EUROPEAN banks face about 300 billion euros ($405bn) in potential losses from the euro-zone debt crisis, the International Monetary Fund said as it urged banks to raise capital to protect the global economy from more turmoil.
The fund said fiscal strains emanating from weaker euro-zone members have had a direct impact of about 200bn euros on banks in the European Union since its debt crisis started last year. In addition to the holdings of government debt, lower bank asset prices raised credit risks between banks for an overall hit of 300bn euros.
The IMF cautioned that the figure -- based on recent market measures -- doesn't necessarily represent the size of a capital hole at European banks, saying such an assessment would require a closer examination of bank balance sheets. But in a report ahead of its annual meeting, it used the calculation to stress the importance of increasing bank capital buffers.
The IMF said the global credit crisis "has moved into a new, more political phase" as governments struggle to get their finances in order and larger European nations debate how to rescue their neighbours.
The latest turmoil in the euro zone, the US debt-rating downgrade and capital shortfalls at banks have renewed threats to financial stability around the world as global growth slows, the fund said.
"Time is running out to address existing vulnerabilities," the IMF said in its Global Financial Stability Report.
"The set of policy choices that are both economically viable and politically feasible is shrinking as the crisis shifts into a new, more political phase."
The IMF urged euro-zone policymakers to ratify an agreement to expand the flexibility of Europe's rescue fund. But it also acknowledged that markets remain sceptical of the rescue facility's ability to relieve pressure on debt from Belgium, Italy and Spain -- three countries that came under pressure more recently.
Nearly half of the 6.5 trillion euros total of government debt issued by euro-zone nations shows signs of heightened credit risk, the fund said.
With the weakening debt sitting on bank balance sheets, the IMF said banks need to raise capital privately if possible and that governments may need to inject capital into their banks in some cases.
The report comes weeks after new IMF managing director Christine Lagarde called for "urgent recapitalisation" of European banks, drawing fierce objections from some European policymakers.
The IMF is the sounding the alarms partly because of worries that banks may respond to capital shortfalls by raising interest rates on their loans and restricting credit, hurting already weak economies. In one scenario, the IMF estimated that weaker credit conditions could reduce growth in the euro zone by 3.5 percentage points and in the US by 2.2 percentage points -- enough to push the economies into recession.
"Banks must be made stronger, not only to increase bank lending, which is essential to the recovery, but also to reduce the risks of vicious feedback loops," IMF chief economist Olivier Blanchard said on Tuesday.
The IMF called on the US to implement a credible plan for addressing its deficit in the medium term, saying that financial markets have taken a sanguine view of the US debt-rating downgrade that "potentially creates a false sense of security" and increases the potential for a sharp market reaction later.
It also said the US needs measures to reduce household debt to boost overall demand in the economy. In particular, the fund called for moves to support the housing market, such as mortgage modifications involving principal write-downs or a program to convert unsold foreclosed homes into rental units.
Emerging markets have fared far better than advanced economies in recent years. But the IMF warned that emerging economies face the risk of "sharp reversals" due to weaker global growth, sudden capital outflows or a rise in funding costs that could weaken their banks at home.
"Emerging markets must limit the build-up of financial imbalances while laying the foundations of a more robust financial framework," the IMF said.
THE AUSTRALIAN
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