The IMF has warned that unless the eurozone resolves its capital crisis, European banks’ balance sheets will contract severely, further damaging growth and pushing unemployment beyond its already record highs in the region.
In its global financial stability report, the IMF concluded that capital flight from the eurozone’s periphery to the bloc’s core, driven by fears of a break-up of the currency union, had sparked “extreme fragmentation” of the euro area’s funding markets. The IMF said this was causing renewed pressure for banks to shrink their balance sheets, particularly those in countries with fiscal woes.
Delays in resolving the crisis meant that unless eurozone officials beefed up their policy response, European banks would dump $2.8tn worth of assets – more than 7 per cent of their balance sheets – by the end of next year. Banks in the periphery would shed just short of 10 per cent of their assets.
The deleveraging would weigh on growth and add more than 2 percentage points to unemployment. Businesses would suffer as bond markets proved unable to plug the gap left by banks.
“The expected amount of bank deleveraging is now higher [than forecast in April] because of lower expected earnings, higher losses linked to worsening economic conditions, and greater funding pressures on banks,” the IMF said. The estimates are based on assumptions about the behaviour of the region’s 58 largest banks.
The IMF said that the European Central Bank’s pledge to buy government debt if countries agreed to reform plans had lowered sovereign bond yields but said that it was too early to tell whether the scheme would relieve deleveraging pressures. “Although many core euro area banks are able to issue debt, and issuance has picked up in recent weeks, broader funding market conditions are still challenging for weaker periphery banks,” the IMF said.
The report said that if there were additional measures “at the national level” alongside the ECB’s actions, banks were likely to offload $2.3tn of assets, or 6 per cent of their balance sheet, by the end of next year.
The additional measures that the IMF recommended included the ability for policy makers to inject capital into banks via the European Financial Stability Facility and European Stability Mechanism, the region’s bailout vehicles. The fund also advised eurozone officials to speed up their response to the crisis.
Testifying at the European parliament in Brussels, Mario Draghi, ECB president, said that capital flight and the financial fragmentation of the 17-member euro area underscored the need for structural reforms. “You can’t have a union when you have certain countries that are permanent creditors and a set of countries that are permanent debtors,” he said.