IMF calls for recapitalisation of European banks

GLOBAL STABILITY REPORT:THE EUROPEAN debt crisis has caused a debt risk of €300 billion in the banking sector, and banks need to be recapitalised if they are to withstand potential losses, according to the International Monetary Fund.

In its Global Stability Report, the IMF found the international financial system is weak and the risks to its stability have increased “substantially” in recent months.

This is the first time since the outbreak of the financial crisis in October 2008 that risks to the system have increased, the IMF said.

The report includes an analysis to back up claims made in early September by the head of the IMF, Christine Lagarde, about weaknesses in European banks. The newly appointed managing director of the fund sparked a row with European policy makers when she claimed that euro zone banks needed significant recapitalisation owing to losses on their holdings of sovereign bonds.

The report finds that sharp falls in the value of peripheral countries sovereign bonds may have resulted in banks capital bases being eroded by €200 billion. An additional credit risk of €100 billion on interbank exposure to peripheral economies brings the total to €300 billion.

The analysis is likely again to be dismissed by European leaders given its limited scope, something which the IMF itself acknowledges in the report, stating “a typical stress test would have several components that are beyond the scope of this exercise.”

The biannual report made one of the most urgent calls for action from governments yet, saying that “risks are elevated, and time is running out to tackle vulnerabilities that threaten the global financial system and the ongoing economic recovery.”

The failure of European policymakers to reach such a solution is eroding their credibility, thereby raising further concerns about peripheral government’s capacity to meet their debt repayments – which in turn is creating a vicious cycle. The report says that “sovereign pressures threaten to reignite an adverse feedback loop between the banking system and the real economy.”

Although the report contains no Ireland-specific analysis, acc-ording to IMF forecasts contained in the report, but not analysed, the contraction of bank lending to Irish businesses – on a year on year basis – will continue at least until mid-2012, even if the rate of decline is expected to be less marked than over the past year. The contraction in lending to businesses in Ireland will remain the sharpest of the peripheral euro area countries,

The report also shows that only the banking systems of Ireland and Greece have experienced declines in deposits since the euro crisis started in early 2010.

Up to the middle of 2011, deposits in Spain and Italy were broadly stable in the beginning of 2010, while the Portuguese banking system’s total deposits were higher. Unlike Ireland and Greece, being forced to resort to bailout has not caused deposit flight in Portugal.

While financial stability issues in the US and emerging markets are discussed, the report highlights risks in the euro area, saying that “political differences within economies undergoing adjustment and among economies providing support have impeded achievement of a lasting solution.”