IMF Survey: Further Action Needed to Reinforce Signs of Market Recovery: IMF

IMF News, April 21, 2009

Source details

Canonical URL: IMF Survey: Further Action Needed to Reinforce Signs of Market Recovery: IMF

Authors: Peter Dattels, Laura Kodres IMF Monetary, Capital Markets Department April
Published: April 21, 2009

An unprecedented policy response to the global economic crisis—including the recent expansion of resources for international institutions and the IMF’s enhanced lending framework—is gradually beginning to restore market confidence.
The IMF’s semiannual Global Financial Stability Report (GFSR), released April 21, warns that the challenges to restoring financial stability remain significant.
“Continued decisive and effective action is needed to preserve and strengthen these first signs of improvement, and to help provide a more stable and resilient platform for sustained global growth,” José Viñals, Financial Counsellor and Director of the IMF’s Monetary and Capital Markets Department, said.

Credit losses have continued to grow; most being borne by banks.
The credit deterioration is taking an increasing toll on bank balance sheets, with the IMF emphasizing the need to cleanse them of impaired assets.
Writedowns continue to mount as the collapse of economic activity leaves companies and individuals increasingly unable to repay borrowings.
Banks will have to rebuild capital as a result of credit losses.

Scenario 1 (TCE/TA = 4 percent): capital injections totaling $875 billion would be necessary for banks located in the United States and Europe using a common measure of leverage—tangible common equity (TCE) to tangible assets (TA)—of 4 percent.
- Estimated equity requirements by end-2010:
- United States: $275 billion
- Euro area: $375 billion
- United Kingdom: $125 billion
- Other advanced economies in Europe outside the euro area: $100 billion
Scenario 2 (TCE/TA = 6 percent): the amount of needed capital rises accordingly.
Some of the needed capital could come from conversion of preferred shares to common equity or from implicit government guarantees covering bank losses on some sets of assets.
The estimates are based on roughly $2.8 trillion losses that banks will incur from the start of the crisis through 2010 and reflect losses already taken and bank earnings this year and next that can be used to bolster capital.
Definitions: TCE is essentially total equity, less preferred shares and intangible assets; TA reflects loans and other common bank assets less intangible assets such as goodwill.

For all financial institutions, the report estimates writedowns on assets that were originated in the United States will total about $2.7 trillion, up from roughly $2.2 trillion projected in an interim report in January.
- The $2.7 trillion writedown is off a total of about $27 trillion in U.S.-originated assets.
The latest GFSR extends writedown estimates to include losses on loans and related securities that were originated in Europe and Japan, which will total approximately $1.3 trillion.
The Fund estimates potential writedowns could be nearly $4.1 trillion on some $58 trillion of assets originated in the United States, Europe, and Japan, including about $1 trillion already taken.
Banks will likely bear about two-thirds of the $4.1 trillion in writedowns, which together with their exposure to emerging markets, is about $2.8 trillion in actual and potential writedowns.
Writedowns will also be borne by other financial institutions, including pension funds and insurance companies.

Emerging market risks have risen the most in the past six months.
The retrenchment of capital flows is straining economies that have relied on foreign-financed credit growth.
The deteriorating economic environment has increased expected bank writedowns and raised the need for fresh capital in emerging market banks.
As institutions reduce assets during deleveraging, international capital flows to emerging markets have been curtailed; on balance, emerging markets could experience net outflows of private capital in 2009, with slim chances of recovery in 2010 and 2011.
Within emerging markets, eastern European economies have been the hardest hit due to linkages between western Europe and emerging European banking systems; western European banks may reduce funding of their eastern European subsidiaries and losses from emerging Europe may damage western European balance sheets.
There are promising regional initiatives in which some western banks have agreed to keep credit flowing to subsidiaries.

The IMF overhauled its lending framework and, at its summit in London on April 2, the Group of Twenty supported a large expansion of the Fund’s resources—from $250 billion to $750 billion.
Changes in the IMF’s lending framework include:
- More emphasis on crisis prevention
- Facilitating larger and more frontloaded financing
- Further streamlining conditions attached to IMF loans
Since approval of the reforms, external credit and credit default swap spreads on emerging market sovereign debt have tightened as markets have become reassured that sizeable external resources will be made available as needed.

Further decisive and effective policy actions will be needed to stabilize the international financial system.
The global banking system needs to be cleansed of its impaired assets.
Supervisors must determine whether a bank is viable.
- Banks that are viable but have insufficient capital will need capital infusions; if private sources are unavailable, public money will have to be used.
- In some cases, partial or total government ownership will be required to assure adequate capitalization and an effective restructuring plan, with the aim of returning banks to private ownership as expeditiously as possible.
- Banks that are not viable should be resolved promptly.
Financial policies must work constructively with other macroeconomic policies to short-circuit the adverse feedback loop between the financial system and the economy.
It is essential to stabilize the financial system—without which a robust and sustained economic recovery will be difficult to attain.

IMF Survey: Further Action Needed to Reinforce Signs of Market Recovery: IMF (April 21, 2009).