Weak politics, balance sheets hurting global financial system - IMF
Published:Friday | September 23, 2011 | 12:00 AM
Lavern Clarke, Business Editor
WASHINGTON, DC:
The world's financial system has grown even more unstable over the past few months, the International Monetary Fund (IMF) said Wednesday, blaming the development on "weak growth, weak balance sheets and weak politics" inside the United States and Europe.
The Fund is suggesting that the two power blocs consider mounting rescue plans to restructure balance sheets: for the banks inside the Eurozone; and for households in the form of write-downs on principal mortgage debt.
IMF financial counsellor and director, José Viñals, said Wednesday at a press conference on the September 2011 version of the Global Financial Stability Report, that the world is back in the "danger zone", putting the recovery at risk - reiterating a central point that IMF staff have been driving home all week ahead of the Fund's annual meeting.
"As we have moved into a new 'political phase' of the crisis, several shocks have recently buffeted the global-financial system, including unequivocal signs of a broader global economic slowdown, fresh market turbulence in the Euro area, and the credit downgrade of the United States," said Vinals.
"This has thrown us into a crisis of confidence."
The IMF is increasingly worried that the banks in Europe are so heavily exposed to sovereign debt at a time when Euro countries are facing a fiscal crisis.
The fund has estimated the size of the sovereign risk spillover at euro200 billion to euro300 billion, and while it suggests that an injection of capital, preferably in the form of common equity, is necessary to shore up the banks' balance sheets, Vinals said it was not as clear-cut as to how much rescue funds might be needed.
Some banks may already have provisioned for losses, others may have booked the sovereign debt as 'available for sale' securities, said Vinals, laying out potential scenarios on why the estimate could be complicated.
"We need more information on how banks price credit risk," he said.
The IMF counsellor stressed the need to maintain a healthy system, saying the banks need to "have sufficient muscle" to support the economic recovery through affordable lending.
He argued for European governments to pursue credible medium-term fiscal-consolidation policies - a reference to strategies to contain fiscal deficits which in turn should affect the need to borrow - as well as "swift and comprehensive balance sheet repair."
Without sufficient capital, banks may be forced to curtail lending or raise the price of credit - both of which the IMF considers potentially harmful to the recovery.
"Private sources of capital should be tapped first. In those cases where this is not sufficient, injections of public funds may be necessary for viable banks," said Vinals. "Weak banks should either be restructured or dissolved."
Asked what might have changed since the European Banking Authority (EBA) announced that the banks were healthy in July, the IMF counsellor said the EBA's assessment related to regulatory capital which was found to be adequate, but that as the financial system weakened mid-summer, the market "raised the bar" and began demanding a higher premium to finance banks within the Euro system.
The banks, he said, could take action on their own behalf by reassigning rates to sovereign debt that had become more risky, but have not moved in that direction.
He also advised that countries continue to pursue low interest rate policies to buy time to restructure both public and private balance sheets, but should be used judiciously to avoid excessive build-up of leverage and diversion of capital to emerging markets.
"The lack of sufficiently decisive policy action to finally address the legacy of the financial crisis has led to the present crisis of confidence. This has thrown us back into the danger zone and poses a major threat to the global economy. Yet we believe that while the path to sustained recovery has considerably narrowed, it has not disappeared. It is still possible to make the right decisions that will help restore global financial stability and sustain the recovery," said Vinals.
"But for this, we need to act now, we need to act boldly and we need to act in a coordinated manner. There is a way; now we need the political will."
Emerging market economies are unaffected for now, but the IMF sees future danger of contagion. At the fund's spring meeting in April, the concern was all about a potential asset bubble financed from quantitative easing funds (QE2) that had flowed to those markets, and the likelihood of having to impose capital controls to guard against overheating in countries such as Brazil.
The QE2 programme ended in June, and while the market expected the US Federal Reserve to announce another monetary stimulus — a QE3 or what is being called 'Operation Twist' , Vinals declined to speculate on what he said was, at that point, a hypothetical situation.
Were the downturn in the global financial system to lead to a rapid reversal of capital flows and falloff in growth in emerging economies, the IMF's "analysis shows that the impact on emerging-market banks could be substantial and thus warrants a further build-up or capital buffers in the banking system," Vinals said.