McKinsey Global Institute

McKinsey Global Institute
September 2009
Global capital markets:

Entering a new era
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Copyright © McKinsey & Company 2009

September 2009

Entering a new era
Charles Roxburgh
Susan Lund
Charles Atkins
Stanislas Belot
Wayne W. Hu
Moira S. Pierce
4
Global capital markets: Entering a new era 5
Preface
Global capital markets: Entering a new era is the latest research by the McKinsey
Global Institute (MGI) on the evolution of the world’s financial markets. This report is
based in large part on findings from three proprietary databases that document the
financial assets, capital inflows and outflows, and cross-border investments of more
than 100 countries around the world since 1990. In this report, we assess the effects
and implications of the current financial crisis and economic downturn through the
lens of global financial assets and capital flows. Although the crisis will take years
to play out fully, we detail how the financial landscape has already shifted in several
important ways. We also analyze the future growth prospects for financial assets in
mature and emerging markets.
Susan Lund, MGI Director of Research, and Charles Roxburgh, MGI Director, led
this project. The project team comprised the following MGI fellows: Charles Atkins,
Stanislas Belot, Wayne W. Hu, and Moira S. Pierce. The team benefited from the
contributions of Paul Arnold and Nidhi Sand. Nell Henderson provided editorial
support.
This report would not have been possible without the thoughtful input and expertise
of numerous McKinsey colleagues around the world. The authors particularly wish
to thank Martin N. Baily, a senior adviser to McKinsey & Company and to MGI, and
Lowell Bryan, a director of McKinsey & Company in the New York office.
Our aspiration is to provide business leaders and policy makers around the world
with a fact base to better understand some of the most important trends shaping
global financial markets today. As with all MGI projects, this research has not been
commissioned or sponsored in any way by any business, government, or other
institution.
Richard Dobbs, Director James Manyika, Director

Seoul San Francisco
Charles Roxburgh, Director Susan Lund, Director of Research

London Washington, DC
September 2009
6

Entering a new era
The current financial crisis and worldwide recession have abruptly halted a nearly
three-decade-long expansion of global capital markets. From 1980 through 2007,
the world’s financial assets—including equities, private and public debt, and bank
deposits—nearly quadrupled in size relative to global GDP. Global capital flows similarly
surged. This growth reflected numerous interrelated trends, including advances
in information and communication technology, financial market liberalization, and
innovations in financial products and services. The result was financial globalization.
But the upheaval in financial markets in late 2008 marked a break in this trend. The
total value of the world’s financial assets fell by $16 trillion last year to $178 trillion,
the largest setback on record. At this writing in September 2009, equity markets
have bounced back from their recent lows but remain well below their peaks. Credit
markets have healed somewhat but are still impaired.
Going forward, our research suggests that global capital markets are entering a new
era in which the forces fueling growth have changed. For the past 30 years, most of
the overall increase in financial depth—the ratio of assets to GDP—was driven by the
rapid growth of equities and private debt in mature markets. Looking ahead, these
asset classes in mature markets are likely to grow more slowly, more in line with GDP,
while government debt will rise sharply. An increasing share of global asset growth
will occur in emerging markets, where GDP is rising faster and all asset classes have
abundant room to expand.
In this report, we assess the effects and implications of the crisis through the lens of
global financial assets and capital flows.1 Although the full ramifications of the crisis
will take years to play out, it is already clear that the financial landscape has shifted in
several ways. Most notably, we find that:
Declines in equity and real estate values wiped out $28.8 trillion of global wealth in
2008 and the first half of 2009. Replacing this wealth will require more saving and
less consumption, which may dampen global economic growth and necessitate
significant adjustments by the banking business.
Financial globalization has reversed, with capital flows falling by more than 80
percent. This has created turmoil for multinational financial institutions, caused
currency volatility to soar, and sharply raised the cost of capital in some countries.
It is unclear how quickly capital flows will revive, or whether financial markets will
become less globally integrated.
Some global imbalances may be receding. The US current account deficit has narrowed,
as have the surpluses in China, Germany, and Japan that helped fund it. However, this
may be a temporary effect of the crisis rather than a long-term structural shift.
1 For previous research, see Mapping global capital markets: Fifth annual report, McKinsey
Global Institute, October 2008 (available at www.mckinsey.com/mgi/) or “Long-term trends
in the global capital markets,” The McKinsey Quarterly, February 2008 (available at www.
mckinseyquarterly.com/home.aspx).
8
Mature financial markets may be headed for slower growth in the years to
come. Private debt and equity are likely to grow more slowly as households and
businesses reduce their debt burdens and as corporate earnings fall back to long-
term trends. In contrast, large fiscal deficits in many mature markets will cause
government debt to soar.
For emerging markets, the current crisis is likely to be no more than a temporary
interruption in their financial market development, since the underlying sources of
growth remain strong. For investors and financial intermediaries alike, emerging
markets will become more important as their share of global capital markets
continues to expand.
GLOBAL FINANCIAL ASSETS DECLINED BY $16 TRILLION IN

2008, THE LARGEST SETBACK ON RECORD
For most of the first eight decades of the 20th century, financial assets grew at about the
same pace as GDP. The exceptions were times of war, when government debt rose much
more rapidly. But after 1980, financial asset growth raced ahead. In the United States,
for example, the total value of financial assets as a percentage of GDP has grown more
than twice as much since 1980 as it had in the previous 80 years (Exhibit 1). Worldwide,
equities and private debt accounted for most of the increase in financial assets since
1980, as companies and financial institutions turned increasingly to capital markets for
financing. By 2007, the total value of global financial assets reached a peak of $194 trillion,
equal to 343 percent of GDP. 2
Exhibit 1
After
After1980,
1980,financial asset
financial growth
asset accelerated
growth accelerated Equity Equity
Private debt Private
securitiesdebt securities
Government debt securities
Deposits
US financial assets as a % of GDP Deposits
US financial assets as a % of GDP 442
417 442
400 392 417
400 392
350
350
300 198 p.p.1
300 198 p.p.1
250 240
207 240
250
200 194
167 207
200
150 93 p.p.1 139
194
167
101
100
150 93 p.p.1 139
50 101
100
0
501885 1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2008
1
Percentage points of GDP.
SOURCE:
0 Federal Reserve; National Bureau of Economic Research; Robert Shiller; McKinsey Global Institute analysis
1885 1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2008
1
Percentage points of GDP.
SOURCE: Federal Reserve; National Bureau of Economic Research; Robert Shiller; McKinsey Global Institute analysis
But the financial crisis interrupted this process. The value of the world’s financial assets
fell to $178 trillion by the end of 2008 (Exhibit 2). This 8 percent decline was the largest
since our data series began in 1990, and in some countries, the drop was far worse.
2 Unless noted otherwise, all financial figures in this report are stated at 2008 exchange rates.
This allows us to compare growth over time, excluding the effects of currency movements.
Figures are not adjusted for inflation. Based on the latest available data, this report also
updates figures published in our earlier reports.
Exhibit 2
Global financial assets fell by $16 trillion in 2008 Equity securities

$ Trillion, using 2008 exchange rates for all years Private debt securities
XX Compound
annual growth
rate 2000-07, Bank deposits
%
Largest declines in
Global financial assets financial assets 2007-08
US -5.5
+9 194 -82
174 178 Japan -2.4
155 62 34
139 54 China -2.4
126 45
70 112 114 113 38 511
48 33 481 Russia -0.8
10 14 37 33 26 42
34 37
10 13 31 32 Hong Kong -0.7
27 28 29
9 18 24 27 28
20 22 24
17 18 India -0.6
46 51 56 61
34 36 38 40 43
19 25 France -0.6
GDP 1990 1995 2000 2001 2002 2003 2004 2005 2006 2007 2008
$ Trillion 21.2 Switzerland -0.6
28.4 37.0 38.5 39.9 42.3 45.5 48.6 52.3 56.8 60.7
Financial Germany -0.4
depth
% of GDP 227 246 303 297 282 298 305 320 334 343 293 Canada -0.3
1
Excludes debt write-downs of $0.28 trillion in 2007 and $0.98 trillion in 2008.
2
In current exchange rate terms the drop in global financial assets would have been $22 trillion in 2008, or 11 percent of global
financial assets.
Note: Figures may not sum due to rounding.
SOURCE: McKinsey Global Institute Global Financial Assets database; Bloomberg
The damage has been widespread, with financial assets declining in nearly every
country (Exhibit 3). Only a handful of economies, of which the United Kingdom is most
notable, had a commensurate increase in 2008. The UK gain, however, was itself a
by-product of the crisis: a UK government program to recapitalize troubled banks
triggered a rise in private debt issuance that more than offset the decline in equities.3
Exhibit 3
Financial assets decreased in all regions except the United Kingdom 2007
2008
$ Trillion, using 2008 exchange rates for all years Amount
Total financial assets per major region Percent (%) ($ Trillion)
US
60.4 -9 -5.5
54.9
43.6
Eurozone -4 -1.6
42.0
28.7
Japan -8 -2.4
26.3
14.4
China -17 -2.4
12.0
8.0 8 0.6
UK1
8.6
4.1 -6 -0.2
Latin America
3.9
4.2
Emerging Asia -9 -0.4
3.8
1.9
Russia -40 -0.8
1.1
2.6
India -23 -0.6
2.0
4.3 -64 -2.8
Eastern Europe
1.5
1
Assets increase primarily due to an increase in international financial institution debt, reflecting a surge of securitization activity
in response to the Bank of England’s accepting securitized assets as collateral for repurchase agreements.
SOURCE: McKinsey Global Institute Global Financial Assets database
3 The European Central Bank and the Bank of England announced in April 2008 they would
accept securitized assets as collateral for repurchase agreements, or repos. This triggered a
surge in securitization. Such repo market transactions with these two central banks accounted
for more than 95 percent of all UK securitized asset issuance in 2008.
10
Equities declined sharply

Falling equities accounted for virtually all of the drop in global financial assets. The world’s
equities lost almost half their value in 2008, declining by $28 trillion. The damage was
widespread, with equity markets declining in every one of the 112 countries in our sample
(Exhibit 4)—producing the most severe crash since the Great Depression (Exhibit 5).
Markets have regained some ground in recent months, replacing $4.6 trillion in value
between December 2008 and the end of July 2009. But as of August 31, 2009, the S&P
500 index, for instance, remained 34 percent below its peak.
Exhibit 4
Every equity market in the world lost value in 2008

% of GDP
Equity growth in developed and

Best and worst equity performances emerging economies
2007-08 growth, % 2007-08 growth, %
Best Colombia -4 World average

performers -45
South Africa -19
Chile -20
Mexico -26 Developed

-43
economies
Czech Republic -29
Worst Greece -64

performers
Ireland -64
Austria -67
Emerging
-51
markets
Russia -68
Iceland -73
Exhibit 5
The 2008 stock market crash was the most severe since the
Great Depression
S&P 500 crashes
% decline from peak, nominal
0
-5 Black Monday
Sept 1987 -
-10
June 1988
-15
-20 World War II
-25 Nov 1938 -
Apr 1942
-30
-35 2000 dot-com bubble
-40 Oct 2000 -
-45 Feb 2003
-50 1973 oil crisis
-55 Jan 1973 -
Dec 1974
-60
Subprime mortgage
-65 crisis
-70 Oct 9, 2007 -
-75 Mar 9, 2009
-80 Mar 9, 2009 –
-85 Jul 31, 2009
-90
0 1 2 3 Great Depression
Sep 1929 -
Years from S&P 500 peak
Jun 1932
SOURCE: Datastream; Robert Shiller; McKinsey Global Institute analysis

In addition, we estimate that global residential real estate values fell by $3.4 trillion in
2008 and nearly $2 trillion more in the first quarter of 2009.4 (See sidebar, A look at
global housing wealth) Together with equity losses, this has erased $28.8 trillion of
household and investor wealth as of the middle of 2009. Replacing this wealth will
require a long period of higher saving. To put this in perspective, the world’s households
saved about 5 percent of their disposable income in 2008, or $1.6 trillion: they would
have to save that amount for 18 consecutive years to amass $28.8 trillion. Of course the
actual time it will take is unknowable at this point, since it will depend on many factors,
including household saving behavior, income growth, and asset appreciation.
A look at global housing wealth

Although the current financial crisis started with the bursting of the US housing
bubble, other economies around the world are feeling the effects of their own real
estate booms and busts. From 2000 through 2007, a remarkable run-up in global
home prices occurred (Exhibit A). US housing prices appreciated significantly—
and still were surpassed by values of those in at least half a dozen European
countries. Residential real estate prices soared in emerging markets, too: for
instance, the value of South Africa’s homes rose by two and a half times over
that period. No publicly available data source on global home prices exists, but
we estimate that the total value of all the world’s residential real estate more than
doubled during this period, to exceed $90 trillion (Exhibit B).
Since 2007, however, home prices have fallen sharply in some countries, erasing
more than $3.4 trillion of household wealth in 2008. And the effects have been
uneven, with the worst-hit countries—such as Estonia—suffering real housing price
declines of 20 percent or more, and many countries—such as Russia—recording
increases in 2008. This suggests potential declines ahead for some countries. And
because home prices are slow to correct, the current slide may persist for some
time. This could depress global consumption and contribute to mortgage defaults,
which continue to plague the financial sector.
Exhibit A
Housing price indices in many countries soared from the mid-1990s
through 2007
Real house prices
1970 = 100
450
420
390
Belgium
360 Spain
UK
330
Netherlands
300 Ireland
Australia
270
Norway
240 Canada
France
210
Italy
180 USA
150 Sweden
120 Switzerland
Japan
90
Germany
60
1970 1980 1990 2000 2008
SOURCE: Bank of International Settlements, per national sources; Haver Analytics; McKinsey Global Institute analysis
4 There is no comprehensive database of global real estate values. Our sample includes
Australia, Europe, Japan, the United Kingdom, the United States, and some emerging
markets. See sidebar, A look at global housing wealth, for more detail.
12
Exhibit B
Global residential real estate values exceeded $90 trillion at their ESTIMATE
peak, but lost $3.4 trillion in value in 2008
Compound annual
Global residential real estate growth rate, %
$ Trillion, using 2008 exchange rates for all years2 1996- 2007-
2007 08
90.8
88.3 87.4 7.7 -3.7
82.3 12.6
10.6
14.0 19.8 11.5
74.5 8.3
9.6 9.5
67.4 7.3 9.6 9.3 -3.5 -2.0
62.1 6.2
56.9 9.8
53.9 5.4
50.6 3.8 10.2
48.3 3.6 31.8 30.2
45.2 46.5 3.1 10.8 27.1 8.1 -10.0
44.1 2.9 11.5 31.0
Other 2.3 2.5 2.7 12.3 26.9
12.9 23.6
13.7 13.3
Japan 14.1 13.9 21.2
19.4
17.5
14.4 15.6
US 12.3 12.8 13.4
36.4 38.6 36.9 9.4 -4.2
30.5 33.4
24.7 27.3
Western 17.7 19.1 20.6 22.1
15.4 16.1 16.7
Europe1
1995 96 97 98 99 2000 01 02 03 04 05 06 07 2008

As a share
189 185 182 182 184 185 189 197 205 214 224 226 218 200
of GDP, %
1 Includes Belgium, Denmark, France, Germany, Italy, Netherlands, Norway, Spain, and the United Kingdom. Data were not
available for Ireland and Switzerland.
2 This data is presented in nominal terms. In real terms (as in exhibit A), the price declines in 2008 would be greater
SOURCE: Organization for Economic Co-operation and Development; Haver Analytics; McKinsey Global Institute
Private debt remained f lat while government debt grew

In contrast to the sharp decline in equities and real estate, the total value of all private
debt—including corporate bonds, financial institution bonds, and asset-backed
securities—rose to $51 trillion by the end of 2008. However, this apparent growth occurs
because our database reports the face value of debt securities, not the market value.
We estimate that applying current market valuations would reduce current private debt
outstanding by $2.4 trillion to $3.2 trillion, leaving its value roughly the same as a year
earlier.5 Although corporate bond issuance reached a record $1.1 trillion in the first eight
months of 2009, the issuance of asset-backed securities and financial institution debt—
far larger components of total private debt assets—has fallen sharply.6
Government debt also grew in 2008, rising 9 percent to $31.7 trillion. This growth was
faster than its previous trend, and it will accelerate further in 2009 and 2010 as many
countries boost borrowing to pay for planned fiscal stimulus spending.
Given the decline in asset values and growth in debt, we see that leverage in the global
economy has increased during the financial crisis rather than declined. This is true for
many households, governments, banks, and some segments of the corporate sector.
In aggregate, the global debt-to-equity ratio nearly doubled, jumping from 124 percent
in 2007 to 244 percent by the end of 2008. This raises the vulnerability of the global
economy to further shocks. It also indicates that the long process of deleveraging in the
private sector has at best only just begun, and in the public sector has yet to begin.
Bank deposits reached $61 trillion in 2008

Global bank deposits7 grew by $5 trillion, or about 9 percent, in 2008 (Exhibit 6).
Deposit growth accelerated in developed economies, reflecting both a flight to safety
5 This calculation is in line with other estimates. The Bank of England’s Financial Stability Report in
June 2009, for instance, reported marked-to-market losses of $2.7 trillion on debt securities.
6 Even the rise in corporate bond issuance was a by-product of the crisis, occurring because
other means of debt financing remained so hobbled.
7 Demand deposits, time deposits, money market accounts, and currency.
by depositors and aggressive efforts by banks to attract deposits. Collectively, mature

economy deposits grew by $2.8 trillion in 2008, reaching $45.3 trillion. These figures
marked a departure from recent trends, in which deposits in mature economies grew
roughly in line with GDP. In the short term, higher growth in deposits may continue if
investors remain risk averse and banks continue to compete aggressively for deposits .
In emerging markets, deposits grew much faster, increasing by $2.1 trillion. However,
they remain just one-quarter the size of deposits in mature economies.
Exhibit 6
Bank deposits increased in 2008, with mature economy Other mature countries
deposits growing faster than historical average Emerging countries

Japan
Eurozone
United States
Global bank deposits CAGR1, %

$ Trillion, using 2008 exchange rates for all years 1990-2007 2007-08
61.1
56.1
9.7 9.4 12.3
50.7 8.7
46.3 7.6
6.8 14.3 18.6 16.9
12.3
34.0 10.4
24.7 8.7
19.0 2.6 4.4 11.5
11.5 2.1 -0.5
1.9 2.2 4.5 11.4
11.5
0.7
11.2 13.1 6.5 8.3
12.1
9.7 9.9 10.8
8.0
6.9
4.1 5.5 11.6 12.5
7.0 9.4 10.3 6.1 8.3
4.2 4.8
1990 1995 2000 2005 2006 2007 2008
Deposits as 89 87 92 95 97 99 101
% of GDP
1
Compound annual growth rate.
SOURCE: McKinsey Global Institute Cross-Border Investments database
FINANCIAL GLOBALIZATION WENT INTO REVERSE, WITH

CAPITAL FLOWS FALLING BY 82 PERCENT
One of the most striking consequences of the financial crisis was a steep drop-off in
cross-border capital flows, which include foreign direct investment (FDI), purchases
and sales of foreign equities and debt securities, and cross-border lending and
deposits. These capital flows fell 82 percent in 2008, to just $1.9 trillion from $10.5
trillion in 2007 (Exhibit 7). Relative to GDP, the 2008 level of cross-border capital flows
was the lowest since 1991. This created turmoil in the global banking system, causing
severe liquidity crises and hurting borrowers dependent on foreign loans. It is unclear
at this writing how quickly these flows will recover.
Reversal of bank lending f lows led the decline

Capital flows not only fell, but most types went into reverse as investors, companies, and
banks and other financial institutions sold foreign assets and brought their money back to
their home countries. As in past financial crises, cross-border lending accounted for much
of the overall decline.8 It fell from $4.9 trillion in 2007 to minus $1.3 trillion in 2008 (Exhibit 8).
This indicates that lenders withdrew more cross-border loans—canceling or not renewing
lines of credit, not rolling over loans, and so on—than they made. About 40 percent of this
decline was due to the drying up of interbank lending after the collapse of Lehman Brothers
8 In the 1997 Asian financial crisis and the 1998 Russian crisis, bank lending was also the most
volatile type of capital flow. See Martin N. Baily, Diana Farrell, and Susan Lund, “The color of
hot money,” Foreign Affairs, March/April 2000.
14
in September 2008. But the majority reflects the withdrawal of foreign lending to nonbank
borrowers, particularly in emerging markets. In the worst-hit countries, foreign bank credit
contracted by as much as 67 percent. Flows of foreign deposits also reversed course, as
investors withdrew $400 billion of deposits from foreign financial centers in 2008.
Exhibit 7
Cross-border capital flows have reversed, falling by 82 percent
Total cross-border capital inflows XX CAGR1

$ Trillions, using 2008 exchange rates
12
10.5
10
8
+15.0%
6 5.3
4 +8.8%
2 3.0 1.9
1.0
0.5
0
1980 1985 1990 1995 2000 2005 2008
% of global 4.5 3.7 4.5 3.6 6.5 11.9 3.2

GDP
1 Compound annual growth rate.

SOURCE: McKinsey Global Institute Cross-Border Capital Flows database
Exhibit 8
The fall in global capital flows in 2008 was driven by a FDI

decrease in bank lending Equity securities
Debt securities
Lending and deposits
Total cross-border capital inflows1
$ Trillion, using 2008 exchange rates for all years
10.5
2.1
8.3
7.6 0.8
1.5
1.2 -82%
5.4
1.1 2.6
5.3 0.6 1.2
3.7 0.8
1.9 3.8 3.0 0.5 2.7
1.5 2.4 1.9
1.0 1.0 0.2 0.7
0.1 0.9 2.0
0.3 0.7 0.9 4.9 1.8
0.5 1.0 1.4
0.5 1.0 2.8 3.1
0.3 1.0 2.1
0.2 1.5 1.2 1.6
0.6 1.0 0.9
-0.2
0
-1.3
1990 1995 2000 2001 2002 2003 2004 2005 2006 2007 2008
% of
global GDP 4.7 5.4 13.5 9.4 7.8 9.9 13.3 15.9 17.3 20.7 3.1
1
Capital inflows represent net purchases by foreigners of FDI, equity, and debt securities, as well as deposits
and loans to local banks.
This fall-off in cross-border lending flows during a recession fits the historical pattern,
as we anticipated in our report last year.9 Cross-border lending had experienced
9 Mapping global capital markets: Fifth annual report, p.12, McKinsey Global Institute, October
2008 (available at www.mckinsey.com/mgi/).
three prior boom-and-bust cycles since 1990, with sharp declines following the
economic and financial turmoil in 1990–91, 1997–98, and 2000–02.
Similarly, global purchases of foreign equities and debt securities tumbled. Cross-border
flows into equities turned negative, falling from $800 billion in 2007 to minus $200 billion
as investors sold foreign equities and repatriated their funds. Purchases of foreign debt
securities slowed sharply nearly everywhere. The exception was the United States,
where government debt inflows skyrocketed as investors sought safety in US Treasuries.
Foreign direct investment historically has been the least volatile type of capital flow, as it
reflects long-term corporate investment plans and purchases of less liquid assets, such
as factories and office buildings. Last year was no exception: although FDI fell from the
peak level of 2007 to $1.8 trillion in 2008, it remained higher than its 2006 level.
Across geographies, the largest declines in cross-border capital flows were in the United
Kingdom and Western Europe (Exhibit 9). Total capital flows to the United Kingdom
were negative for the year, reflecting that foreign investors withdrew more money from
the United Kingdom than they put in. The fall-off in capital flows in Western Europe—
equivalent to 21 percent of collective GDP—reflected the reversal of lending flows between
the United Kingdom and the eurozone, a decline in flows between individual eurozone
countries, and the plunge of flows between European countries and the United States.
Exhibit 9
Capital flows fell most sharply in the United Kingdom and Western Europe
Change in capital inflows as a share of GDP, 2007-08 Absolute decline Total inflows, 2008
% $ Billion $ Billion
UK -101 -2,657 -1,163
Western Europe -21 -3,134 1,173
U.S. -11 -1,459 599
Emerging Asia
-7 -138 43
(except China and India)
Japan -7 -352 -16
China -4 -159 143
Eastern Europe -3 -51 247
India -3 -28 51
Latin America -2 -92 143
World total -15 -8,542 1,943
SOURCE: McKinsey Global Institute analysis
Falling capital f lows contributed to higher credit spreads

and currency volatility
The drying up of cross-border capital flows has had several ramifications. It has
contributed to the increase in the cost of capital and curtailed fund-raising by companies
around the world (Exhibit 10). Credit spreads have widened substantially since the US
subprime mortgage crisis began in early 2007. For several years before the current crisis
began, spreads had lingered below their historic average, fueling the global credit boom
and prompting some observers to worry that investors were dangerously underpricing
risk. By the middle of 2008, after the US subprime debacle had mushroomed into a
broader financial market crisis, spreads had tripled for riskier borrowers, and spreads
16
soared even more after Lehman’s collapse in September. Since peaking in the last
months of 2008, credit spreads have eased, but at this writing they remain higher than
they were before the crisis and are likely to remain higher for many years.
Exhibit 10
Credit spreads1 widened dramatically but now have declined
Basis points (monthly)

1,000 US
Japan
900
Eurozone
800
UK
700 10-year average
for US
600
500
400
300
200
100
0
J F MAM J J A S ON D J F MAM J J A S ON D J F MAM J J
2007 2008 2009
1
The difference between yields of five-year bonds issued by BBB-rated finance companies and
yields of sovereign benchmark bonds of the same maturity.
Note: Most firms must borrow at the BBB level, so BBB spreads are viewed as a good proxy for overall
corporate borrowing conditions.
SOURCE: Bloomberg; McKinsey Current Crisis Intelligence Desk analysis
The disruptions in international capital flows also caused a spike in short-term

exchange rate volatility (Exhibit 11). For instance, in just one week in October 2008,
the value of the Korean won depreciated by more than 20 percent against the
Japanese yen, boosting the competitiveness of Korean manufacturers compared
with their Japanese counterparts. Similarly, the Mexican peso depreciated by 19
percent against the US dollar in the same month. In Russia, government officials saw
their foreign reserves rise by record amounts in the first half of the year because of
strong trade surpluses but then had to sell several hundred billion dollars of reserves
in the second half to defend their pegged currency value.
Exhibit 11
As capital flows dried up in the second half of 2008,

currency volatility surged Euro
Pound
Volatility1 in currency exchange rates
Volatility of price against US dollar, % Yen
4.0 Mexican peso

Ruble
3.5 Rupee
3.0
2.5
2.0
1.5
1.0
0.5
0
Jan Apr Jul Oct Dec Jan Apr Jul
2008 2009
1
As measured by absolute value of ten-day rolling average standard deviation.
SOURCE: Bloomberg
Crisis has raised questions about the future of globalized finance

Over the past ten years, the web of cross-border investments has grown dramatically
as financial globalization has taken off (Exhibits 12 and 13). However, these links
weakened slightly in 2008 as the value of cross-border investments declined in most
of the world. The cross-border investments between the United States and Japan,
and between the United States and United Kingdom, fell particularly sharply. And
the recent large reversals in capital flows raise questions about whether financial
globalization will continue. The plunge in cross-border lending, for instance, is
causing many governments to reconsider the advisability of allowing foreign banks
to dominate the local economy. Particularly in Eastern Europe and in Latin America,
the crisis forced local subsidiaries of foreign banks to withdraw credit as the capital
adequacy of the home bank came into question. This reaction partly reflects the well-
known “home bias” in the investments of both investors and bankers, who tend to
give more weight to local investments than foreign ones. However, the withdrawals
also resulted from political pressures on banks to maintain or even increase domestic
lending in return for government support. Policy makers are now weighing the
benefits of foreign banks—that they increase competition and provide more efficient
financial intermediation—against the costs of abrupt declines in funding.
It is unclear whether and when global capital flows will rebound after this recession.
Recent evidence suggests that some types of flows, such as interbank lending and
investment in emerging markets, are recovering. For instance, net new flows into
emerging market mutual fund portfolios rose in 2009. But the largest component
of cross-border capital flows has been lending, and it is uncertain when banks will
repair their balance sheets and when they will regain an appetite for cross-border
expansion, or whether government policies will pressure them to prioritize home
market lending. The 30-year rise of financial globalization may now stall.
Exhibit 12
The web of cross-border investments in 1999 0.5-1% of world GDP

1-5% of world GDP
Width of lines shows total value of cross-border investments between regions1
5-10% of world GDP
Figures in bubbles show size of total domestic financial assets, $ billion, 1999
2008 exchange rate 10%+ of world GDP
World GDP, 1999 = $35 trillion
Blue lines represent an
increase between 1998-
1999
UK
4,291 Western
Europe
28,797
Russia, Emerging
US
Eastern Asia
37,983
Europe 4,830 Japan
883 23,354
Hong Kong,
Singapore,
Taiwan
Middle East, 1,936
rest of world
Latin 1,413 Australia,
America
New Zealand,
1,530
and Canada
3,576
1
Includes total value of cross-border investments in equity and debt securities, lending and deposits,
and foreign direct investment.
18
Exhibit 13
The web of cross-border investments weakened slightly in 2008

Width of lines shows total value of cross-border investments between 0.5-1% of world GDP
regions1 1-5% of world GDP
Figures in bubbles show size of total domestic financial assets, $ billion, 2008 5-10% of world GDP
2008 exchange rate
10%+ of world GDP
World GDP, 2008 = $61 trillion
UK
Russia, Blue lines represent an
8,612
Eastern increase between 2007-
Europe 2008
3,441 Emerging Orange lines represent a
Western Asia decrease between 2007-
US Europe 17,869 2008
54,912 47,341
Japan
26,166
Hong Kong,
Middle East, Singapore,
rest of world Taiwan
5,390 3,292 Australia,
New Zealand,
Latin and Canada
America 6,531
4,707
1
Includes total value of cross-border investments in equity and debt securities, lending and
deposits, and foreign direct investment.
GLOBAL FINANCIAL IMBALANCES HAVE RECEDED, BUT THIS

MAY BE A TEMPORARY REVERSAL IN TREND
After 2000, many countries around the world began to run increasingly large current
account deficits and surpluses, resulting in a buildup of global financial imbalances.
Economists have worried for years about the potentially damaging economic effects
of a sudden correction, in which an abrupt change in investor sentiment triggers
steep currency depreciation in the deficit countries, sending interest rates higher
and GDP lower. During the current crisis, this scenario has played out in only a few
countries, such as Iceland. But the broader reversal of capital flows and fall-off in
global trade has begun to diminish some imbalances.
The US economy has been one major source of global financial imbalances, with a current
account deficit that grew to $804 billion, or more than 6 percent of GDP, at its peak in
2006. As the financial crisis intensified and the global economy worsened, several factors
caused this gap to narrow to 3 percent of GDP in the first quarter of 2009 (Exhibit 14).
The US current account deficit shrunk primarily because of an increase in net exports.
Although US imports and exports have both fallen, imports have dropped more than
exports, as US consumers have pulled back sharply on spending. The shrinking deficit
also reflects a narrowing difference between US saving and investment. For many
years, US investment has far exceeded US saving. Both have fallen during the crisis,10
but investment has dropped more, reducing the gap between the two.
Meanwhile, current account surpluses in China, Germany, and Japan—the

countries with the largest such surpluses—have declined as the global recession
has dampened trade (Exhibit 15). Although China’s current account surplus reached
a record $426 billion in 2008, its trade surplus declined in the first half of 2009 by
10 The US national saving rate—the rate of saving by households, government, and business
combined—declined at the end of 2008 and the beginning of 2009 to 11.8 percent. Although
US households are saving more, that increase is more than offset by the sharp rise in the
government deficit and lower corporate saving.
31 percent.11 The current account surplus in both Germany and Japan declined in
2008 and in the first half of 2009. Outside of China, Asian countries’ current account
surpluses shrunk dramatically in late 2008 and early 2009 as exports fell.
Exhibit 14
The United States current account deficit has narrowed to 3 percent

US current account balance
% of GDP, seasonally adjusted annual rate
1
-1
-2
-3%
-3
-4
-5
-6
-6
-7
1980 1985 1990 1995 2000 2005 Q1’09
SOURCE: Bureau of Economic Analysis; McKinsey Global Institute analysis
Exhibit 15
China, Germany, and Japan have experienced sharp declines in their

current account surpluses
$ Billion, half-yearly, using 2008 exchange rates
China’s goods trade balance1 German current account balance Japan’s current account balance
175
151 -31%
145
137
128 128 131
122 121 124 126
117 -59%
104 107 107
100 -56%
88 87
60 64
58
2006 07 08 H1’09 2006 07 08 H1‘09 2006 07 08 H1‘09
1
China does not publish quarterly current account statistics; however, the monthly goods trade
statistics have historically accounted for about 70% of China’s current account surplus.
SOURCE: Haver Analytics; McKinsey Global Institute analysis
As a result of these developments, the sum of the absolute values of surpluses and
deficits in the United States and Asia declined in 2008 for the first time since 2001.
However, imbalances grew in many other parts of the world (Exhibit 16). For example,
current account imbalances increased among individual eurozone countries in 2008,
11 See The new power brokers: How oil, Asia, hedge funds, and private equity are faring in the
financial crisis, McKinsey Global Institute, July 2009. Available at www.mckinsey.com/mgi.
20
as they have since the adoption of the euro as a common currency in 1999.12 And
soaring commodity prices in the first half of 2008 caused mounting surpluses for
exporters of oil, natural gas, minerals, and other raw materials. So, by the end of the
year, the total of all the current account balances in the world had grown.
Exhibit 16
Global imbalances soared after 2000, although only half of the rise is
explained by the United States and Asia
Contribution
Sum of absolute value of current account balances to growth
$ Trillion, using 2008 exchange rates 2000-08
3.5
3.0 Other 23%
Middle East
2.5 11%
and
North Africa
2.0
Eurozone1 20%
1.5
1.0
US and
46%
Asia
0.5
0
80 82 84 86 88 90 92 94 96 98 00 02 04 06 08
Current accounts
as % of GDP 2.3 2.8 1.9 1.8 3.4 4.1 5.6
1
The growth in eurozone imbalances reflects a rise in current account surpluses in Germany and the Netherlands,
as well as increased deficits in Italy, France, and Spain. The magnitude of these of these imbalances accelerated
after the adoption of the euro in 1999.
SOURCE: International Monetary Fund; McKinsey Global Institute analysis
If the trends of early 2009 were to continue, total global financial imbalances would
likely decline this year. However, they may swell again once global trade and capital
flows rebound and GDP starts growing again. Indeed, energy prices may rise when
the economy gains steam, generating trade surpluses for many oil and natural
gas exporters.13 US investment is likely to pick up as companies proceed with
investments postponed during the recession. And we don’t know yet whether US
households will continue to save more after the recession ends, or whether China’s
households will consume more.14 All of these factors will influence the direction of the
world’s current account balances.15
12 The absolute sum of current account balances among eurozone countries grew at a 6.7
percent annual rate in the 1990s—and then accelerated to a rate of 16.3 percent after 2000.
This may be the result of a common currency shared by countries with different levels of
development. Germany has consistently run a surplus, while Spain, Italy, and Greece have run
deficits.
13 See Averting the next energy crisis: The demand challenge, McKinsey Global Institute, March
2009. Available at www.mckinsey.com/mgi.
14 See If you’ve got it, spend it: Unleashing the Chinese consumer, McKinsey Global Institute,
August 2009. Available at www.mckinsey.com/mgi.
15 One uncertainty is whether increased consumption by countries with surpluses will be
sufficient to offset decreased US consumption. In 2008, the combined consumption of
Germany, Japan, and China totaled about $6.5 trillion, compared with US consumption of
about $10 trillion. Clearly, no other single country is able to fill in for US consumers.
CREDIT BUBBLES GREW IN BOTH THE UNITED STATES AND

EUROPE PRIOR TO THE CRISIS
Although the crisis started in the United States, it followed multiyear borrowing
expansions in many other countries as well. Total global borrowing—comprising all
loans, forms of credit, and debt securities—rose by 70 percent from 2000 through
2008, to $131 trillion. Not only has the recent credit market turmoil nearly stopped this
growth, but it has set the stage for a long process of debt reduction going forward.
The United States, the eurozone, and the United Kingdom accounted for most
of the growth in credit from 2000 through 2008. Although borrowing in emerging
markets, also grew during this period, it mainly reflected GDP growth.16 In contrast,
total US credit outstanding rose from 221 percent of GDP in 2000 to 291 percent in
2008, reaching $42 trillion (Exhibit 17). Households accounted for 41 percent of the
increase, a bigger share than any other group, and mortgages accounted for most of
the growth in household credit. US financial institutions also boosted their borrowing
significantly, accounting for 24 percent of the total increase.
Exhibit 17
The United States and the eurozone explain most of the

increase in global borrowing since 2000 Government Households
xx Compound Nonfinancial business Financial institutions1
annual growth
% of GDP rate, %
US borrowing by sector, 2000-08 Eurozone2 borrowing by sector, 2000-08
350 350
0.8 1.0 304
300 291 300
258
246 60 74
250 250 231 73
221
50
200 50 78 200 73
97
64 79
150 150
64
67
100 84 96 100 62
53
67 48
50 50
48 57 52 71
40 44
0 0
2000 2004 2008 2000 2004 2008
1
Financial debt includes commercial paper, bonds, and interbank borrowing. It does not include securitized assets or deposits.
2
Euro area 15 (fixed composition): Austria, Belgium, Cyprus, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg,
Malta, Netherlands, Portugal, Slovenia, Spain.
SOURCE: Federal Reserve; European Central Bank; European securitization forum
However, contrary to popular misconception, total US debt outstanding is lower relative

to GDP than that of the eurozone or the United Kingdom, and has grown more slowly.
Eurozone indebtedness rose to 304 percent of GDP by the end of 2008. This was 73
percentage points more than borrowing in 2000. But in contrast to the US experience,
eurozone household borrowing played a relatively modest role. Instead, nonfinancial
institutions accounted for the biggest share of growth. Eurozone financial institutions
also boosted their borrowing significantly, driven by their growing use of short-term
debt to fund lending, and accounted for nearly as much of the overall growth.
16 In a sample of the 15 largest emerging markets, we find that credit has grown rapidly in
absolute terms, from $7.0 trillion in 2000 to $21.0 trillion in 2008. But this mainly reflects GDP
growth: as a percent of GDP, it has increased from 105 percent to just 113 percent.
22
Meanwhile, UK borrowing climbed even higher, to 320 percent of GDP by 2008, a gain
of 71 percentage points since 2000. In the United Kingdom, as in the United States,
households were the biggest drivers of debt growth, accounting for 43 percent of
the increase.
No one knows what the optimal or sustainable level of borrowing is for a country.
But it is clear that the recent debt surges in the United States, the eurozone, and the
United Kingdom were not sustainable and will likely reverse. This may mean less
consumption and investment—and possibly more sluggish growth—for some time.
When we look at the types of credit that grew, and financial intermediaries that
provided the credit, we see other differences across regions.
In the United States, the bond market plays a bigger role than the traditional banking
sector. Loans held on bank balance sheets in the United States account for just
20 percent of total credit outstanding (Exhibit 18). The rest comprises multiple
other forms of credit. Thus, the assets of traditional, deposit-taking banks in the
United States have been surpassed in size by those of other institutions we refer to
collectively as the “nonbank financial system” (Exhibit 19). Restoring health to US
credit markets, therefore, will require more than boosting bank lending; also essential
will be reviving securitization and other forms of credit.
In the eurozone and the United Kingdom, in contrast, traditional banks played a much
larger role than nonbanks in the borrowing boom. On-balance sheet loans by banks
account for 44 percent of credit outstanding in the eurozone and 46 percent in the
United Kingdom (Exhibit 20). The securitization markets in the eurozone and UK have
grown rapidly, but each is the source of less than $1 trillion in outstanding credit—and
therefore remains much smaller than the $9 trillion US market. Thus, for Western
Europe in the short term, restoring the health of the banking sector is critical to
repairing the financial system. In the longer term, it may also help to foster the growth
of bond markets and securitization markets as alternative sources of financing.
Exhibit 18
The rise in US borrowing was funded by nonbank channels
Compound annual Securitized assets

growth rate Bank on-balance
% sheet loans
Credit assets outstanding
$ Trillion nominal, using 2008 exchange rates 1990-2000 2000-08 OFI on-balance
sheet loans1
41.7 42.1 6.4 8.2
Loans from
39.0 other sectors2
8.7 8.6 5.1 7.1
Corporate
32.9 8.6
bond market
4.2 9.3 11.9
4.6
7.2 3.6 1.1 4.3 -2.6 Financial institution
1.1 bonds
0.9 3.3 3.4 9.6 9.1
22.4 3.6 3.1 Government
1.0 6.5 6.8 18.2 10.3 bond market3
12.2 5.0 2.7 6.7 7.1 9.4 GSE MBS/CMO4
1.1
3.3 5.0
0.7 1.4 8.6 9.1 Private label
2.0 7.3 12.2 9.0 securitization
3.1 6.6
1.6 2.3
0.9 4.6 4.5 5.0 5.0
3.5 2.8 8.1
3.5 2.5 4.4 4.0 3.9
3.3
0.3 1.0 1.4
1990 2000 2005 2007 2008 Q1 2009

1
Other financial institutions include finance companies, broker-dealers, funding corporations, REITs, insurers, and
pension/retirement funds.
2
Includes loans from households, nonfinancial corporations, and foreign institutions.
3
Includes US Treasuries and municipal/local government bonds.
4
Government-sponsored enterprise issued mortgage-backed securities and collateralized mortgage obligations.
SOURCE: US Federal Reserve; Securities Industry and Financial Market Association; Federal Deposit Insurance Corporation;
McKinsey Global Institute analysis
Exhibit 19
The US nonbank financial system has surpassed the banking

system in size
Size of components of US leveraged financial institutions
CAGR3 CAGR3
Nonbank financial system financial assets 2004-Q1 09 Financial assets of the two systems 1990-2009
$ Trillion % $ Trillion %
Agencies Investment banks Nonbank system
Hedge funds1 Finance companies and Banking system
off-balance sheet vehicles2
28
14.8 14.6
14.4 26
12.6 24
7.3 22
11.3 5.2 5.8 5.9
10.7 20
4.6 18 9.4
4.3 16
4.4 1.1 3.1
2.3 1.2 14
1.8 12
6.6
1.3 3.0 2.5 10
1.0
2.4 3.4 8
1.7 2.0
6
5.0 7.2 4 5.8
4.8
3.6 3.6 3.9 3.6 2
0
1990 95 2000 05 2009
2004 05 06 07 08 Q1 09
1IFSL estimates (assets under management, unleveraged) from hedge fund industry report, Q2 2009.
2 Calculated as the difference between the total size of the "nonbank" financial system (via fed funds) and agency, broker-dealer, hedge fund estimates.
3 Compound annual growth rate.
SOURCE: Federal Reserve; International Monetary Fund; International Financial Services London; McKinsey Global Institute
Exhibit 20
In contrast, banks have provided the majority of the credit

in the eurozone and United Kingdom Bank loans Corporate bond/CP markets Securitization
market
OFI Loans1 Financial institution bonds
Credit outstanding
Loans from Government bond market
$ Trillion, using 2008 exchange rates for all years other sectors2
Compound Compound
Eurozone annual growth UK annual growth
rate, ’00-’08 rate, ’00-’08
Sources of credit in the economy % Sources of credit in the economy %
36.2 7.5 9.8 10.2
33.5 9.2
28.3 6.7 7.6

16.1 4.5 12.2
20.7 4.0
15.3
1.1
1.3 12.6 3.0
3.3 14.8
2.3 4.5
9.6 7.6 1.4 3.3
1.6 2.1 2.3 1.8
1.6 1.8 5.2 1.8 1.9 0.5 6.4
1.8
1.8 0.5
5.4 5.7 10.1 1.6 8.3
1.2 4.0 0.5
1.1 1.6
2.6 0.3 1.3
6.1 0.9 8.8
5.8 5.6 3.3 0.8 0.7
4.7 0.6 59.83
20.3 0.5 0.9
0.2 0.9 1.0 0.9 0 0.5 0.2
2000 2005 2007 2008 2000 2005 2007 2008
1 Other financial institutions include finance companies, broker-dealers, funding corporations, REITs, insurers, and pension/retirement funds.
2 Includes loans from households, nonfinancial corporations, and foreign institutions.
3 Computed over 2005-2008 since data is unavailable for 2000.

SOURCE: Haver analytics; Securities Industry and Financial Market Association; McKinsey Global Institute analysis
MATURE FINANCIAL MARKETS MAY BE AT AN INFLECTION

POINT WITH SLOWER GROWTH AHEAD
Last year may have marked an inflection point in the growth trajectory of financial
markets in North America, Europe, and Japan. Financial assets in those regions more
than tripled from 1990 through 2007, to $158 trillion, or 403 percent of GDP. But the
circumstances that fueled the rapid increases of past years, particularly in equities
and private debt, have changed, making it likely that total financial assets will grow
more in line with GDP in coming years.
24
Growth in equity markets may revert to GDP trend

Equities were the fastest-growing asset class in mature markets from 1990 through
2007 because of two main factors: rapid growth in corporate earnings and rising
equity valuations (reflected in P/E ratios). New IPOs were a small and relatively
immaterial contributor.
Going forward, each of these sources of growth may be diminished. Both corporate
earnings as a share of GDP and P/E ratios had risen well above their long-term
averages in mature economies. Now, earnings growth has slowed and valuations
have reverted to their mean. Meanwhile, external analysts forecast GDP growth
in developed economies to be more modest in coming decades than in recent
years as their populations age and government debt grows. These projections give
little support to the hope that corporate earnings and valuations will rise again to
significantly and sustainably higher levels in mature markets (Exhibit 21).
Exhibit 21
In the United States and Europe, equity valuations as of June

2009 are close to their historical average
US corporate earnings US forward P/E
as a percent of GDP
Eurozone forward P/E
United States and eurozone

Forward P/E ratios Corporate earnings as a % of GDP
20 12
18
16
10
14
12
8
10
6 0
2003 04 05 06 07 08 2009
SOURCE: Bloomberg; Datastream; J. P. Morgan; Institute of International Finance; McKinsey Global Institute analysis
New equity issuance is another, albeit much smaller, source of overall growth in
equity market capitalization, and it has picked up in the first half of 2009. Some argue
it may remain high in the short term as companies review their capital structure in
light of the crisis. However, net new equity issuance in mature markets has been
negligible compared with overall market capitalization in recent years.17 So while
mature equities markets may rise further in the short term as financial markets return
to health and the global economy recovers, the trends we’ve cited mean it is unlikely
that equities will grow much faster than GDP in the long term.
Private debt outstanding is likely to grow much more slowly than in

recent years
Similarly, the forces that drove rapid increases in private debt securities in mature
markets over the past two decade have stalled, at least for now. Almost all the private
17 In the United States, new equity issuance has actually been negative for domestic companies in
recent years, as the value of share buybacks has exceeded new issues. In the United Kingdom,
new issuance has accounted for less than 1 percent of equity market capitalization growth.
debt growth since 1990 has occurred in two categories: debt issued by financial
institutions, which accounted for 49 percent of the total, and asset-backed securities,
at 43 percent (Exhibit 22). The value of outstanding corporate bonds, in contrast, has
grown steadily, but at a rate that was only marginally faster than GDP growth.
Exhibit 22
Financial institution bonds and securitized assets drove past growth in

private debt
Securitized assets
Financial institution CAGR1
bonds %, 1990-
Mature country private debt
$ Trillion, using 2008 exchange rates; 1990-2008 Corporate bonds 2008
60
53
15
18.8
40
25
30 8.4
20
15
10 16
7 10
8 6.4
3 3 5
0
1990 1995 2000 2008
Private debt
% of GDP
54 61 84 131
1
Compound annual growth rate.
SOURCE: McKinsey Global Institute Global Financial Assets database; McKinsey Global Institute analysis
Going forward, these dynamics may be reversed. Corporate bond issuance has
surged in 2009 because banks have cut back their lending as they repair balance
sheets. Corporate bond issuance levels may well remain high for several years until
the banking sector returns to health. But corporate bonds account for only 15 percent
of outstanding private debt, so they cannot contribute significantly to growth in the
overall stock of private debt.
Issuance of debt by financial institutions declined 11 percent overall in 2008 in mature

markets, with the sharpest fall-off in the United States.18 Over the next two years, in the
United States alone, $1.5 trillion of financial institution debt will roll over. Banks will face
higher interest costs, partly because they are likely to replace some short-term debt with
debt of longer maturities. Still, despite the large volume of issuance, the outstanding stock
of financial institution debt is unlikely to grow much, and may decline.
Likewise, the issuance of securitized assets has plummeted and is negligible outside
of government programs in the United States and the United Kingdom (Exhibit 23).19
Securitization will most likely revive over time, with low-risk, plain-vanilla securities
(such as assets backed by prime mortgages) coming back first. Still, the very high
pace of new issuance in the years before the crisis—reflecting in part the mortgage
boom in the United States and other countries—is unlikely to be repeated. The total
outstanding stock of securitized debt could decline in coming years.
18 The decline in bond issuance varied significantly between regions. US financial bond issuance
decreased by 29 percent, while European financial bond issuance increased by 10 percent,
mostly because of the issuance of covered bonds.
19 In the United States, asset-backed securities now are issued almost solely by government-
sponsored enterprises such as Fannie Mae and Freddie Mac, or through government
programs such as the Federal Reserve’s Term Asset-Backed Securities Loan Facility. In
the United Kingdom, securitization has increased in response to the bank recapitalization
programs of the European Central Bank and Bank of England.
26
Exhibit 23
Global securitized asset issuance has dropped precipitously in 2008

$ Billion, using 2008 exchange rates
Global annual issuance Eurozone/Other

UK
US
2,899
2,609
512
323 2,339
1,949 282
158
1,511 1,691 111 505
137 87 231
47 263
984 197
698 139 1,142
111 48 2,128 2,105
400
40 1,607 1,572
1,326 1,407
399
798
547
343
2000 01 02 03 04 05 06 07 2008
SOURCE: Dealogic; Securities Industry and Financial Markets Association; McKinsey Global Institute analysis
Government debt is set to expand rapidly

In contrast to equities and private debt, government debt is set to expand rapidly and
account for a larger share of financial asset growth across mature markets. We are
already seeing increased government borrowing to pay for new programs to recapitalize
the financial system and stimulate economic growth. The International Monetary Fund
has projected that such efforts will cause the combined government budget deficits of
advanced economies to balloon from 75.2 percent of GDP in 2007 to 93.6 percent in
2009. In some countries, the level will go much higher. US government debt is projected
to grow from 63 percent of GDP in 2007 to 100 percent by the end of 2010.20 Japan’s
government debt, already at 188 percent of GDP after more than a decade of fiscal
stimulus efforts, is projected to increase to 226 percent by the end of 2010.
Government debt issuance will create new opportunities for financial intermediaries.
But these large debts represent a significant transfer of wealth from future
generations to today’s populations and will be a drag on growth as they are paid
down in the future. And as governments pump massive amounts of new money into
the world’s economies—through both monetary and fiscal policies—they run the risk
of inflating prices for consumer goods, commodities, and assets, which could create
new financial bubbles in the future.
Bank deposit growth has picked up for now

Bank deposits increased in 2008 because of heightened risk aversion among retail
investors and efforts by banks to attract new deposits. Over the next several years,
deposits could continue to grow faster than GDP if these trends hold. Retail investors,
burned by lost savings in stocks and other financial assets, may remain cautious.
And banks, now facing higher costs for issuing their own debt, may offer higher
interest rates on deposits. In the long term, however, rapid growth in bank deposits is
unlikely in most mature markets, where retail investors have opportunities to achieve
higher returns through equity and fixed-income mutual funds. The exception is
20 See Mark Horton, Manmohan Kumar, and Paolo Mauro, “The State of Public Finances: A
Cross-Country Fiscal Monitor,” IMF staff position note, July 30, 2009.
Japan, where bank deposits account for 44 percent of total financial assets, a share
comparable to that in emerging markets (Exhibit 24).
Exhibit 24
Equity securities
Financial assets by region, 2008 Private debt securities
$ Trillion, % Government debt securities
Bank deposits
100% = 54.9 4.7 42.0 8.6 1.1 1.5 26.2 12.0 2.0 3.8
12 17 12
21 24 22 23 24
35 9 32
5
7
14 38
28 12 4 23
41 36 10 35
6 19
24
17
19
10
14 58
50 50 44 44
37 31 32 36
23
US Latin Euro- UK Russia Eastern Japan China India Emerging

America zone Europe Asia
Financial
depth 385 119 314 326 68 99 533 278 162 232
% of GDP
CAGR (90-08)1
7.6 22.0 8.4 9.3 45.2 24.3 2.4 24.2 18.7 19.6
%
1 Compound annual growth rate using 2008 exchange rates.

Note: Some numbers do not sum due to rounding.
Source: McKinsey Global Institute Global Financial Stock database
EMERGING FINANCIAL MARKETS COULD REBOUND

MORE QUICKLY
The 2008 crisis originated in mature markets, and the effects spread quickly around the
world. In emerging markets, the total value of financial assets fell $5.2 trillion in 2008, a loss
of 15 percent (Exhibit 25). Capital flows to developing countries plunged 39 percent (Exhibit
26). The cost of fund-raising has skyrocketed in many emerging economies as foreign
lending flows have reversed, while debt and equity capital flows have dropped sharply.
Exhibit 25
Emerging economy financial assets fell by $5 trillion in 2008

$ Trillion, using 2008 exchange rates Equity securities Government debt securities
Private debt securities Bank deposits
XX Compound annual growth rate 2000-07
Largest declines in
Total emerging economy financial assets financial assets
China -2.4
35 -15
+22
Russia -0.8
30
25 16 India -0.6
8
9 10 20 9 3 Saudi Arabia -0.2
4 2 2 16 6 21 5
1 1 1 13 2
1 11 4 4 Brazil -0.2
0 0 2 2 4
2 4 1 3
0 1 2 1
1 2 3
0 2 2 12 14 South Korea -0.2
9 10
1 5 6 7 7
5 United Arab
-0.1
Emirates
1990 1995 2000 2001 2002 2003 2004 2005 2006 2007 2008
Israel -0.1
GDP 1.9 3.9 6.7 7.2 7.7 8.9 10.4 11.8 13.5 16.0 18.5
Trillion $ South Africa -0.1
Financial 63 105 139 143 146 150 152 167 187 218 160
depth Malaysia -0.1
% of GDP

28
Exhibit 26
Foreign capitals flows to emerging markets fell by $600 billion in 2008

Change in capital inflows 2007-08 Absolute decline 2008 inflows
% of GDP $ Billion $ Billion
Emerging Asia -4.2
-326 237
Russia -4.1
-70 106
China -3.7
-159 143
Middle East -3.6
-89 122
India -2.3
-28 51
Eastern Europe -2.3 -92 409
Brazil -2.0 -32 55
Latin America -1.6 -52 140
Africa -1.3 -12 36
Emerging countries -3.2 -599 948
For many reasons, however, we believe the current crisis will cause no more than
a pause in the development of emerging market financial systems. Indeed, some
indicators suggest that emerging markets may already be rebounding. Equity
markets in emerging Asia, for instance, have gained more than 30 percent since the
end of 2008, while those in Latin America have climbed more than 40 percent. Both
represent a far stronger comeback than in mature economies and one that reflects
stronger GDP growth. In China, Indonesia, South Korea, and Singapore, GDP grew
at an average annual rate of more than 10 percent in the second quarter of this
year.21 And while debt issuance by emerging market governments and corporations
declined in the second half of 2008, it rebounded in the first half of 2009.
Beyond the short-term recovery, the long-term fundamental drivers of financial

market growth remain strong in developing economies. Many have high national
saving rates, creating large sources of capital to invest. They typically have very large
infrastructure investment needs that require financing. And their financial markets
today are much smaller relative to GDP than those in mature markets, suggesting
ample room for growth (Exhibit 27). The total value of all emerging market financial
assets is equal to just 165 percent of GDP—145 percent if we exclude China—well
below the financial depth of mature economies.
More specifically, we see the potential for growth by looking at individual asset classes.
Equities, for example, are the second-largest asset class after bank deposits in virtually
all emerging markets (Exhibit 28). Yet they still have ample room to grow as more state-
owned enterprises are privatized and as existing companies expand. For instance, we
estimate that just a quarter of the value of Chinese corporations is listed on public equity
markets, compared with more than 70 percent of US corporations.
21 “An astonishing rebound,” The Economist, August 15, 2009

Exhibit 27
Financial markets in most emerging economies have significant

room for growth
Financial depth: Value of bank deposits, bonds, and equity as a percentage of GDP, 2008
%
550
Japan
500
450
Netherlands
400
Spain
United States
350 United Kingdom
Singapore
300 South Africa Malaysia France
China Italy
Germany Australia
250 Canada
South Korea
200 Chile
Morocco
150 India Brazil Czech Republic Norway
Egypt Hungary
Mexico Poland United Arab Emirates
100 Kazakhstan Turkey Saudi Arabia
Ukraine Argentina
50 Indonesia Russia
0
2,500 10,000 25,000 60,000
GDP per capita at purchasing power parity1
Emerging markets Mature markets
1
Log scale.
Exhibit 28
Bank deposits and equities are the largest asset Equity securities
Private debt securities
classes in emerging economies Government debt securities
$ Trillion, % Bank deposits
CAGR 1990-2008
Percent
Emerging Mature
economies economies
100% = 29.6 146.8
26.6 21.6 21.9 5.4
9.8 21.7 20.9 9.0

15.3
17.8 19.0 6.7
48.4
38.9 18.5 5.2
Emerging countries Mature countries

2008
Share
31% 69%
of GDP
* Compound annual growth rate using 2008 exchange rates for all years.
Note: Some numbers do not add to 100% due to rounding.
Source: McKinsey Global Institute Global Financial Stock database
30
Likewise, markets for corporate bonds and other private debt securities have
substantial room for growth. The value of private debt assets is equal to just 15
percent of GDP in emerging markets, compared with 119 percent in Europe and
160 percent in the United States. Corporate bond markets are unlikely to flourish
in emerging markets without significant legal and financial reforms.22 But with the
appropriate regulatory changes, corporate bond markets could provide an alternative
to bank financing, and some of the plain-vanilla forms of securitization (such as those
backed by low-risk prime mortgages) could develop.
Bank deposits also constitute an asset class with enormous growth potential in the
developing world, where large swaths of the population have no bank accounts.
McKinsey estimates that in emerging markets, there are 2.8 billion adults with
discretionary income who are not part of the formal financial system. Bank deposits
will swell as household incomes rise and individuals open savings accounts.
Further financial market development in emerging markets is not guaranteed, however.

One uncertainty is whether policy makers will undertake the financial market reforms
necessary to enable capital market development. In the wake of the financial meltdown,
many are questioning the desirability of rapid financial asset growth (see sidebar
Reinterpreting financial deepening). The crisis underscored the dangers of the kind of
unhealthy financial deepening that results from asset and credit bubbles. Nonetheless,
financial market development can be beneficial if it enables capital to be allocated
more efficiently and allows greater opportunities for risk diversification. If the right
reforms enable this kind of deepening to occur, emerging market economies, which are
projected to account for half of global GDP by 2035, will be the main beneficiaries.
22 See “Emerging markets’ new financial development path,” p. 18, Mapping global capital
markets: Fifth annual report, October 2008, McKinsey Global Institute (available at www.
mckinsey.com/mgi/).
Reinterpreting financial deepening

Over the past two decades, the total value of the world’s financial assets grew
faster than global GDP, from 227 percent in 1990 to 343 percent in 2007. Many
analysts, including those at MGI, viewed this development mainly with optimism.
Securitization was thought to enable investors to diversify their risk and reduce
the need for expensive bank capital. More efficient intermediation lowered
borrowing costs. Indeed, academic research has found some evidence that
financial deepening is associated with higher economic growth.23
Now the crisis has called some of this conventional wisdom into question. Much
of the rise in assets in mature markets did not reflect capital being channeled into
economically productive activities; rather, it reflected growing asset bubbles. It
turned out that the risk diversification benefits of securitization had been illusory
because some of the biggest investors in securitized instruments were the
leveraged financial intermediaries that had created them. And the global spread
of such assets did not diminish risk by dispersing it; on the contrary, these assets
were a source of contagion, transmitting the crisis around the world when asset
prices collapsed. Meanwhile, equity market bubbles have regularly appeared
in both mature and emerging markets. It is now clear that financial deepening is
often built on shaky fundamentals, such as asset bubbles and high government
debt, that provide no lasting benefits.
Yet policy makers debating how to retool the system to prevent future crises
should keep in mind the merits of financial deepening. Deep financial markets
helped foster the significant productivity growth of the 1990s and gave many
borrowers unparalleled access to credit. Public equity listings can improve
corporate governance. Debt capital markets serve as an important alternative
to bank credit, particularly in times of financial system distress. Financial
system reform should be aimed at retaining these benefits while curbing the
dangerous excesses.
Going forward, emerging markets stand to gain the most from financial
deepening. Many emerging market economies rely on banking systems that
mainly fund large corporations. If these companies could raise funding in debt
markets, as they do in mature markets, banks would focus more on lending
to the small and midsized businesses that fuel economic growth. Similarly
households—many of which lack access to formal banking services, much
less consumer credit or long-term borrowing—hoard their savings, restraining
economic growth in their own countries while exacerbating financial imbalances
in the global economy. Indeed, as leaders in the emerging world seek to
encourage more domestic consumption in their economies, the task of fostering
healthy financial system development is more important than ever.
23 Robert G. King and Ross Levine, “Finance and growth: Schumpeter might be right,” The
Quarterly Journal of Economics, Volume 108(3), August 1993; and Ross Levine, “Finance and
growth: Theory and evidence,” National Bureau of Economic Research Working Paper 10766,
September 2004.
September 2009
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Copyright © McKinsey & Company
www.mckinsey.com/mgi

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Global capital markets:

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Copyright © McKinsey & Company 2009

Global capital markets:

Richard Dobbs, Director James Manyika, Director

Charles Roxburgh, Director Susan Lund, Director of Research

Global capital markets:

GLOBAL FINANCIAL ASSETS DECLINED BY $16 TRILLION IN

Global financial assets fell by $16 trillion in 2008 Equity securities

Equities declined sharply

Every equity market in the world lost value in 2008

Equity growth in developed and

Best Colombia -4 World average

Mexico -26 Developed

Worst Greece -64

SOURCE: McKinsey Global Institute Global Financial Assets database

SOURCE: Datastream; Robert Shiller; McKinsey Global Institute analysis

A look at global housing wealth

1995 96 97 98 99 2000 01 02 03 04 05 06 07 2008

Private debt remained f lat while government debt grew

Bank deposits reached $61 trillion in 2008

by depositors and aggressive efforts by banks to attract deposits. Collectively, mature

deposits growing faster than historical average Emerging countries

Global bank deposits CAGR1, %

FINANCIAL GLOBALIZATION WENT INTO REVERSE, WITH

Reversal of bank lending f lows led the decline

Cross-border capital flows have reversed, falling by 82 percent

Total cross-border capital inflows XX CAGR1

% of global 4.5 3.7 4.5 3.6 6.5 11.9 3.2

1 Compound annual growth rate.

The fall in global capital flows in 2008 was driven by a FDI

UK -101 -2,657 -1,163

Western Europe -21 -3,134 1,173

U.S. -11 -1,459 599

Japan -7 -352 -16

China -4 -159 143

Eastern Europe -3 -51 247

Latin America -2 -92 143

World total -15 -8,542 1,943

SOURCE: McKinsey Global Institute analysis

Falling capital f lows contributed to higher credit spreads

Credit spreads1 widened dramatically but now have declined

Basis points (monthly)

The disruptions in international capital flows also caused a spike in short-term

As capital flows dried up in the second half of 2008,

4.0 Mexican peso

Crisis has raised questions about the future of globalized finance

The web of cross-border investments in 1999 0.5-1% of world GDP

The web of cross-border investments weakened slightly in 2008

GLOBAL FINANCIAL IMBALANCES HAVE RECEDED, BUT THIS

Meanwhile, current account surpluses in China, Germany, and Japan—the

The United States current account deficit has narrowed to 3 percent

SOURCE: Bureau of Economic Analysis; McKinsey Global Institute analysis

China, Germany, and Japan have experienced sharp declines in their

2006 07 08 H1’09 2006 07 08 H1‘09 2006 07 08 H1‘09

3.0 Other 23%

CREDIT BUBBLES GREW IN BOTH THE UNITED STATES AND

The United States and the eurozone explain most of the

However, contrary to popular misconception, total US debt outstanding is lower relative

The rise in US borrowing was funded by nonbank channels

Compound annual Securitized assets