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Banks safer, but not strong enough to provide ample credit

Published:Friday | October 10, 2014 | 12:00 AM
The International Monetary Fund headquarters building in Washington where the 2014 meetings got under way on Monday. File

McPherse Thompson, Assistant Editor - Business

WASHINGTON, DC: Banks globally are much safer now, more than six years after the start of the financial crisis, but they do not have the muscle to provide enough credit to vigorously support the economic recovery, according to the findings of a report released on Wednesday.

This means that having stabilised their balance sheets, the financial institutions now face a new challenge and need to adapt their business models to the post-crisis market realities and new regulatory environment, said Financial Coun-sellor José Vidals.

"When banks are receiving a clean bill of health in terms of capital adequacy, it means that they are safe enough to lead a normal life," he said. "In many countries we need banks to be the athletes, who can vigorously support the recovery."

Vidals was addressing a press conference to launch the October 2014 edition of the Global Financial Stability Report, ahead of the annual meetings of the International Monetary Fund and World Bank Group.

He said the report analysed 300 large banks in advanced economies and found that those with almost 40 per cent of total assets were not strong enough to supply adequate credit in support of the recovery. In the Eurozone, the proportion rose to about 70 per cent.

He suggested that those banks would need a fundamental overhaul of their business models, including, among other considerations, mergers or retrenchment.

Vidals said that while banks grapple with those challenges, capital markets were providing more significant sources of financing, "which is a significant development".

However, he said that was shifting the locus of risks to shadow banks, noting, for example, that credit-focused mutual funds have seen massive asset inflows and have collectively become a very large owner of United States corporate and foreign bonds.

"The problem is that these fund inflows have created an illusion of liquidity in fixed-income markets. The liquidity promised to investors in good times is likely to exceed the available liquidity provided by markets in times of stress, especially as banks have less capacity to make markets," Vidals said.

At the same time, emerging markets have grown in importance as a destination for portfolio investors from advanced economies, he said, noting that they now allocate more than US$4 trillion or about 13 per cent of total investments to emerging market equities and bonds, a share which has doubled over the past decade.

"Together, these factors will amplify the impact of shocks of asset prices, resulting in sharper price falls and more market stress," said Vidals, the IMF's director of capital and monetary markets.

He warned that "such an adverse scenario would hurt the global economy and, at the limit, could even compromise global financial stability. This chain reaction could be triggered by a wide variety of shocks, including geopolitical flare-ups and a bumpy normalisation of US monetary policy".

To safeguard stability and strengthen the recovery, Vidals said, policymakers need to address the new global imbalance between financial and economic risk-taking through structural reforms, smart fiscal policies and financial policies in addition to monetary policy.

Vidals said economic risk-taking would benefit from an improved flow of bank credit to the economy, and that bank supervisors needed to facilitate the structural transformation, which would allow banks to improve their profitability without excessive risks and support the economy through lending.