IMF's Global Financial Stability Review says urgent need for international co-operation to tackle systemic risks posed by banks deemed 'too important to fail'
Time is running out for governments to overhaul regulation of global banks that have become bigger and more powerful since the start of the financial meltdown three years ago, the International Monetary Fund warned today.
In its half-yearly health check on the financial sector, the Washington-based fund said there was an urgent need for international co-operation to tackle the systemic risks posed by banks deemed "too big to fail".
"The future financial regulatory reform agenda is still a work in progress, but will need to move forward with at least the main ingredients soon", the IMF said in its Global Financial Stability Review. "The window of opportunity for dealing with too-important-to-fail institutions may be closing and should not be squandered, all the more so because some of these institutions have become bigger and more dominant than before the crisis erupted.
"Policymakers need to give serious thought about what makes these institutions systemically important and how risks to the financial system can be mitigated."
The fund said the end of the recession and the pickup in financial markets had cut the estimated losses of banks from $2.8tn (£1.8tn) last October to $2.3tn. Losses for UK banks were shaved by $99bn to $398bn.
But it stressed that the debts amassed by governments in their attempts to mitigate the impact of the global recession threatened to open a new chapter in the credit crunch. The need to finance growing budget deficits could push up interest rates, intensifying the credit squeeze on companies and putting renewed financial pressure on banks.
"Concerns about sovereign risks could undermine stability gains and take the credit crisis into a new phase, as nations begin to reach the limits of public sector support for the financial system and the real economy." Debt levels in the G7 nations – the US, the UK, Germany, France, Canada, Italy and Japan – were nearing 60-year highs, the report said.
"To address sovereign risks, credible medium-term fiscal consolidation plans that command public support are needed. This is the most daunting challenge facing governments in the near term. Consolidation plans should be made transparent, and contingency measures should be in place if the degradation of public finances is greater than expected."
The IMF said government borrowing would remain high over the next two years, particularly in the UK and the eurozone. In Britain, the increase in both corporate and household debt in the pre-crisis years meant non-financial private sector debt stood at over 200% of GDP, "one of the highest among mature economies".
Demand for credit in the UK would exceed supply by £140bn this year and £120bn in 2011, the IMF predicted, noting that the UK would have a far higher financing gap than either the US or the euro area. Further action by the Bank of England and other central banks to buy up securities through quantitative easing programmes might be needed, the report added. The fund highlighted commercial property as a particular risk in the UK, noting that prices were down 40% since the peak.
Predicting a slow, shallow and uneven recovery in credit, the fund said bank profits would be affected by a tougher regulatory regime.
"Even though capital needs have fallen, banks still face considerable challenges: a large amount of short-term funding will need to be refinanced this year and next; more and higher quality capital will likely be needed to satisfy investors in anticipation of more stringent regulation; and not all losses have been written down to date. In addition to these challenges, new regulations will also require banks to rethink their business strategies. All of these factors are likely to put downward pressure on profitability."
The report provided conditional support for the Conservative plan to scrap the Financial Services Authority and hand banking regulation to the Bank of England. "A unified regulator – one that oversees liquidity and solvency issues – removes some of the conflicting incentives that result from the separation of these powers, but nonetheless if it is mandated to oversee systemic risks it would still be softer on systemically important institutions than those that are not. This arises because the failure of one of these institutions would cause disproportionate damage to the financial system and regulators would be loathe to see serial failures."
Care would be needed, the IMF said, to ensure the right balance between making the financial system safer and ensuring that it continued to be efficient and innovative.
Copyright Speakers Corner 2016