|Global economy faces 'chronic' crisis if reforms are not completed, warns IMF
|A growing trend towards excessive risk-taking and lack of action to repair broken bank balance sheets could trigger a “chronic” new phase in the financial crisis, the International Monetary Fund has warned.
The IMF said that while near-term risks had abated in response to loose central bank policies, reforms to repair ailing banks were not yet complete and could pose a threat to future stability, particularly in Europe.
“While major UK and core euro area banks have been actively de-risking and deleveraging .r01;.r01;. more needs to be done to complete the repair of their balance sheets,” the IMF said in its half-yearly Global Financial Stability Report.
It came as Jens Weidmann, Germany’s central bank chief, warned that Europe could take ten years to recover from the crippling debt crisis.
“Overcoming the crisis and the crisis effects will remain a challenge over the next decade,” Mr Weidmann told the Wall Street Journal.
“The calm that we are currently seeing might be treacherous [if countries delay reforms].”
Mr Weidmann, who is a governing council member of the European Central Bank, said that the ECB could cut its benchmark interest rate from a historic low of 0.75pc if new information warranted action. However, he added: “I don’t think that the monetary-policy stance is the key issue.
“Everyone is asking what more can the central bank do instead of asking what other policy makers can contribute.”
The IMF said that recent events in Cyprus were an “important reminder of the fragility of market confidence”. It urged governments to make “sustained progress” with implementing a banking union.
It warned that euro periphery banks such as those in Spain and Portugal faced a large overhang of debt – equivalent to up to a fifth of total liabilities – which they would struggle to finance.
The IMF called for greater co-ordination to address bank weaknesses, and said that progress so far had been “uneven”.
“Without greater urgency towards international co-operation and comprehensive bank restructuring, weak bank balance sheets will continue to weigh on the recovery and pose ongoing risks to global stability,” the IMF said.
It also found evidence in the United States that “accommodative monetary policies are bringing about an intended shift toward risky assets”.
“Higher borrowing in an environment of slower earnings growth is boosting corporate leverage, reversing the post-crisis trend of maintaining conservative balance sheets,” the IMF said.
“A prolonged period of low interest rates may create incentives to increase leverage beyond manageable levels, extend the decay in underwriting standards, and reinforce the search for yield.”
José Viñals, the IMF’s director of monetary and capital markets, said he was concerned about the rapid deterioration in underwriting standards.
“At this early stage of the cycle we are already seeing a deterioration,” he said.
The extent of the recent underwriting boom was shown by Wall Street giant Goldman Sachs on Tuesday, which posted its strongest underwriting quarter on record. Goldman’s performance partly reflected “significantly” higher revenues from fees related to leveraged finance – where clients take on more risky loans.
Bank of America and JP Morgan also reported strong increases in debt underwriting fees this week.
“Restraining a rapid rise in leverage and encouraging prudent underwriting standards will remain key objectives,” said the IMF.
The fund said that some US public pension funds had significantly increased risk exposure, and in some cases were using investors’ money to gamble on complex derivatives and hedge funds in a bid to generate higher returns. It said the weakest funds had increased “alternative investments” to “about 25pc of assets in 2011 from virtually zero in 2001.”
The report added that the Libor scandal, where several banks have been accused of rigging interest rates, would continue to weigh on lenders’ profits.