Financial sector remains ‘Achilles heel’ of recovery: IMF

WASHINGTON - The eurozone debt crisis has spilled over into private banks and set back the global financial sector’s recovery from the near collapse of late 2008, the International Monetary Fund (IMF) said Tuesday in a six-monthly report on the financial industry.

The IMF pointed to the weakened banking sector as a missing piece of the puzzle as the world economy struggles to recover from the recession in late 2008 and early 2009. Some firms remained vulnerable to a new crisis of confidence and should raise more capital reserves.

“The key message … is that the financial system remains the Achilles heel of the economic recovery and much work still needs to be done to ensure global financial stability,” said Jose Vinals, director of the IMF’s monetary and capital markets department.

Vinals said the IMF still expected to see a “gradual improvement” in the financial sector over the coming year, but the pace of that recovery would depend on the “decisiveness” of banks and governments in repairing the remaining damage to their bottom lines.

“The process of bank balance sheet repair and reform remain unfinished business,” Vinals said. Governments “should remain open to providing financial support if and when needed”.

The IMF said European governments had acted quickly to stabilize markets by offering a major rescue package when Greece’s spiralling debt levels first spooked investors in the spring. But the crisis had also refocused concern on banks’ balance sheets and upped the pressure on both sides to raise new funds in coming years.

The spillover was “increasing the likelihood of a grim scenario of shrinking credit, slower growth and weakening balance sheets”, which would in turn put more pressure on businesses and consumers trying to get access to loans, the IMF said in its report.

The troubles of wealthy countries were also prompting investors to flood more money into emerging economies, which have emerged from the deep recession in a far better position. This dynamic was causing a “structural shift” in investment towards developing countries.

Three years after the start of the financial crisis in the US and Europe, the IMF estimated that banks had realised about three quarters of the losses related to the turmoil. Banks still needed to write off about $550 billion in bad loans out of a total $2.2 trillion.

The IMF argued that “continuing, forceful policy measures” would be needed to keep the financial sector stable, suggesting central banks may have to continue lending to banks for longer than expected.

The need for banks to raise new capital was greater in Europe than in the United States, where the government and Federal Reserve had taken over many of the riskiest assets - mostly in the housing sector - that were undermining banks’ balance sheets.

The task for US authorities remained pulling the government out of its private stakes without disrupting the still-fragile financial sector, the IMF said.

By contrast, the challenge for emerging powers like China and India was coping with the dangers that come with an influx of capital. Unchecked, it could wind up creating the kinds of asset bubbles that sparked the financial crisis in the industrial world.

Investments in developing countries were “sizeable and potentially volatile”, Vinals warned. Financial sectors in emerging countries had to be “robust” enough to survive a flight of capital, should fickle investors have a sudden change of heart.