Wednesday, September 30, 2009

Have Global Financial Risks Subsided?


Chris Giles of the FT reports that the IMF warns on further institutional losses:

Banks around the world still have to reveal about half their likely losses resulting from the financial and economic crisis, the International Monetary Fund said on Wednesday, warning there was still a “significant” risk of another downward lurch in the global recession.

A failure to reveal the true scale of the losses they are likely to face and boost capital held in the banks would undermine the economies of the US, the UK and the eurozone and could generate a renewed vicious spiral where weak banks damage economic prospects, raising default rates and further threatening the health of banks, the IMF said.

José Viñals, the Fund’s head of monetary and capital markets, said: “In order to provide the credit that the economic recovery will need, you need to have some muscle as a bank – that means having, among other things, sufficient capital.

“Banks need more capital – they need more capital in Europe; they need more capital in the US; they need more capital in other parts of the world in order to have enough strength to provide more lending.”

But the IMF reduced its estimate of the ultimate losses in the financial system in 2007-10 to $3,400bn (€2,300bn, £2,100bn) from $4,000bn in its twice-yearly Global Financial Stability Report .

Within banks, the Fund estimates that losses will total $2,800bn, of which they have so far recognised only $1,300bn. “US domiciled banks have recognised about 60 per cent of anticipated writedowns, while euro area and UK domiciled banks have recognised about 40 per cent,” the report said.

Losses are likely to prove largest in the US and UK – where banks held more toxic assets and the downturn in commercial property has been greatest – but US banks have been quicker to recognise them than those in the eurozone or UK. The Fund said delays in recognising losses generally related to a failure to make provisions for bad loans on banks’ books.

Mr Viñals urged banks not to squander the chance to preserve capital in banks by retaining profits and avoiding large dividends as well as raising fresh capital from markets.

He said such restraint was especially important this year as banks’ profits had been boosted by exceptionally low funding costs. “If in future you are going to have more capital and better capital, it is important that you start preparing for it now – so conserve capital and keep it inside the bank.”

To get to a healthy level of capital – seen by many as tangible common equity representing 4 per cent of total assets – the Fund estimates that US banks would have to raise $130bn in additional capital, eurozone banks $310bn and UK banks $120bn. Although the additional capital-raising in Europe’s banks appears greater than in the US, the sums reflect the fact that Europe does more business through its banks and the sector is much bigger than in the US.

As a proportion of total assets, the necessary capital-raising is similar in all three areas, with the greatest need for new capital evident in Scandinavian economies. The improvement in the prediction of likely losses reflects growing confidence in financial markets and higher assets prices, which have reduced mark-to-market losses on banks’ books, and an improved outlook, with lowered estimates of credit losses.

Capital would be drained by future losses, but the emergency measures implemented so far meant that “banks in all regions have achieved a degree of stability in their capital positions”.

Although banks have been profitable this year as their borrowing costs have fallen with exceptionally low interest rates and the rates charged on lending have remained higher, the IMF warned that this happy position for banks might not last. “In the medium term, banks are likely to suffer reduced margins from paying more for deposits and incur higher interest costs,” it said, so greater capital-raising measures were still necessary.

But the capital-raising exercises by banks and recapitalisation by government already undertaken have made banks more resilient to the losses they are likely to incur, the IMF added. Capital will be drained by future losses, but the emergency measures implemented so far meant that “banks in all regions have achieved a degree of stability in their capital positions”.

Massive public deficits also complicated the financial stability picture, the IMF warned. They implied that total borrowing needs in certain countries, particularly the US and UK, will exacerbate the difficulties in raising finance for the private sector, and imply the need to raise finance from abroad, potentially undermining the dollar and sterling, or raising long-term market interest rates.

“In terms of regional vulnerability, the UK appears most susceptible to credit constraints … given its significant reliance on the banking channel and the projected sharp decline in domestic bank balance sheets, as well as substantial public financing needs,” said the IMF.

[Note: The FT link has an interesting interview with Greenspan and Strauss-Kahn.]

Let me just say that the IMF's Global Financial Stability Report is an excellent document that every serious money manager needs to read carefully. It provides an outstanding overview of global financial system.

I went through it today and concluded that global financial risks have subsided but banks are by no means out of the woods. The semiannual report struck me as one of cautious optimism.

Tomorrow, the IMF will raise its forecast for 2010 global growth to about 3 percent from 2.5 percent, said Murilo Portugal, the fund's deputy managing director.

But any recovery in the global economy will be tepid and while the risks to the global financial system have subsided, banks still confront substantial challenges.

The report suggests that although their balance sheets have been stabilized, some of it because governments have injected capital, banks are not yet in a strong position to lend support to the economic recovery. A "financing gap" could arise—that is, projected credit capacity will be insufficient relative to the demands of sovereign borrowers and the private nonfinancial sector.

According to the IMF, such a situation constitutes a downside risk to the recovery and the report suggests that continued policy intervention may be needed to keep credit flowing.

***UPDATE: IMF Raises 2010 Growth Forecast***

The IMF says the global recovery is underway. Bloomberg reports that Asia leads the recovery:

The Washington-based IMF said the economy will expand 3.1 percent in 2010, more than a July forecast of 2.5 percent. China’s economy will grow 9 percent and India’s 6.4 percent. That compares with growth of 1.7 percent in Japan, 1.5 percent in the U.S. and 0.3 percent in the euro region.

You can track the IMF's World Economic Outlook updates by clicking here. Kevin Carmichael of the Globe & Mail reports that IMF predicts Canada to outpace rest of G7.

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