IMF Survey: Governments Must Take Stronger Measures to Strengthen Banks

IMF News, January 28, 2009

Source details

Canonical URL: IMF Survey: Governments Must Take Stronger Measures to Strengthen Banks

Publication date: January 28, 2009
Main message: Financial markets continue to deteriorate and governments must take stronger measures to clean up banks' balance sheets and bolster their capital.
IMF raised its estimate of potential financial sector writedowns on U.S.-origin assets to $2.2 trillion, up by $0.8 trillion from the October 2008 estimate of $1.4 trillion.
Deterioration in asset values has spread beyond U.S. subprime mortgages to corporate and commercial real estate securities, bank loans, insurance companies, pension funds, hedge funds, Europe, and emerging market countries.

The crisis began in 2007 among subprime mortgages in the United States and has spread globally, contributing to a worsening global recession.
The IMF’s revised World Economic Outlook (released simultaneously with the GFSR update on January 28) indicates markedly dimmed prospects for global growth and a sharp slowdown in international trade.
Banks have obtained enough new capital to offset existing writedowns largely because of public sector injections during the final months of 2008, but some banks may still lack a sufficient capital cushion to "weather a global economic downturn."
IMF rough estimates indicate that for European and U.S. banks (including exposures to assets domiciled in the United States, Europe, and emerging markets), "at least half a trillion dollars is necessary to prevent their capital position from deteriorating further."

The IMF warns of an adverse "feedback loop": bank actions to reduce exposures by selling assets and refusing to renew maturing loans weaken the economy, which in turn increases pressures on banks to sell more assets and further restrict credit.
The report states economies will not recover until the global financial system returns to health.
To date, measures to cap potential bank losses and inject capital "have not yet stemmed concerns about the health of the financial system" and the speed and size of the adverse feedback loop has overwhelmed policy responses.

Central banks must provide ample liquidity to the financial system.
Banks must be recapitalized to cover potential writedowns.
Problem assets on bank books must be dealt with in some manner.
Policymakers and the private sector must take more "decisive and urgent action" to strengthen the system and make deleveraging less disorderly.

Speedy recapitalization and handling of distressed assets. The IMF suggests authorities may find a "bad bank" approach useful: keep good assets on the books of recapitalized institutions and transfer impaired assets to a "bad bank" that can hold to maturity or dispose of them. The Resolution Trust Corp is cited as an example used during the savings and loan crisis of the 1980s.
Ensure short-term policies are consistent with the long-run vision for the financial system; clarity on the final design of the financial system is essential to maintain policy credibility.
Transparency about policies, use of public financial support, and decisions about the future of individual financial institutions—especially identification of bank problem assets, conditions on recapitalization, and setting of adequate capital levels.
High level of international cooperation on national financial policies to prevent competitive distortions, regulatory arbitrage, and excessive "national bias." The IMF notes that "No one model of restructuring will be appropriate for every country or every bank, but even if the models differ, international coordination remains essential."

Initiatives underway to improve regulatory and supervisory frameworks are crucial to building a resilient and innovative financial system.

Source: IMF Survey: Governments Must Take Stronger Measures to Strengthen Banks (January 28, 2009).