Credit risks across many sectors are rising with a looming cyclical deterioration in credit conditions and global debt at near-record levels, says Fitch Ratings. However, the macroeconomic conditions and the sector breakdown of leverage in developed markets differ significantly from the last downturn in 2008. Fitch expects governments and non-financial corporates to be at the center of any coming storm for credit conditions. 

Since 2007, aggregate financial sector and household debt as a percentage of GDP globally has remained roughly steady according to data from the IIF. In contrast, governments and non-financial corporates have seen their debt rise significantly, up 27 percentage points (pp) and 16 pp, respectively. These sectors' capacity to manage a macroeconomic slowdown accompanied by tightened financial conditions will thus be challenged. 

Government debt/GDP ratios have increased substantially across most large and developed economies since 2007, leaving some sovereigns heavily exposed in the event of a future economic downturn with potential negative rating implications. A turn in the global credit cycle characterized by tighter financial conditions is more likely to be felt by emerging markets in the short term, which will face heightened volatility and capital flow disruption. 

Non-financial corporates were not a primary source of risk during the last financial crisis. However, corporate leverage has risen markedly since then, enabled by low rates, rising equity valuations and the expansion of non-bank lenders. In addition, corporate borrowers have largely used this funding to expand shareholder returns and M&A, which have far outstripped capex. This has already driven negative rating trends for U.S. corporates over the past two years, despite relatively strong economic growth during that time. Ratings distribution in the U.S. corporates portfolios has changed significantly since the pre-crisis period, with 'BBB' category rated issuers rising relative to higher investment-grade categories. 

Compared to sovereigns and non-financial corporates, banks in developed markets are in a more robust and resilient position compared to the last financial crisis. Capital levels and liquidity are significantly stronger, owing to a wave of regulatory reform, while reduced risk appetite and smaller loan portfolios have led to a significant reduction in banking assets as a proportion of GDP. While banks have retrenched, higher risk lending activity has moved into less visible areas of the non-banking financial system. This could increase uncertainty for the financial market heading into a downturn while adding to risks from the interconnectedness between non-bank financial institutions and the rest of the financial market.