Fitch says leverage jump in pandemic points to increased financial risk

The marked rise in leverage across many economies resulting from the COVID-19 pandemic may point to increased risk of financial stress over the coming years, says Fitch Ratings.

“Our Macro-Prudential Indicator (MPI) scores suggest moderate or high vulnerability to banking system stress for 17 developed market (DM) economies, up from nine a year earlier. This is the most since 2013, although still below the peak of 30 in early 2008, and the share of markets with raised MPI scores is just under half the historical average of 40%,” Fitch said.

It said interpreting MPI scores was complicated by the nature of the COVID-19 shock. Higher leverage is less likely to be a sign that credit bubbles are forming, as real credit growth accelerated only slightly (global median: 3%) in 2020. Credit ratios should drop back towards pre-pandemic levels in some markets in 2021 as economic activity recovers. Banking System Indicators have generally held up during the crisis.

Nevertheless, lending during the pandemic went into weakened economies and much of it was channelled towards the worst-hit sectors and borrowers. Policy tightening or a stuttering, uneven recovery could test some borrowers’ ability to repay debt taken on to survive the pandemic.

Fitch said loose monetary conditions and Government support measures also led to strong real house price increases in many markets. Sharp asset price rises may be another sign of greater financial system vulnerability. However, the gains were not typically sufficient to trigger thresholds for MPI 3, with only Germany at this score.

MPI scores may understate risks in some emerging markets (EMs), with just seven EMs scoring MPI 2 or worse, as Fitch’s model relies on real credit growth for EMs, rather than credit-to-GDP ratios, which increased markedly in Latin America and the Middle East and North Africa.