The International Monetary Fund’s latest Global Financial Stability Report (GFSR) predicts additional trillions of dollars in bank losses and warns that there is still a significant risk of another economic downturn. In addition, massive public deficits may crowd out private borrowers, increasing the difficulty of financial institutions to raise needed capital.
José Viňals, Director of the IMF’s Monetary and Capital Markets Department stated that “If we fail to meet the challenges still being faced by the financial system in the present crisis, we risk reigniting systemic risks and even derailing the economic recovery now in train. As you know, that is something we simply cannot afford”.
A gradual reopening of capital and funding markets to banks and a recovery in their earnings are signs that banking systems have stepped back from the brink of collapse.
For both banks and other financial institutions, the GFSR calculates that actual and potential writedowns from bad assets such as loans and securities have fallen by some $600 billion over the past six months—from about $4 trillion to $3.4 trillion, as a lessening in financial stress has narrowed spreads.
Nevertheless, banks still confront substantial challenges. The GFSR estimates that commercial banks have already recognized $1.3 trillion through the first half of 2009, but face another $1.5 trillion of potential asset writedowns ahead. Hence, overall, banks have recognized slightly less than half of their expected losses. U.S. banks have recognized slightly more than have those in the United Kingdom and euro area.
Even though bank earnings are recovering, they are not expected to be big enough to offset fully the anticipated writedowns over the next 18 months.
The GFSR suggests that although their balance sheets have been stabilized, some of it because governments have injected capital, banks are not yet in a strong position to lend support to the economic recovery.
The banking system was brought back from the brink of disaster by trillions of dollars in government loans and guaranties, effectively transferring losses from private to public balance sheets. This “cure” may be worse than the disease as massive public borrowing weakens national balance sheets and crowds out private borrowings that are essential to an economic recovery. Some may see signs of an incipient economic recovery but it is likely to be constrained as both financial institutions and governments struggle to rebuild weak balance sheets. The massive borrowings by governments to bail out the financial system will be a dead weight on economic recovery for decades to come.