The International Momentary Fund has released its April 2011 Global Financial Stability Report, which identifies a modest recovery in advanced economies and a “robust” recovery in emerging economies. Pointing out the global vulnerability to shocks such as oil prices affected by uncertainty in the Middle East & North Africa region, the report provides a reminder that continued improvement in the global economy is reliant on confidence and stability.
In its recommendations, the IMF has suggested that developed economies need to encourage less “lean” and more “clean” in the banking system. A sustainable path to economic recovery should include “stronger bank balances” and moderated debt burdens in the private sector rather than reliance on credit.
Meanwhile, emerging economies are warned to avoid overheating by putting in place strong regulation. It is projected that, by preventing a build-up of vulnerabilities, those nations could side-step the issues which led to recession in advanced economies. Potential bubbles and inflationary pressure are fingered as future problems which governments will need to curb.
The greatest challenge over the next few months, according to the IMF report, is an “orderly deleveraging” of the mechanisms supporting banks and sovereigns, especially in the Euro area. Government interest payments are predicted to rise (under a baseline scenario). These should be manageable as long as deficit reduction plans remain on target, with the exceptions of the US and Japan, who need to do more.
The IMF report suggests that bailing out the banks did not fully resolve the global financial crisis and that some smaller banks will still need to be “resolved” before balance sheets return to healthy levels and confidence is fully restored:
Overall, despite the transfer of risks from the private to the public sector during the crisis, confidence in the banking systems of many advanced economies has not been restored and continues to interact adversely with the sovereign risks in the euro area… in order to restore market confidence and reduce excessive reliance on central bank funding, considerable further strengthening of euro area bank balance sheets will be needed.
The IMF suggests four key policies to avoid allowing short-term funding difficulties to escalate into another “systemic liquidity event”:
- enhance transparency (including through more rigorous and realistic stress tests)
- close weak institutions
The IMF is also encouraging a “back to basics” mortgage culture which ensure much safer loan arrangements and more transparent mortgage contracts.