IMF: Financial sector remains "Achilles heel" of recovery (1st Lead)

Oct 5, 2010, 15:25 GMT

Washington - The eurozone debt crisis has spilled over into private banks and set back the global financial sector's recovery from the near collapse of late 2008, the International Monetary Fund (IMF) said Tuesday in its six-monthly report.

The IMF pointed to the weakened banking sector as a missing piece of the puzzle as the world economy struggles to recover from the recession in late 2008 and early 2009. Some firms remain vulnerable to a new crisis of confidence and should raise more capital reserves.

'The financial system remains the Achilles heel of the economic recovery and much work still needs to be done to ensure financial stability,' said Jose Vinals, director of the IMF's monetary and capital markets department.

While European governments had acted to stabilize markets by offering a major rescue package for indebted economies, the IMF said the episode had refocused concern on banks' balance sheets and upped the pressure on both sides to raise new funds.

The spillover was 'increasing the likelihood of a grim scenario of shrinking credit, slower growth and weakening balance sheets,' which would in turn put more pressure on businesses and consumers trying to get access to loans, the IMF said in its report.

Three years into the financial crisis, the IMF said banks had realized about three quarters of the losses related to the turmoil. Banks still needed to write off about 550 billion dollars in bad loans out of a total 2.2 trillion dollars.

The IMF argued that 'continuing, forceful policy measures' would be needed to keep the financial sector stable, suggesting central banks may have to continue lending to banks for longer than expected.

Governments 'should remain open to providing financial support if and when needed,' Vinals said.

The need for banks to raise new capital was greater in Europe than in the United States, where the government and Federal Reserve had taken over many of the riskiest assets - mostly in the housing sector - that were undermining banks' balance sheets.

The task for US authorities remained pulling the government out of its private stakes without disrupting the still-fragile financial sector, the IMF said.

By contrast, emerging powers like China and India continue to face an increasing influx of capital. Markets have begun to view many growing developing countries as more solid investments than the more sluggish and indebted economies of Europe and the United States.

The challenge for developing countries was 'how to cope with the effects of relative success,' the IMF said. The flood of capital, if left unchecked, could wind up creating the kinds of asset bubbles that sparked the financial crisis in the industrial world.

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