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Banks’ $4 trillion debts are ‘Achilles’ heel of the economic recovery’, warns IMF

By Philip Aldrick, Economics Editor
Published: 2:27PM BST 05 Oct 2010

More taxpayer support is needed to ensure global financial stability despite the billions already pledged, the International Monetary Fund has warned, as banks remain the “achilles heel” of the economic recovery.

Lenders across Europe and the US are facing a $4 trillion refinancing hurdle in the coming 24 months and many still need to recapitalise, the Washington-based organisation said in its Global Financial Stability Report. Governments will have to inject fresh equity into banks – particularly in Spain, Germany and the US – as well as prop up their funding structures by extending emergency support.

“Progress toward global financial stability has experienced a setback since April … [due to] the recent turmoil in sovereign debt markets,” the IMF said. “The global financial system is still in a period of significant uncertainty and remains the Achilles’ heel of the economic recovery.”

Although banks have recognised all but $550bn of the $2.2 trillion of bad debts the IMF estimates needed to be written off between 2007 and 2010, they are still facing a looming funding shock that will need state support. “Nearly $4 trillion of bank debt will need to be rolled over in the next 24 months,” the report says.

“Planned exit strategies from unconventional monetary and financial support may need to be delayed until the situation is more robust, especially in Europe… With the situation still fragile, some of the public support that has been given to banks in recent years will have to be continued.”

Although the IMF does not mention individual countries, it is clear it has concerns about the UK. According to the Bank of England, British banks need to refinance £750bn-£800bn of funding by the end of 2012, £285bn of which is emergency support that expires in the same period.

The IMF adds: “Without further bolstering of balance sheets, banking systems remain susceptible to funding shocks that could intensify deleveraging pressures and place a further drag on public finances and the recovery.”

The report welcomed banks efforts to recapitalise, noting that the average tier one ratio rose above 10pc in 2009, but cautioned that “despite these improvements, banking system risks are more elevated today”. Europe’s financial system, in particular, “remains vulnerable to downside risks and further funding strains if capital buffers are not strengthened”, the IMF said, naming the regional Cajas of Spain and Landesbanken in Germany.

Even US banks may need an extra $13bn of capital if “real estate prices fell significantly”. The research shows that the UK has been relatively prudent on bad debts and capital, having wirtten off all but $50bn of the bad debts identified by the IMF – just 10pc of the total.

The IMF also called for urgent global co-ordination of banking reforms, chiding regulators for having failed to agree on the details: “The sooner reforms can be clarified, the sooner financial institutions can formulate their strategic priorities and business models. In the absence of such progress, regulatory inadequacies will continue for some time, increasing the chances of renewed financial instability.

“Policymakers cannot relax their efforts to reduce refinancing risks, strengthen balance sheets, and reform regulatory frameworks.”

Governments must also address their budget deficits and public debts to help resurrect confidence in the banks and “reduce the risk that sovereign debt concerns compromise financial stability”.

“Fiscal risks remain high, particularly in advanced economies and significant structural weaknesses remain in sovereign balance sheets, which could spill over to the financial system, and have adverse consequences for growth over the medium-term,” the IMF said.

However, it added that governments now face a challenge in balancing “fiscal consolidation to reduce debt on the one hand while ensuring sufficient growth on the other”.

The IMF estimates in its “baseline” scenario that Britain’s debts will reach 86.4pc of GDP in 2015. But should the austerity measures result in “growth of 1pc less than the baseline”, debts will rise to 99.2pc of GDP in the same period.

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