The funding of banks and governments, especially in some vulnerable euro-area countries, poses a “pressing challenge” to the global financial system even as stability improves elsewhere, the International Monetary Fund said.
European banks need to increase the quality and quantity of their capital to regain access to funding markets and will probably need help from governments, the IMF said today. At the same time, financing conditions are still “tense” for some European countries, which run the risk of having to rely increasingly on their domestic investors to sell debt, it said.
“At the heart of the global financial crisis was an abrupt rediscovery of credit risk,” the IMF wrote in its Global Financial Stability Report. “The turbulence in some euro-area financial markets over the past six months suggests that the process is still ongoing.”
While the improved outlook for the world economy and “strong prospects” in emerging markets bolster global stability, the IMF stressed that confidence has not yet been restored in the banking systems of many advanced countries. Global financial institutions face $3.6 trillion of maturing debt in the next two years, the IMF said.
High debt levels are a vulnerability for many rich nations, the IMF said. Besides sovereign and banking debt, that also includes household debt in the U.S. and Spain and corporate debt in parts of the euro region and Japan.
“In the euro area, the prospects for the financial sector remain closely tied to sovereign stress,” the IMF wrote. The report added that “many banks still face investor doubt about their financial future.”
The IMF welcomed the efforts under way to address the issue of weaker banks in Europe, particularly in Germany and Spain. The stress tests being prepared by European regulators are a “golden opportunity” to improve transparency, it said.
The Washington-based fund said the tests should include the broadest possible coverage of banks in each country and “have a more stringent capital hurdle, especially for banks that rely on wholesale funding markets,” among other recommendations.
Last year’s tests, which allowed national regulators to use their own capital definitions, were criticized by bank analysts for not being tough enough.
“A comprehensive set of policies -- including capital- raising, restructuring and where necessary resolution of weak banks, and increased transparency about banking risks -- is needed to solve banking system vulnerabilities,” the IMF said.
The IMF looked across a range of risk indicators for a sample of banks in 12 countries. It found that banks in Greece and Ireland, which received bailouts from the European Union and the IMF, “are currently facing the greatest balance sheet pressures.”
Spain’s cajas and Portuguese banks are also vulnerable “from their holdings of sovereign bonds,” while banks in Austria, the U.K. and the U.S. “have high loan losses, but are aided by relative profitability.” Some German banks, as well as “weak Italian, Portuguese and Spanish savings banks” have low levels of capital, making them vulnerable to further shocks, it said.
The IMF also did projections of average funding costs for countries through 2015, using its own growth forecasts and data on debt maturity. It found that costs are set to rise by as much as 249 basis points for Greece, 149 points for Portugal and 117 points for Spain.
In the U.S., the large debt burden of households threatens to weaken banks’ balance sheets further and should be decreased, the IMF said.
“The housing market’s inventory overhang raises the risk of further mortgage default,” it said.
Emerging-market economies’ main task at the moment is to limit overheating as they face a surge of capital inflows “to avoid ‘cleaning’ later,” the IMF said.
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