Policy action and global economic recovery have reduced risks to the financial system but recovery will still be difficult, according to the International Monetary Fund’s (IMF) Global Financial Stability Report released today.
The IMF has calculated that actual and potential writedowns from bad assets have fallen by $600 billion (£378 trillion) over the last six months, from $4 trillion to $3.4 trillion, suggesting that the financial system is heading towards recovery.
However, the IMF estimates that whilst commercial banks have recognised $1.3 trillion of losses through the first half of 2009, they will still face another $1.5 trillion of potential writedowns.
The report says that whilst bank earnings are recovering, they will not be sufficient to fully offset anticipated writedowns over the next 18 months.
A combination of lower earnings and continuing pressure to deleverage will mean that banks need to raise more capital.
This strain on banks’ balance sheets could mean they are not in a strong enough position to lend support to the economic recovery, and a “financing gap” between bank supply and borrowing demand could emerge.
The IMF report also warned of the increased supply of public debt, saying that governments fiscal stimulus packages transferred financial risk from the private to public sector.
It recommends that countries design and implement medium-term fiscal consolidation plans to move towards unwinding of this debt.
The IMF also recommends reforms to financial regulation, including restoring market discipline by increasing the level and quality of capital, widening policy to cover a greater scope of institutions and improving international collaboration for the regulation of cross-border institutions.