June 21, 2012 / 10:06 PM / 8 years ago

IMF's Lagarde demands action to avert threat to euro

LUXEMBOURG (Reuters) - The International Monetary Fund urged the euro zone on Thursday to channel aid directly to struggling banks rather than via governments and called for the European Central Bank to cut interest rates, saying the future of the euro was at stake.

The stark message from IMF Managing Director Christine Lagarde, delivered to euro zone finance ministers who met in Luxembourg, will increase pressure to forge a unified approach to tackling problems at struggling banks such as those in Spain.

“We are clearly seeing additional tension and acute stress applying to both banks and sovereigns in the euro area,” Lagarde told a news conference after the meeting.

“A determined and forceful move towards complete European monetary union should be reaffirmed in order to restore faith,” she said. “At the moment, the viability of the European monetary system is questioned.”

Lagarde spelled out a plan that envisioned the issuance of jointly guaranteed euro zone debt as well as more centralized economic control in the 17 countries that use the euro.

As ministers prepared to provide up to 100 billion euros ($126 billion) in aid for Spain to shore up its stricken banks, Lagarde said financial support for banks should be given directly, rather than via the state.

Analysts believe such a model could entail allowing the euro zone’s permanent rescue scheme, the European Stability Mechanism (ESM) to directly inject capital into banks in return for a shareholding, or to lend at penalty rate of interest.

“There must be a recapitalization of the weak banks, with preferably a direct link between the European Financial Stability Facility(EFSF)/ESM and the banks, without going through the sovereign, in order to break the negative feedback loop that we have between banks and sovereigns.”

Her comments mirrored an appeal made by the finance minister of Ireland, which was forced to take a state bailout to prop up its lenders.

“The experience of Ireland should have been learned by the European authorities. To recapitalize banks and to transfer the accounting of it onto the sovereign seems to be an additional burden,” Michael Noonan told reporters at the meeting.


Lagarde also called for the Frankfurt-based European Central Bank to carry out monetary policy with “sufficient creativity” to help the euro zone, and the IMF fleshed out that idea in a new report on the single currency area.

“The ECB has room, albeit limited, to ease policy rates and signal a commitment to a more accommodative stance for a prolonged period,” the IMF said in the report.

The ECB left rates at 1 percent in early June and its president, Mario Draghi, says the onus is on the region’s governments to act to boost confidence in a region with a slumping economy.

Still, many economists expect the ECB to cut borrowing costs in the coming months, and rate setter Ewald Nowotny has said the central bank has the ability to ease policy if the economy continues to weaken.

“If necessary, unconventional measures should be used. This means giving consideration to non-standard measures, such as the re-activation of the SMP, additional LTROs with suitable collateral requirements, or the introduction of some form of quantitative easing,” the report said, referring to its programs of bond buying and longer-term loans. ($1 = 0.7933 euros)

Reporting by John O'Donnell; editing by Rex Merrifield

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