The International Monetary Fund is urging Europe to push shaky banks to strengthen their finances as the best way to keep the debt crisis in Greece, Portugal and Ireland from hitting a growing eurozone economy.
The Washington, DC-based international organization says stress tests are a key opportunity to fix banks by forcing those found to be weak to raise new capital, which can be done by investors or government stumping up more money.
The issue is important to the rest of the economy because a number of banks hold Greek, Irish and Portuguese debt, complicating efforts to resolve those countries debt problems. A default or restructuring of that debt could hit banks so hard they wouldn't be able to loan money to companies, spreading financial trouble to the wider economy.
Antonio Borges, director of the IMF's European department, said that fears that the troubles in the heavily indebted countries would spread to banks elsewhere had lessened recently. But he said that was not a reason to hold back recapitalizing banks.
"A year ago the situation was much more difficult than today," Borges said at a news conference in Frankfurt. "This does not mean the situation in the European banking system is solid and strong."
"This is one area where we think Europe could move a little faster," he said. "There is no reason for this, because there are plenty of resources, plenty of capital across Europe, and we would appreciate if there was faster action."
The European banking regulator is running stress tests on banks, with results due in June. A set of tests last year was regarded as too easy to restore confidence in the system. Some economists say that national regulators are reluctant to crack down on their own banks for fear of disadvantaging them in competition with banks in other countries.
Raising new capital also dismays shareholders as they are asked to either put in more money or see their holdings diluted by new share issues.
The IMF estimates that the 17 countries that use the euro will see growth of 1.7 percent this year and 1.9 percent next year, if debt crises don't derail the economy.
"Financial linkages between countries with sovereign debt troubles and the rest of Europe could potentially pose more risk to the outlook," the IMF said in its regional economic outlook for Europe released Thursday.
With it said banks holding bonds from indebted countries, a shock to confidence could spread quickly throughout Europe.
Figures Thursday provided some evidence that Europe's recovery has slowed down. Eurostat, the EU's statistics office, revealed that industrial production fell 0.2 percent in March from the previous month. The decline was unexpected as the consensus in the markets was for a modest increase during the month. It also represented the first monthly fall since last September.
The industrial production figures were released a day ahead of the first estimate of eurozone economic growth in the first quarter. At the moment, the consensus in the markets is that the economy grew by a fairly healthy 0.6 percent during the first three months of the year, with output recovering from the previous quarter's 0.3 percent, when economic activity was hurt by snow storms across Europe.
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