Global Bank Losses of $4.1 Trillion, Says Imf

The global financial sector faces writedowns of $4.1 trillion from the toxic assets that have crashed in value since the start of the credit crunch 20 months ago, the International Monetary Fund said today .

In its first comprehensive study of the impact of the crisis on banks and other financial institutions, the Fund said that it had increased its estimate of the potential losses in the US from $2.2tn to $2.7tn as a result of the deepening economic slump over the past three months. Europe and Japan between them account for $1.3tn of the writedowns, with UK banks facing losses of $316bn.

The Fund warned that the damage to the balance sheets of institutions would take years to remedy and would lead to a credit famine in Britain, the US and Europe.

In addition, it said the open-ended taxpayer bailouts provided to the crippled financial sector in recent months risked adding to the debt burdens of western countries already facing a demographic time bomb.

"The global financial system remains under severe stress as the crisis broadens to include households, corporations, and the banking sectors in both advanced and emerging market countries", the IMF said in its half-yearly Financial Stability Report. It called for the redesign of the global financial system to provide a "more stable and resilient platform for sustained economic growth."

Although the Fund said government support packages were helping to stabilize the financial system, it added that further decisive, effective and internationally co-ordinated actions would be needed to sustain the improvement.

"Shrinking economic activity has put further pressure on banks' balance sheets as asset values continue to downgrade, threatening their capital adequacy and further discouraging fresh lending," the report said. "Thus, credit growth is slowing, and even turning negative, adding even more downward pressure on economic activity."

It added that even if policy actions were swift and worked as planned, recovery for the financial sector would be long and painful and economic recovery would be protracted. "The accompanying de-leveraging and economic contraction are estimated to cause credit growth in the US, the United Kingdom, and euro area to contract and even turn negative in the near term and only recover after a number of years."

The IMF said the key challenge was to break the "downward spiral" between a weakened financial system and the global economy. It set out a detailed program of reforms – including curbs on credit growth during booms, tougher regulation of a limited number of institutions considered "too big to fail" and better cross-border supervision.

Lending between banks came to a halt in August 2007 when the financial markets first became aware of the impact of losses in the US sub-prime mortgage market, but the IMF said there had been some signs of improvement in the interbank markets since the intervention of governments to prevent a global financial meltdown last October.

It added, however, that funding strains had persisted and banks, despite being bailed out by the taxpayer, were still short of capital. "As a result, many corporations are unable to obtain bank-supplied working capital and some are having difficulty raising longer-term debt, except at much more elevated yields."

In its breakdown of the losses on toxic assets, the IMF said two-thirds of the writedowns affected banks. But the FSR warned that pension funds and insurance companies had also been hit hard by the crisis. Pension funds had seen the value of their assets tumble and life insurance companies had suffered losses on equity and corporate bond holdings, in some cases depleting their regulatory capital surpluses.

"While perhaps most of these institutions managed their risks prudently, some took on more risk without fully appreciating that potential stressful episodes may lie ahead."