Recovery has lost steam and risks remain high, IMF warns

The European sovereign debt crisis and continuing uncertainty surrounding the US housing market have set back progress towards financial stability and improvements in credit risk, according to the International Monetary Fund.

In its semi-annual Global Financial Stability Report, published on October 5, the IMF warned the outlook for financial stability is subject to considerable downside risk, tail risks remain elevated and bank balance sheets need to be further bolstered to deal with the refunding needs of the banking sector.

"Although the financial situation has improved after turmoil in European sovereign debt markets, substantial market uncertainties persist and tail risks are elevated, with markets still expecting volatility to remain high. Policy actions are needed to contain low-probability but high-impact events by adequately addressing sovereign risks, tackling legacy problems in the banking system, and providing greater clarity on the new financial regulatory landscape," the report states.

The report also highlights the considerable funding challenges facing banks as emergency central bank support measures are phased out and new regulations emerge, estimating that more than $4 trillion of debt is due to be refinanced over the next two years.

Despite ongoing vulnerability to periods of renewed stress, European banks should be able to repair their balance sheets and rebuild capital buffers, the IMF suggests, but problems facing weaker institutions still need to be resolved, with the implementation of restructuring plans in some cases.

"This is particularly the case for segments of the banking system that have been found to have compromised business models. The German Landesbanken, for example, suffer from weak profitability and, in Spain, the Cajas sector is now undergoing substantial reform and excess capacity is being reduced. A healthy banking system also requires high-quality supervision by adequately resourced and skilled supervisory agencies, supported by an effective resolution framework," the report notes.

This article first appeared on Risk.net