A day after the IMF warned that the world is facing a dramatic economic slowdown cliff, it follows up by pulling off the scab on a festering European wound, with Reuters reporting that according to the IMF, "Europe's debt crisis has increased the risk exposure of banks in the region by 300 billion euros and they need to recapitalize to ensure they can weather potential losses. In its Global Financial Stability Report, the IMF said it sought to "approximate the increase in sovereign credit risk experienced by banks over the past two years." Earlier this month, IMF Managing Director Christine Lagarde drew fire from European officials when she called for a mandatory recapitalization of Europe's banks. News reports last month said the IMF had identified a 200 billion euro shortfall in European bank capital, but officials in Europe insisted the figure was off the mark and the capital position of most banks in the region was solid." So what does the IMF do to address protests by the IMF that it was overestimating undercapitalization? It hikes them by 50%! Yet even so it is still €700 billion short of Goldman's estimate for a €1 trillion hole in Europe. Also, assuming European banks had three peaceful years in which to recapitalize at much higher valuations, it is safe to say they will absolutely not do it now, when the market has basically locked them out. And needless to say, when Greece defaults all these shortfall numbers will have to be revised.... by a factor of 10x... higher.
European officials stood by bank stress tests they conducted in July that found only eight banks deficient in capital with a combined shortfall of only 2.5 billion euros, a figure widely criticized as too low and politically skewed.
The IMF's report on Wednesday made clear the 200 billion figure was not a hard measure of a capital shortfall.
Instead, it measured how risk exposure had increased as sovereign debt prices had fallen. It said a further 100 billion euro increase in exposure was related to a recent decline in bank asset prices and rise in bank funding costs.
The report said banks should raise capital privately although public funds may be necessary for viable banks. Lagarde had said Europe might need to consider tapping its sovereign debt bailout fund to bolster banks.
The IMF said the damage could spread from Europe to banks in emerging market economies.
For the first time, it estimated emerging market bank balance sheets could be reduced by up to 6 percentage points if the pace of global growth fell sharply on the back of Europe's troubles and forced a sudden reversal in capital flows.
The IMF said banks in Latin America were most vulnerable, while banks in Asia and eastern Europe were more sensitive to increases in funding costs.
"Risks are elevated and time is running out to tackle vulnerabilities that threaten the global financial system and the ongoing economic recovery," the report said.
The IMF called for a "coherent" strategy to address the risk of financial and economic spillovers from the European debt crisis, which has forced Greece, Portugal and Ireland to turn to the European Union and IMF for rescue loans.
We will bring you the full paperweight report once released. We are confident it will have many pretty charts in it.