WASHINGTON (Reuters) - Sovereign debt risk in Europe and continued real estate woes in the United States have dealt a setback to global financial stability in the past six months, the International Monetary Fund said on Tuesday.
The IMF said risks to the financial sector could be reduced if legacy problem assets were cleaned up, if governments improved their fiscal positions and if more clarity were provided on global financial regulation.
“The global financial system is still in a period of significant uncertainty and remains the Achilles’ heel of the economic recovery,” the IMF said in its semi-annual Global Financial Stability Report.
“The recent turmoil in sovereign debt markets in Europe highlighted increased vulnerabilities of bank and sovereign balance sheets arising from the crisis,” the fund said.
Jose Vinals, director of the IMF’s Monetary and Capital Markets Department, said recent volatility in currency markets was not a major concern for global financial stability as long as the changes ”move in the direction of medium-term fundamentals.
“The best way of protecting against any unintended consequences of foreign exchange rate changes on financial balance sheets is to have sound buffers to accommodate whatever changes happen,” he added.
The IMF said it trimmed its estimate of total global bank write-downs related to the financial crisis between 2007 and 2010 to $2.2 trillion from its April estimate of $2.3 trillion, largely on a drop in securities losses. Banks have recognized more than three-quarters of these write-offs, leaving about $550 billion still to be taken.
However, the fund said banks had made less progress in dealing with near-term funding pressures -- nearly $4 trillion of bank debt needs to be refinanced in the next 24 months.
“Overall, bank balance sheets need to be further bolstered to ensure financial stability against funding shocks and to prevent adverse feedback loops with the real economy,” the IMF said.
The forceful policy response to the European debt crisis in April and May of this year helped to offset market and liquidity risks to banks. But the sector’s stability in the region remains vulnerable to potential market shocks, the IMF said.
In the United States, concerns about household balance sheets and real estate markets amid persistently high unemployment are clouding the outlook for loan quality and bank capital needs.
“Although manageable from a financial stability perspective, a double dip in real estate could have a long lasting impact on the economic recovery,” the IMF said.
U.S. banks have had to raise modest amounts of capital, but this largely reflects the shifting of much of the mortgage risks and losses onto Fannie Mae and Freddie Mac, the IMF said. Capital challenges for these government-controlled entities could reactivate a negative global feedback loop between the financial system and the economy.
The fund said it conducted its own “stress test” on the top 40 U.S. banking companies and found that in an adverse scenario where real estate prices fell significantly, these banks would require $13 billion in additional capital to maintain a 4 percent Tier 1 common capital ratio.
“Mid-size banks are particularly vulnerable because it may be more difficult for them to raise capital,” the IMF said.
Vinals said the IMF was not immediately concerned with the risk of asset bubbles in emerging market economies but acknowledged there were “hot spots” that needed monitoring.
Brazil said on Tuesday it would increase its tax on foreign bond purchases to curb a rapid rise in its currency and to protect exporters amid a surge of private capital into the country.
Vinals said the earlier tax imposed by Brazil on equity investments to slow the flow of capital had diverted investments from stocks into bonds but did little to tackle the overall flows.
“I think the jury is still out. We just have to see what happens to assess the effectiveness of these new measures,” he added.
Additional reporting by Lesley Wroughton and Emily Kaiser in Washington; Editing by Neil Stempleman and Padraic Cassidy