Deleveraging

Deleveraging is the process of reducing the level of debt relative to equity, assets, or income. It involves lowering leverage to strengthen balance sheets, reduce insolvency risk, and improve financial resilience. Deleveraging can occur in households, nonfinancial firms, banks, and governments, and it often follows periods of excessive borrowing or financial stress.

Common mechanisms include paying down existing debt, selling assets to raise cash, issuing equity or raising capital, restructuring or writing down liabilities, and, in some cases, entering bankruptcy or default. For financial institutions, deleveraging frequently entails shrinking the balance sheet and boosting capital ratios, which can constrain new lending in the short term. For households and firms, it typically means reducing leverage through savings or asset sales.

Macro-economically, deleveraging can dampen demand and slow growth. Reduced credit availability, higher precautionary saving, and lower investment can weigh on consumption and output in the near term. In the longer term, a healthier balance sheet can improve stability and resilience to future shocks. The pace and sequencing of deleveraging matter; abrupt balance-sheet repair can trigger a credit crunch, while gradual deleveraging may support a more durable recovery.

Policy considerations include monetary policy accommodation to ease liquidity conditions, targeted debt relief or restructuring programs, and macroprudential regulation to balance credit growth with financial stability. Leverage is commonly tracked by debt-to-income, debt-to-equity, or debt-to-GDP ratios to gauge progress and risks.