IMF questions fitness of Eurozone banks

Washington: Eurozone banks are still not in a position to be “athletes” supporting economic recovery six years after the financial crisis, the International Monetary Fund warned on Wednesday as it called for a fundamental overhaul of their business models.

In its twice-yearly Global Financial Stability Report, the fund said banks in the single currency area needed to increase the cost of some of their lending and might have to retrench further than they had already to be in the position to support business investment.

The IMF’s warning on banks’ health came as it fretted that low interest rates in the Eurozone were not sufficient to support risk-taking that was beneficial to economic growth, but might nevertheless be encouraging the build-up of financial vulnerabilities.

Launching the report, Jose Vials, the head of financial stability at the IMF, said that while the world needed low interest rates to support growth, cheap borrowing costs risked causing the build-up of further imbalances. There is “not enough economic risk-taking in support of growth, but increasing excesses in financial risk-taking posing stability challenges”, he said.

Part of the reason for this diagnosis was that banks, particularly in the Eurozone, had become sufficiently safe to lead what he called “a normal life” but were not strong enough “to be ‘athletes’ who can vigorously support the recovery”.

The IMF found that a quarter of the 300 banks in advanced economies it examined did not have adequate capital buffers or profitability to support lending growth of 5 per cent a year. Most of these banks were in the Eurozone, where the proportion of lenders unable to support the recovery stood at 46 per cent, representing 60 per cent of assets.

“These banks will need a more fundamental overhaul of their business models, including a combination of repricing existing business lines, reallocating capital across activities, consolidation, or retrenchment,” Vials also said.

He added that the European Central Bank’s asset quality review and stress tests presented a good moment to address these fundamental weaknesses, which were still holding back lending in the periphery of the Eurozone.

While the fund worries about the lack of easy credit available to companies and households even with low interest rates, it also is concerned about the side effects of ultra-loose monetary policy. These include a build-up of financial risks as investors search for yield and are attracted to increasingly risky places to place savings.

The report showed asset prices had been high and volatility low across financial instruments at a time when the global economic news had been surprisingly disappointing. Vials also said the trends suggested investors were still complacent about the risks they faced. He warned many fund managers were engaged in similar strategies and could face severe difficulties in retrieving their money if everyone rushed for the exit simultaneously.

To address the twin concerns that low interest rates were not encouraging sufficient economic risk-taking at the same time as providing incentives for financial excess, the IMF called for regulators to ensure banks had strong enough capital buffers to provide sufficient credit to restart vigorous economic growth.

In addition, the IMF recommended redoubling efforts to regulate and limit financial risk-taking; for example, by ensuing redemption terms in mutual funds reflected the true risks of illiquidity. The fund also made the case for imposing macroprudential limits on lending that might create financial excesses and for greater transparency over true lending levels in the shadow banking sector.

— Financial Times