BIS calls for European banking union and urgent fiscal reform in developed nations

The Bank for International Settlements (BIS) has issued a strong call for governments around the world to act swiftly to address the root causes of the global financial crisis, including dealing with economic sectoral imbalances, excessive leverage, public over-indebtedness and over-burdened central banks. Only then is it likely sovereign bond yields in many countries will return to rates more typically associated with ‘risk-free' levels, the BIS said.

The BIS stressed the matter is urgent, adding that the on-going crisis in the eurozone – which it believes could be resolved through the creation of a banking union – is a "harbinger" for many countries around the world, should those countries fail to act quickly to address their structural imbalances and indebtedness in the private, public and commercial sectors.

Jaime Caruana, general manager of the BIS, told cental bank governors attending the BIS annual general meeting in Basel on June 24, that public debt in advanced economies has risen from 75% in 2007 to a current 110% and that "fiscal trajectories are unsustainable in most industrialised countries".

Addressing these imbalances – even when countries have sufficient political will to drive through reform – could take some time, according to the central banking body's 82nd annual report, which was released the same day. "In most advanced economies, the fiscal budget excluding interest payments would need 20 consecutive years of surpluses exceeding 2% of GDP – starting now – just to bring the debt-to GDP ratio back to its pre-crisis level," the BIS annual report said.

The annual report painted a gloomy picture of the world economic and financial system, highlighting that growth even in emerging economies was slowing, and that credit default spreads for many banks were back at all-time highs, loan-to-book ratios for some banks stood at a mere 50% and big banks are once more reliant on trading revenues and have large derivatives positions.

In most advanced economies, the fiscal budget excluding interest payments would need 20 consecutive years of surpluses exceeding 2% of GDP - starting now - just to bring the debt-to-GDP ratio back to its pre-crisis level

The BIS stated that sectoral imbalances were largely in the areas of financial services, which is over-leveraged and outsized in some countries, with investors concerned about the real value of assets held on books, real estate and too much dependence on exports in emerging countries. Caruana added that the service sector is over-regulated in many markets, labour markets are too rigid, and choices about taxation and public spending are "still frequently driven by short-term considerations".

"Research, training and education continues to receive too few resources. And tax inefficiencies remain. Such limited progress in structural reform is making it harder to correct the large imbalances revealed by the most severe financial busts," the BIS secretary general added.

And the BIS pulled no punches on Europe, calling for structural adjustment, fiscal consolidation ad bank recapitalisation as well as a unified framework for bank regulation, supervision, deposit insurance and resolution. "That approach will decisively break the damaging feedback between weak sovereigns and weak banks, delivering the financial normality that will allow time for further developments of the euro area's institutional framework," the report said.

However, the prescription for Europe appeared to contradict another recommendation in the report – that nations in relatively sound fiscal positions, notably emerging market countries, should start provisioning against potential fiscal problems, such as higher social security costs, down the line.

The report also did not appear to offer a roadmap identifying how its proposed banking union in Europe would be implemented – for example, the proportion of payments and commitments each country would pay and the bodies responsible for new oversight.

But the BIS did call for far more urgent action to tackle what it described as insolvency in the banking sector. "Bank recapitalisation needs to be complemented with earlier loan-loss recognition and more realistic asset valuation," said Caruana, who added that the low loan-to-book ratios of banks in many major jurisdictions have fallen during the past year, indicating investors are even more concerned with the quality of assets held by banks.

"Only... when balance sheets across all sectors are repaired, can we hope to move back to a balanced growth path," added the BIS annual report. "Only then will virtuous cycles replace the vicious ones now gripping the global economy."