OREANDA-NEWS. October 15, 2015.

Speakers:
Jose Vinals, Financial Counsellor, Director of the Monetary and Capital Markets Department, IMF
Peter Dattels, Deputy Director, Monetary and Capital Markets Department, IMF
Matthew Jones, Assistant Director, Monetary and Capital Markets Department, IMF
Jennifer Elliott, Deputy Division Chief, Monetary and Capital Markets Department, IMF
Andreas Adriano, Senior Communications Officer, Communications Department, IMF

MR. ADRIANO - Good morning. Welcome to this press conference on the presentation of the new report on global financial stability for 2015. You have the interpretation information, if you need to ask questions in other languages.

Let me just remind you of the other events today. At 10:30 we have the presentation of the Fiscal Monitor, with Mr. Gaspar, and at 1:15 we have the press conference with Mr. Western, the director of the Western Hemisphere Department. Let me introduce you to the speakers: Financial counselor and Director of the monetary and capital markets, Jose Vi?als; Deputy Director, Peter Dattels; Matthew Jones and Jennifer Elliott, respectively Chief and Deputy Chief of the Global Financial Analysis Division, the team that puts the report together. Mr. Vi?als has some opening remarks and then we'll be happy to take your questions.

MR. VINALS - Thank you very much. It is a pleasure for me to be here in Lima this morning, to present this Global Financial Stability Report and it is also a pleasure seeing you here to share with us this event.

Today I have one main message and one recommendation. The main message is that global financial stability is not yet assured and that downside risks prevail. The recommendation is for an urgent upgrade of policy so as to avoid the downside risks and achieve our upside scenario of successful normalization of monetary and financial conditions which is key to secure financial stability and to strengthen the economic recovery.

So, let me now develop this message and this recommendation. I will start by providing you with our overall assessment of global financial stability by asking the question: What has changed since our last report in April? There I have some good news. The good news is that financial stability in advanced economies has improved, and this has happened as the economic recovery has broadened and solidified.

The Federal Reserve has indicated that monetary policy lift off is close in the United States as the economic preconditions are nearly in place. In the euro area, the policies of the European Central Bank (ECB) are gaining traction, and credit conditions are improving. But, as flagged in this one, and also in our spring report, risks have rotated from advanced economies to emerging markets. Although it is true that many emerging markets over the past years have enhanced their policy frameworks and resilience to external shocks, it is also the case that there are significant domestic imbalances in quite a number of these countries. Moreover, as Mr. Obstfeld mentioned yesterday in the presentation of the WEO, growth is slowing for the fifth year in a row in emerging markets, and this is happening as the commodity super-cycle has ended, and as unprecedented credit booms of these past years are also coming to an end.

This is of special relevance. Why? Because emerging markets now comprise a large share of the global economy, and also because of the role that global markets play in the transmission of shocks from some emerging markets to others, and also for the spillovers to advanced economies. We certainly had a flavor of this in this summer in the financial turmoil that originated in China.

In light of this, let me now move to discuss what are the main challenges that policymakers face at the global level. And here, we have a triad of challenges. You could think of a trinity of challenges. I wouldn't say a holy trinity, but it is a very, very significant trinity of challenges.

The first one has to do with emerging markets vulnerabilities. In light of the process of releveraging, which has taken place in emerging markets in recent years, nowadays the balance sheets of corporates and banks are stretched. We estimate that there is up to 3 trillion dollars in over borrowing in emerging markets.

Higher leverage in the private sector and greater exposure to global financial conditions have left many firms in emerging markets more susceptible to economic downturns, and emerging economies more exposed to capital outflows into deteriorating asset quality.

China, the most important emerging market in particular, faces a delicate balance in transitioning to a more accumulation-driven growth model, without activity slowing too much, while at the same time reducing high debt through orderly deleveraging, and all of this at the same time as it is moving toward a more market-based financial system. Certainly, this is a challenging set of objectives, which need to be navigated successfully because this would be key for China and for the world.

But, it is not just emerging markets that need to play a role. Advanced economies are also challenged. This is the second challenge I want to emphasize. Advanced economies need still to decisively address the remaining legacies from the crisis because this would be essential to consolidate financial stability and to reduce headwinds to growth. For instance, in the euro area, tackling sovereign and banking vulnerabilities as well as filling the remaining gaps in the euro area architecture remain critical.

In the United States, embarking on what is now the most telegraphed yet unprecedented process of increasing the policy rate for the first time in nine years, it is going to be an important transition, both for the United States and for global financial markets.

This brings me to the third challenge of the trinity, which is how will global financial markets cope with potential situations of strain? There, what we have learned is that financial markets can amplify shocks, and in fact, they can become a source of volatility and contagion when market liquidity is low. Indeed, our report finds that market liquidity has become less resilient in the present as compared to a few years in the past.

This is all the more important given that the starting conditions are of very compressed risk premia across many asset markets, across many financial markets, as a result of the much needed expansionary monetary policies that have been taken in recent years and that continue with us. The risk is that this compressed risk premia could decompress in a disorderly manner causing a vicious cycle between fire sale, redemptions, and volatility. Leverage in investment funds also has the potential to amplify volatility. Our analysis finds that there is 1.5 trillion dollars in embedded leverage through derivatives in bond funds.

Now, the three challenges that I have just outlined call for an urgent policy upgrade. Why? Because what we want to achieve is a successful normalization of monetary and financial conditions together with a sustained recovery. But, policy missteps and/or adverse shocks could result in a very different scenario. Could result in prolonged global market turmoil that would ultimately stall economic recovery resulting in what I call a failed normalization. The difference between these two scenarios of successful and failed normalization is quite stark. And, it amounts to nearly 3 percent of global output by 2017.

So, in light of that, what are the policies that need to be urgently upgraded? Let me start with monetary policies. Monetary policies in key advanced economies must remain accommodative, responsive, and fully conscious of the global spillovers back and forth of policy actions. In the United States, amidst more uncertainty in the global economy, it is our judgment that the Federal Reserve should wait to increase policy rates until there are further signs of inflation rising steadily toward its objective, with continued strength in the labor market. While the process will remain data dependent, the pace of subsequent policy rates increases should be gradual and well communicated.

But, monetary policy alone, as we know, cannot get us out of the present situation and deliver the upside. For that, other policies need to accompany monetary policy so that it doesn't remain home alone. Of course, these are the structural policies and the fiscal policies that both the WEO yesterday and the Fiscal Monitor will talk about later on today. But, financial policies also have an important role to play. For example, in the euro area the ECB cannot be relied upon solely to maintain financial stability. Other policies need to play a role. For example, the completion of the banking union and the advancement of the capital markets union.

In the euro area in particular, it is of the utmost importance to address in a comprehensive manner the remaining legacy of nonperforming loans in the banking system. That is key to enhance the transmission mechanism of monetary policy, to bolster confidence, and to improve the economic outlook. According to our analysis, resolving nonperforming loans in the euro area banks could deliver about 3 percent of loans in new lending capacity, and this amounts to around 600 billion euros.

Now, what is it that emerging markets need to do? Let me start with the most important one, which is China. In China, the rebalancing and the deleveraging process, which is a must, will require great care. As I mentioned, the Chinese authorities are facing unprecedented challenges in making the transition to a new growth model and to a more market-based financial system.

Deleveraging the corporate sector, and enhancing market discipline, will unavoidably entail some corporate defaults, the exit of a number of nonviable firms, and write-offs on nonperforming loans thus requiring further strengthening of the banks. As the historical experience repeatedly shows, moving decisively to deal with these challenges is ultimately much less costly than trying to grow out of the problems.

For emerging markets more generally, a policy upgrade is needed to build resilience and maintain confidence. Emerging markets need to get ahead of the credit cycle. What does that mean? That with slower growth and rising corporate leverage, immediate prudential attention is needed to enhance the resilience of corporates, which are heavily indebted, and also of banks, which have provided a lot of this lending to corporates. And furthermore, maintaining sovereign investment grade status through appropriate measures is crucial.

If push comes to shove, managing any outbreaks of financial contagion will require nimble and judicious use of available policy buffers. Last, at the global level, safeguarding against market illiquidity and strengthening market structures are priorities. A better oversight of liquidity in the asset management industry is key to avoid the risk of fire sales and a rush for redemptions from investment funds at times of strain.

So, to conclude, a collective effort is needed on the part of everybody, advanced economies and emerging markets, to deliver a policy upgrade which is needed urgently to face up to the rising challenges in this changing and uncertain world, and to deliver both solid financial stability, and better growth prospects. As I mentioned, 3 percent of global output is at stake. Let me stop here and now my colleagues and I will be happy to answer any questions that you may have.

MR. ADRIANO - Please identify yourself and your affiliation before your question. We will start here.

QUESTIONNER: I wonder if you can talk a little more about China. You talk in the report about the issues with corporate leverage. You talk about the issues of rising nonperforming loans in the banking system. What exactly is it? Can you elaborate on what worries you about the Chinese financial system, and what odds would you attribute to the possibility of a major credit event emanating from China?

MR. VINALS - In China as I mentioned, what you have is a combination of three challenges. The macroeconomic rebalancing channel, the orderly deleveraging challenge in order to reduce the existing financial vulnerabilities, while at the same time moving to a more market-based financial system. In the case of the interlinkages between corporates and banks, in China credit excesses are important. The amount of over borrowing in China is close to 25 percent of GDP, measured by the difference between credit to GDP and what our standard measures of a trend credit to GDP. So that means that China must undergo a process of orderly deleveraging in the corporate sector.

Now, a lot of the credit has been provided both by the banking system and by nonbanks, and while in the last few years the Chinese authorities have been successful in reducing the very rapid growth of credit coming from both banks and nonbanks, the stock of credit is still very significant. If you look at the corporate sector, and at some measures of how stronger the balance sheets in corporates, what you can see is that there is about 25 percent of the corporate debt which is owned by firms, which have a relatively weak debt servicing capacity. That is something which is a vulnerability going forward, which requires attention. Many of these firms are in the construction and real estate sector. A number of them are state-owned enterprises. So these are firms and sectors which are systemic and which require vigilance.

On the other hand, if you look at the banking system, what you see there is that nonperforming loans are very low, and that profitability is high and that liquidity is also high in the banking system. So the present situation is one of solidity. But unavoidably, with a slowdown in Chinese growth, which is leading to a lower profitability on the part of corporates, and the facts that 25 percent of the debt, as I said, is owned by a firms in a weaker debt servicing capacity, nonperforming loans are likely to increase in the future. There, one needs to reinforce the strength of banks, the loss absorbing capacity of banks to be ready to deal with this natural increase in nonperforming loans without any major strains.

Regarding your question, what is the probability of an immediate credit event in China? Well, if you are asking, having any particular firm getting into trouble, we have already had a couple of them in the last few months and they have not been systemic. So, I do not foresee any systemic credit event coming from China in the near future. But, it is very important that one gets ready by enhancing the solidity of the banking system, and by exerting, reinforced regulatory and supervisory vigilance to be prepared for any scenario. I do not foresee a systemic credit event in China in the near future.

QUESTIONNER: Following up the previous question, I wonder how the IMF has evaluated the renminbi's devaluation in August. Is that a misstep of policy as you mentioned, or a communication problem?

MR. VINALS - I think that the policy change that the Chinese authorities announced and instrumented in August was a good one in the sense of moving towards a more market-based exchange rate system. I think that over time China needs to introduce a bigger role for market forces in all parts of the economy, in a gradual and cautious manner, including in the foreign exchange market.

What happened in August is that the timing was complicated, given the previous uncertainties that had been unleashed by the very significant correction that took place in equity markets, and the increasing concerns and uncertainties about the future path of growth in China. In that regard, the fact that the authorities provided more flexibility in the regime to the exchange rate was perhaps misinterpreted by markets as signaling more fears on the part of the authorities of growth in China in seeking a further depreciation of the renminbi to help on the domestic front.

I don't think that was the intention. The intention was a more market-based floating exchange rate system. But, this issue, which had to do with the way that the policy change was communicated, and the time at which it was communicated led to significant downward pressures on the renmimbi, which were quite rapid, and then the authorities, having intervened, according to let's say anecdotal evidence and also to the reported reserve numbers that had been announced by the Chinese authorities, in trying to strike a balance between more flexibility, but not happening too fast.

I think that is something that needs to evolve in a natural way, and that in the future there is a need for more exchange rate flexibility. So it was not the wrong move, but the timing was difficult and the communication could have been better.

QUESTIONNER: As for Europe, you say that if nonperforming loans were sold to investors backing a 10 percent return, 600 billion in new lending capacity will result, but which is the Italian percent of this amount? And, for Italy, do you think that centralized asset management company of nonperforming loans could do better for our country?

MR. VINALS - I always get a question on Italy from the first row, so I knew it was you. And, I'm going to let Jennifer give you the number for Italy. I will just answer part of the question, which is, what is the best way of dealing with nonperforming loans. I think that dealing with nonperforming loans is key, because nonperforming loans trap part of the balance sheet of banks. In the euro area as a whole this means 900 billion euros. Italy is part of it. This part of the balance sheet is trapped. In a way it is immobilized. It doesn't generate profit because the loans are not performing. It creates risk for the banks, so you have to put up capital to deal with that. The capital which is trapped by debt cannot be used for lending. And on top of that it is costly to manage nonperforming loans.

It is like you have something in your organism that needs to get out. The way for it to get out is a combination of things: a combination of supervisory pressure, this time on the part of the Single Supervisory Mechanism, which the Bank of Italy forms a part, putting pressure on the banks to continue provisioning the nonperforming loans; developing better framework for the renegotiation of debts in court and out of court; reducing things like the foreclosure time, which maximizes the value of any loan, any nonperforming loan sold in the market, and therefore it is more attractive for potential buyers to buy it. Last but not least, putting in place in some cases, an asset management company to act as a vacuum cleaner of loans in the country.

In Italy I think that this is a good thing to do. But, of course, it is complicated to put in place because it needs to comply with the European competition rules. For example, in other countries, like in Spain, this was an instrument for relieving banks from the pressure of nonperforming loans and there are many historical experiences of countries that have used these things successfully.

MS. ELLIOTT - About 200 billion euros within the 600 [billion]. On the new lending capacity, we don't have it broken down by country. Out of 600 billion of new lending capacity, a significant amount of that would be in Italy, but we did not break it down by country for the --

MR. VINALS - One rule of thumb you could apply, if Italy is 200 out of 900, that is a proportion that is a bit more than 22 percent. You may want to use it is a rule of thumb that against the 600 billion, but we don't have the right amount.

QUESTIONNER: Can you better help me understand, you have been giving me short hours reading all of this IMF material.

MR. VINALS - I hope you have enjoyed it.

QUESTIONNER: In a weird, way, yes. Can you help me better understand the contagion that emerging markets financial vulnerabilities represent to U.S. financial markets? Secondly, can we not see all of the potential disruption, the weakness that we're seeing, the overleveraged debt, as a consequence of nearly a decade of unprecedented easy monetary policy?

MR. VINALS - Let me take part of this question and let me colleagues handle the first part. The overleveraging in emerging markets has happened primarily in the private sector, and if you look at the factors that have been behind this rapid leveraging up in the corporate sector, you could think of two categories of factors. Factors relating to the fundamentals of the firms that have been borrowing in domestic and international markets. How good they were in terms of profitability, in terms of strength of the balance sheet? You could think of the fundamentals of the economy in which this firm is based. Those would be factors affecting the amount of leverage. Better firms you would expect to leverage more, and countries which are stronger, to be able to more successfully leverage. But also, you have global factors, like the one you alluded to, of easy monetary policies and other global markets like high commodity price in the past. We have looked empirically at this issue in the report, and what we find is that in recent years, the main driver of the leveraging process in emerging market corporates has had to do not with the firms being better, borrowing more, or with countries being stronger having their corporates borrowing more. It has been that everybody has been able to borrow more and at very low interest rates because of two factors, global factors: The easy monetary policies and the high commodity prices.

Now, the future is going to look different. It is already looking different because commodity prices have come down, and because most of this borrowing has been made in dollars, and the Fed is likely to increase interest rates in the future, which should lead to further capital outflows from these economies, and some further depreciation of their currencies. So, the answer is yes, global factors have been a big part of it, but not just monetary policies, but also the high commodity prices, that has been crucial. That doesn't mean that the monetary policies that were put in place in advanced economies were wrong. On the contrary. Without that, both the advanced economies and the world would be today in a much, much worse place. This is a side effect of these monetary policies.

MR. DATTELS - Perhaps I can touch on the scenarios that we have in the report, and the question was, how are the scenarios affecting emerging markets and advanced economies. As Jose laid out, policymakers are facing a triad of global challenges. One set of challenges in the advanced economies, dealing with the legacy of the crisis, emerging markets in terms of managing emerging market vulnerabilities, and thirdly global markets and the market fragilities that have been in evidence.

Broadly speaking, what the concern is managing these policies, are we subject to confidence shocks as a result of policy missteps, or failures to implement the policies? This can come from either advanced economies or emerging markets themselves. The channel through which a confidence shock in emerging markets could feedback into advanced economies comes initially through a decompression of risk premia in financial markets. We have seen some taste of this in terms of falls in equity prices, and widening of credit spreads. Equally, we highlight the potential for term premia to increase in bond markets.

So the effect of these decompression of risk premia that may be amplified by weaker systemic liquidity or market fragility, could lead to some overshooting in these risk premia. What is the result of that? That tightens financial conditions. As those financial conditions tighten, it creates an impact on growth prospects, particularly for advanced economies. And you need to remember that the ability to deal with this type of a scenario weakens because monetary policies are at the lower bound, so the typical ability of advanced economies to reduce interest rates is taken away, remaining at the lower bound.

The scenario we had is for advanced economies, the loss in output compared to the baseline over the 2.5 years, to the end of 2017, is about 2.4 percent. That is a substantial decline against a fairly low growth rate to begin with. In terms of emerging markets, a shock in confidence in dealing with advanced economies spilling over to financial markets into emerging markets comes through essentially three channels.

First to mention is the financial contagion aspect, where risk premia rise in emerging markets, of which we have seen some over the summer turmoil, those types of channels operating. As Jose mentioned, corporate debt shocks, in terms of the unwinding of excesses in credit that need to occur in emerging markets, set against lower corporate earnings. Lastly, the commodity shocks that have hit, and could hit in a down scenario, where we have a fall of commodity prices of about 20 percent on the energy side. So those channels through emerging markets create a contraction in output of about 2.5 percent, which is about the same as in advanced economies, although they're affected in different ways. That is a long answer to a short question. Apologies for that.

QUESTIONNER: Two-part question. Firstly, in the report, when you are referring to China, you talk about potential banking overspills of, I think the figure you used was 800 billion dollars, and you looked particularly at the Hong Kong/Shanghai relationship, so on. There were several advanced country banks, in particular two British banks, HSBC and Standard Chartered, which are very exposed to that neighborhood. I just wondered if you had them in your sights. Secondly, in the opening remarks you were quite strong on the Federal Reserve postponing an interest rate reduction until inflation had advanced a bit. I just wonder what you felt the immediate impact would be if they went early?

MR. JONES - In the report we talk briefly about the cross border banking relationships in China and the significance of those on a global scale, and for many advanced country banking systems, clearly China given its size and role in the global economy, the financial sector linkages to China are quite significant.

I think one thing we say in the report is that as the Chinese rebalancing and slower growth starts to occur, this obviously has big implications for bank balance sheets in terms of their asset quality challenges from the growing corporate sector weakness. The banks are going to need to enhance their loss absorbing buffers to deal with those challenges, as they meet those potential exits of nonviable firms that Jose mentioned, and greater role for market forces playing.

This will require additional provisioning and higher levels of capital and lower bank earnings. Now, for globally active banks that have a significant presence in China, they are going to face some of the same challenges as the economy slows down and you may see an impact on their corporate earnings, and on their need provisions as well. So clearly, global banks that are active in China will face some of the very same challenges we write about in the report. But generally, those banks, their capital buffers remain adequate, and I think while it will clearly have an impact on their earnings, with continued supervisory vigilance that should not present a systemic problem.

MR. VINALS - Coming back to the Federal Reserve, why not just do it? That is the question. Why not just do it. And the answer is, do it when you do it well. Don't do it either too late or too early, and of course this is all subject to interpretation, but our analysis at the Fund is that the process should be data dependent. If we look at the data today, we do not see wage and price inflation having the strength that would make necessary to increase interest rates at this stage in order to guarantee the fulfillment of the inflation objective. Inflation is still far, in terms of projections also, far from the objective. And, one needs to gather a bit more information, particularly now that things are becoming more uncertain, in order to make sure that whether one embarks on this route, one is not going to stop, or reverse. I think that being cautious on this is appropriate, and the Fed so far has been cautious.

(Inaudible.)

MR. VINALS - I think that, again, one needs to gather a bit more information regarding data on the U.S. economy, but at a time where you are faced with the zero lower bound still, I think that the risks of acting prematurely in terms of tightening are higher than the risks of acting a couple of months afterwards. In light of that, I think that the data dependent process that the FOMC has emphasized is the right one, and so far, it hasn't justified an increase in policy rates. Our analysis also looking at data now, doesn't see it, and doesn't see it for the next few months.

QUESTIONNER: Two brief questions. One on Spanish banks. Four years ago one of the few redeeming features of Spanish banks in the midst of a very serious banking crisis in the eurozone, of which Spain was part, one of the few redeeming features was the presence of Spanish banks in countries like Brazil, Peru, etcetera. I think the Fund even mentioned that as something that we should feel optimistic about. Four years later it would appear, I don't know what the borrowing figures for Latin America, but if would appear Latin American banks, particularly in Brazil, are very exposed to over leverage in an economy that is now in a very deep recession. So, the first question is, to what extent are Spanish banks going to be exposed to Latin American problems?

Secondly, on the corporate debt denominated in dollars, it looks like the IMF has been very successful in warning governments in emerging economies of the dangers of sovereign debt denominated in foreign currencies. You don't really seem to have done such a good job on corporate debt. So, the question is, is that a failure? Should the IMF have been more effective in devising policy recommendations that would have avoided what looks like a ticking time bomb in terms of corporate debt denominated in dollars in emerging economies?

MR. VINALS - Let me answer the second part of the question and my colleague, Ms. Elliott, will answer the first part regarding Spanish banks in Latin America. The IMF certainly has been drawing attention to the issue of corporate debt in emerging markets, not just now. If you look at the reports a year ago, a year and a half ago, we already have analysis pointing out the growing risks in this domain. And this is something which the IMF can do, which is to put in the face of the world what are the vulnerabilities. But the actual policy actions need to take place in the countries. Now, let me say, that a number of countries have taken actions. For example, talking about Latin American countries, if you look at the total debt which in emerging markets now is in foreign exchange, is about 16 percent. 16 percent of the corporate debt is denominated in foreign exchange. The question is how much of it is hedged. You can hedge in two ways. You can hedge through natural hedges, if you export in dollars and your debt is in dollars, you are covered. Or, you can hedge through financial products. There is a lot less information about that. So, another thing where the IMF has been active is in saying, listen, we need better data at the international level. At the national and international level and many countries themselves don't have yet data which is good enough to fully understand how exposed is their corporate sector. But, some countries have been rather proactive in this regard.

For example, if you look at a country like Peru, it is rather hedged, it is well hedged. The foreign exchange exposures of the corporates are well hedged. Action has been taken. If you look at Chile, the same thing is happening. If you look at Mexico, the same thing is happening. If you look at Brazil, where the corporates have significant unhedged positions, their authorities have been providing publicly foreign exchange hedges so that they have a more secure position. If you look outside of Latin America, in countries like India, the central bank has been very active in calling the corporates to be proactive in hedging because it finds that they are not sufficiently hedged. So I think that we have had an impact in raising awareness and also leading countries into being more proactive in making their corporates more aware of it, making the banks more aware that if they lend to corporates that are unhedged, they may have to pay higher capital ratios, or things like that, or higher capital reserve requirements. I don't think the problem is fully solved, but I don't think you can say the IMF has not spoken at an early enough time, or that a number of countries particularly in Latin America have not followed.

MS. ELLIOTT - On the Spanish banks, indeed, particularly the two largest banks have large exposures to Latin America and have achieved a lot of profitability in the past years based on that exposure. We see it as a drag on profitability going forward. At the same time, Spanish banks have worked very hard to build capital and strengthening and converging to Basel III, so we see it as a more resilient situation as well.

QUESTIONNER: I'm sorry that I was a bit late to the conference, but I was wondering if you could give us an overview, a small overview about the financial sector in Latin America, specifically in Central America and of course I am wondering if the banks may be weakened if the Fed raises the interest rates because a lot of our debts are in foreign exchange, dollars, so if you can give us a brief overview that would be nice. I don't know if you can answer in Spanish.

MR. DATTELS - The channels through which Latin American banks in general are going to be impacted are essentially through the three channels outlined earlier. The first is, financial contagion, that is the rise in risk premia in global markets and there are some economies in Latin America that are more affected through that channel and some are less. On the lower bound for example is Chile. Given Mexico's close alignment with the U.S. and the degree of financial integration, it is higher.

Second is through commodity prices. The banking systems are going to be exposed to corporates whose earnings are declining as a result of commodity price exposures, and you think of Ecuador, Brazil, Venezuela. And, the third channel is through over-leveraging and through the turn in the credit cycle that we highlight in the report.

If you combine all three of those vulnerability factors, that combined with the loss of output that we highlight in the report, that hits the banking systems more in terms of a rise in nonperforming loans and an erosion of capital buffers. I want to just very briefly circle back to the point about the corporate sector, and I think that what we highlight in the report is the new emerging nexus between the corporate sector and the sovereign. We have talked a lot about the links between banking and sovereign stress that we have had. But, if you do look at the extent of corporate borrowing in international markets, a sizable amount of that has been represented by state-owned enterprises, which represent a contingent liability in those state-owned enterprises, a large share of it has been in the commodity sector.

What we highlight in the report is the potential emergence of those contingent liabilities becoming more visible. That is particularly important and affects the sovereign balance sheets in terms of a potential downgrade risk. So what you see is that the spreads and the cost of financing rising in the corporate sector, particularly in those economies, so exposure creates a risk that sovereigns may have to step in and recognize those contingent liabilities.

MR. ADRIANO - Thank you very much. I'm sorry we cannot take all remaining questions. There are other events. Just a reminder, 10:30 the presentation of the Fiscal Monitor. Thank you very much. Have a good day.