The International Monetary Fund said on Tuesday that sovereign debt risk in Europe and continued real estate woes in the United States have dealt a setback to global financial stability in the past six months.
The IMF said risks to the financial sector could be reduced if legacy problem assets were cleaned up, if governments improved their fiscal positions and if more clarity were provided on global financial regulation.
"The global financial system is still in a period of significant uncertainty and remains the Achilles' heel of the economic recovery, the IMF said in its semi-annual Global Financial Stability Report.
"The recent turmoil in sovereign debt markets in Europe highlighted increased vulnerabilities of bank and sovereign balance sheets arising from the crisis," the fund added.
The IMF said it had trimmed its estimate of total global bank write-downs related to the financial crisis between 2007 and 2010 to $2.2 trillion from its April estimate of $2.3 trillion, largely due to a drop in securities losses. Banks have recognized more than three-quarters of these write-offs, leaving about $550 billion still to be taken.
However, the fund said banks had made less progress in dealing with near-term funding pressures — nearly $4 trillion of bank debt needs to be refinanced in the next 24 months.
"Overall, bank balance sheets need to be further bolstered to ensure financial stability against funding shocks and to prevent adverse feedback loops with the real economy," the IMF said.
The forceful policy response to the European debt crisis in April and May of this year this year helped to offset market and liquidity risks to banks. But the sector's stability in the region remains vulnerable to potential market shocks, the IMF said.
In the United States, concerns about household balance sheets and real estate markets amid persistently high unemployment are clouding the outlook for loan quality and bank capital needs.
"Although manageable from a financial stability perspective, a double dip in real estate could have a long lasting impact on the economic recovery," the IMF said.
U.S. banks have had to raise modest amounts of capital, but this largely reflects the shifting of much of the mortgage risks and losses onto Fannie Mae and Freddie Mac, the IMF said. Capital challenges for these government-controlled entities could reactivate a negative global feedback loop between the financial system and the economy.
The fund said it conducted its own "stress test" on the top 40 U.S. banking companies and found that in an adverse scenario where real estate prices fell significantly, these banks would require $13 billion in additional capital to maintain a 4 percent Tier 1 common capital ratio.
"Mid-size banks are particularly vulnerable because it may be more difficult for them to raise capital," the IMF said.
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