More than a quarter of banks in advanced economies (with total assets of nearly $12 trillion) remain in a weakened state, despite the recovery of the global economy in recent months, and are vulnerable to continuing economic risk, experts of the International monetary Fund.
Low inflation and interest rates, weak activity in capital markets, increased capital requirements, the excess volume of non-performing loans and other problems and risks led to a serious fall in the profitability of banks. As stated in the report “global financial stability”, published on 5 October, despite the decline in risks in the short term, increasing medium-term risks that inhibit the increase of profitability (low margin over time can reduce the reserves of banks and undermine their ability to sustain growth), and increase the risk of a gradual slide into economic and financial stagnation.
IMF urges financial sector as soon as possible to solve the problem of low profitability due to structural reforms and stressed the need to adapt it to the era characterized by low growth and low interest rates, and to changes in market and regulatory environment. The organization also calls on the authorities to take measures to strengthen market confidence and intensify growth in the world economy as “negative rates are approaching the limits of its effectiveness, and side effects of low interest rates increase in respect of banks and other financial institutions in the medium term,” and warns that the financial stagnation can lead to a drop in global production at around 3% until the end of 2021.
The economic recovery will not help
As explained in the report from April (when the April issue of the report) had eased short-term risks to global financial stability. In particular, prices for commodities rose from their minimum values at the beginning of the year and the ongoing adjustment in emerging market countries contributed to the restoration of capital flows. Problems associated with slower growth in China, lost sharpness on the background of measures to stimulate economic growth. Europe, in turn, took measures to mitigate the monetary policy that has supported asset prices and caused some recovery of risk appetite, and gradually adapted to Brexit. In emerging markets due to the moderate recovery in prices for raw materials and improvements in external conditions (lower interest rates and increase in investment opportunities), increased movement of capital. The IMF, in particular, have improved the Outlook for Russia and Brazil.
But, despite this, increasing medium-term risks. In particular, due to the continuing slowdown in the global economy financial markets are forecasting low inflation and low interest rates for a long time, and the migration of the normalization of monetary policy at an even later date. In many countries, [which, the IMF does not specify] is plagued by political instability: a strengthening of social inequality and lack of income growth “opened the door to populist policies with a focus on isolation”.
The IMF stresses that these risks complicate the solving of the crisis problems, make the markets more vulnerable to shocks, and increase the risk of a gradual slide into economic and financial stagnation. In such circumstances, financial institutions difficult to maintain balances in the normal state. The cyclical recovery of the economy though, and helps address the problem of low profitability, but it is not fully able, according to experts of the organization.
Risk of a quarter of banks
The IMF reviewed the state more than 280 banks, representing more than 70% of the entire banking system of the United States and Europe. According to the organization, more than 30% of European banks with total assets of $8.5 trillion and 25% of U.S. banks with assets of $3.2 trillion, even if economic recovery remains weak and will not be able to receive a steady income. Low profitability may, over time, reduce the reserves of banks and weaken their ability to support growth.
C risk caused by slower growth and low interest rates, also face pension funds and insurance companies. These risks threaten their solvency on a par with the problems associated with population aging and low yield assets. “The increased concern regarding these organizations working with long-term savings and investment, could provoke even greater savings and thereby enhance the effect of the financial and economic stagnation,” analysts fear the IMF.
That suggests the IMF
According to experts the IMF, banks must adapt to the conditions of slow growth and low interest rates due to the reduction of large amounts of inherited bad loans and optimization of balances and sectoral structures. “This will require adjustments to outdated business models to maintain profitability and adapt to the new realities of work and regulatory requirements,” the report says.
In some cases, the weak banks will have to stop working, and banking systems to reduce their scope, experts of the IMF. According to them, it is necessary that the remaining banks had sufficient loan demand to ensure a dynamic and robust banking system that will be able to build and maintain their increased reserves
of capital and liquidity.
The authorities can help banks to reduce the volume of bad debts, bringing the end of the reform of financial regulation without a significant increase in the total capital requirements while sustaining a stable level of capital. “Financial markets benefited from the recovery of the propensity to risk taking as a result of unprecedented measures taken by Central banks. Although to sustain a recovery still requires accommodative monetary policy, a more comprehensive package of economic policy measures would ease the growing burden on Central banks,” the IMF experts said. The main beneficiaries of such measures will be of Greek and Italian banks, the report noted.
In the Eurozone, in particular, the IMF considers it necessary to reduce the excess of bad loans and to eliminate insufficient capital to weak banks. “The sale of problem loans as a result of such reforms will lead to the fact that the net impact on the cost of capital will change with the loss of
the amount of around €80 billion on growth in €60 billion,” the report reads. The IMF also believes that the optimization of the Federal networks of banks could reduce their costs by approximately $40 billion.
To strengthen the balance sheets of insurers and pension funds, the IMF calls on the Supervisory authorities, in particular, to determine the risks of insolvency and funding gaps in the medium term and at the same time to strengthen a program of reforms to strengthen standards on internal models and
the basics of capital and increasing transparency.