Global banking system 'living dangerously'

Four years after the financial crisis began, the IMF says confidence in the world banking system is yet to be fully restored, with many advanced nations still "living dangerously". Huge flows of volatile capital into emerging market economies were creating fresh threats to financial stability and global recovery.

Adding to recent criticism of the slow pace of America's attempts to reduce its borrowings, the IMF's financial counsellor, Jose Vinals, said that because of their huge debts, the US and Japan were "vulnerable" to any rise in interest rates unless they took "decisive action ... over the medium term".

The IMF said banks were far from fixed, and those in Europe were especially "weak", with about a third of the EU's banks operating with inadequate capital buffers. "Structural weaknesses and vulnerabilities in the euro area pose downside risks."

However, Vinals was more encouraging on the largest single threat to the survival of the single currency - a Spanish sovereign debt crisis.

He said Spain had "decoupled" from the problems experienced by Greece, Ireland and Portugal, although authorities would need to continue to work hard to regain the confidence of the markets. He saw no need for Greece or Ireland to default or "restructure" their debts.

The "good news", Vinals said in launching the Financial Stability Report, was that risks have declined since the last review in October, thanks to the gradual economic recovery and support from central banks keeping interest rates low and governments keeping spending high.

The "not so good" news was that those monetary and fiscal polices were "masking" serious underlying fiscal vulnerabilities, and the "legacy of debt" in many rich economies was weighing on household, financial and national balance sheets, leaving risks high.

Looking forward to the EU's next round of bank "stress tests" in June, Vinals urged authorities to ensure these were sufficiently "credible, ambitious and stringent".

IMF analysis revealed some 30 per cent of European banks, representing a fifth of the total asset base of the system, had tier one capital ratios of less than 8 per cent, and were thus inadequately capitalised and unable to obtain cost-effective funding.

Too many European financial institutions, said Vinals, "should not be there" and he encouraged regulators to quicken the pace of recapitalisation, reconstruction or resolution of these banks.

"This weak tail of banks is creating excess capacity and raising funding costs for other banks as well."

Vinals also hinted that the next major global financial crisis is likely to come from "overheating" emerging markets.

Large and volatile capital flows have flooded into markets in Brazil, India, China and other countries, promising rapid growth and high returns for investors. The pace of expansion of bank credit in some of these countries was now so high that danger of a new crop of underperforming loans was growing, which in turn would lead to stress in their banking sectors and dislocation in their real economies - in effect, a rerun of the West's financial crisis, albeit from a stronger base.

THE DANGERS
From the IMF's Financial Stability Report:

* European banks weak, with a third operating with inadequate capital buffers.

* US and Japan vulnerable to any rise in interest rates.

* Next financial crisis likely to come from "overheating" emerging markets such as Brazil, India or China.

- INDEPENDENT