think tank. The Institute was established in the aftermath of the 2008 financial crisis with the objective of studying long-term economic developments, which have – or promise to have – a global impact within and beyond the financial services. Further information about the Credit Suisse Research Institute can be found at www.credit-suisse.com/researchinstitute.