In its latest report on financial stability released today, the IMF, which is also currently meeting to find a solution to globalization that benefits all people not just the very top, warned that risks to financial stability are growing. It warned about what it calls "medium-term" dangers in both emerging and developed economies, and expressed particular concerns about Europe, Japan and China.
As cited by the BBC the report says investors were taken by surprise by the result of the British referendum on the European Union, but the political shock was absorbed by markets. They passed what it calls "this severe stress test". But looking further ahead, the IMF sees growing risks. A key factor for future bank health is profits or lack thereof. As Deutsche Bank has found out the hard way in recent weeks, weak profitability makes it harder for banks to build up their capital - which they can do by holding on to some profit rather than giving it all to shareholders as dividends. It also makes it harder for them to expand lending to business and consumers, as is needed to support economic recovery.
The IMF, which elsewhere has been pushing for more QE, blamed low interest rates borne by central bank policies, for the lack of profitability. The struggle to make profits also reflects the persistent economic weakness in the developed world, which means weaker demand for credit.
The IMF also turned attention to Europe's trillion+ NPL problem noting that "some banks in the eurozone have a burden of problem loans, which are not being repaid and that they have still not dealt with. The report identifies Italian and Portuguese banks as facing serious challenges of profitability and capital levels.
Persistent low interest rates, sluggish capital markets activity, higher capital requirements and legacy nonperforming loans have strained profits for banks in the developed world. The firms need to reduce bad debt stocks and undertake structural reforms to improve profitability, the IMF said.
it gets worse: as Bloomberg adds, the global economic recovery would still leave about a quarter of banks in developed countries too weak to support further growth and susceptible to future shocks. This means that banks controlling about $12 trillion of assets would remain vulnerable during a rosy economic environment marked by faster economic activity, rising interest rates and declining defaults.
From the IMF:
Weak profitability could erode banks’ buffers over time and undermine their ability to support growth. Over 25 percent of banks in advanced economies (about $11.7 trillion in assets) would remain weak and face significant structural challenges. More deep-rooted reforms and systemic management are needed, especially for European banks. Japanese banks also face significant business model challenges. These banks are expanding abroad to offset thin margins and weak domestic demand, but this exposes them to greater dollar funding risks. A disruption of dollar funding sources could force Japanese banks to curtail their offshore lending and investment.
The solvency of many life insurance companies and pension funds is threatened by a prolonged period of low interest rates. Low interest rates add to the legacy challenges facing many insurance companies and pension funds, along with those from aging populations and low or volatile asset returns. Heightened concern over these important long-term-saving and investment institutions could encourage even greater saving, adding to financial and economic stagnation pressures.
So what is the IMF's suggestion? Why change the rules of course.
According to the report, governments can help with legal changes to make it easier for banks to get rid of bad loans, adding that in the euro zone alone, the effect on bank capital would be to swing from a loss of 80 billion euros ($89 billion) to a gain of 60 billion euros, the IMF estimated. Italian and Greek banks would be the biggest beneficiaries of such changes, the report said, adding that recent steps taken by the Italian government to implement such reductions might not be enough, according to the report.
And all it would take is a change in the rules which somehow will boost bank profitability?
“This will require adjusting dated business models in order to maintain profitability, and adapting to new business realities and regulatory standards."
As BBC adds, there is also a warning about Japanese banks and their expansion overseas, which the report says is the result of economic weakness and very low interest rates in their home market. That leaves them exposed to some risk in terms of access to the foreign currency funds they need to maintain that business.
Outside the rich countries, China is seen as a potential trouble spot. The report says that rapid credit growth and the expansion of "shadow banking" (lending done by firms that are not banks) "pose mounting risks to stability".
The rapidly growing financial system in China is becoming increasingly "interconnected", the report says. The extent to which firms in the sector are interconnected - that is, have transactions with one another - was identified as a key factor in the financial contagion that was a feature of the international financial crisis.
The IMF's recommended medicine for these mounting risks is partly about generating a stronger economic recovery, including reforms to underpin growth. There are also calls for more specific financial steps, such as making it easier for banks to tackle problem loans and the banks themselves tackling high costs.
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There was some good news: the IMF noted that banks are in some respects stronger than they were before the financial crisis. They have more capital, a kind of financial buffer that enables them to survive losses. Their liquidity has improved, which means they have more chance of coping if they suddenly have to find funds quickly.
On a more positive note, the fund does say that short-term risks have abated since its previous assessment of global financial stability in April. Pressures on emerging markets have eased, the report says. Rising commodity prices (though they are still relatively low) have helped and so has the reduced uncertainty about China's prospects in the near term.
However, no matter where the banks are located, they are all struggling to make money the report concluded.