European banks still pose global risks

By Darrell Delamaide

Opinion: IMF joins critics urging EU to act to force balance-sheet repairs MarketWatch Nonperforming loans at euro-area banks are a threat to global financial stability. WASHINGTON (MarketWatch) — The ship is scraping bottom as it sails through uncharted waters. What are the chances it will founder? This a picture that could fit European banks, according to the description given this week by top officials at the International Monetary Fund. The stressed condition of many euro area banks, due in large part to lingering and unresolved levels of corporate debt, poses a serious threat to the world financial system, the IMF said in its annual Global Financial Stability Report. “Further efforts need to be made in Europe to strengthen bank balance sheets, through the European comprehensive bank assessment exercise and its follow-up,” said José Viñals, head of the agency’s Monetary and Capital Markets Department. “Also it is very important to tackle the corporate debt overhang.” Read more from the IMF’s report. Other threats to global financial stability, the IMF official said, are posed by the U.S. exit from easy liquidity, an economic slowdown in China, disruption in emerging markets, and in light of recent events in Ukraine, geopolitical risks. But the situation with European banks presents an especially tricky challenge to policy makers. The large and growing amount of non-performing loans is weighing down the banks, the IMF said, limiting their profitability and ability to provide credit. The challenge is to clean up balance sheets across the board without alarming markets. “It is not enough to fix the banks,” Viñals said. “Policy makers also need to finish the job of repairing corporates.” The IMF is not alone in worrying about Europe’s banks. Former U.K. Chancellor of the Exchequer Alistair Darling said at a panel discussion at the IMF spring conference that while the U.S. and U.K. have largely cleaned up their banks, it is “still a work in progress” in Europe. Darling criticized the European Union’s proposed rescue fund for banks as totally inadequate at only 55 billion euros /quotes/zigman/4867933/realtime/sampled EURUSD +0.00%  . “In my experience, 50 [billion] doesn’t even save you one bank.” Because banks remain interconnected, the failure of one could pose a risk to the whole system. “This is a real, real problem,” Darling said. “This may be the last chance to sort it out.” Citigroup’s /quotes/zigman/5065548/delayed/quotes/nls/c C -0.02%  chief economist, Willem Buiter, also warned about the risk posed by the banks in Europe as well as by sovereign debt in the periphery. “Europe is simply too confident,” Buiter said during the same panel discussion. “Risks are being grossly underestimated.” The fact that markets seem to be buying the official hype about European recovery and solvency doesn’t faze this economist. “Markets are in denial,” he said dismissively. They may be powerful, but recent experience has shown they are “not wise,” Buiter said. “Investors are still sniffing the glue provided by Mario Draghi,” Buiter said, referring to the president of the European Central Bank and his pledge to do whatever it takes to preserve the euro. Anecdotal evidence seems to support this critical view. Financial Times reporter Sarah Gordon this week cited the example of the Spanish construction firm FCC /quotes/zigman/249334/realtime ES:FCC -1.70%  , which remains buried under a legacy of debt that is symptomatic of much of European industry in spite of improving business. IMF’s Viñal attached considerable importance to the EU’s impending stress test for banks and an appropriate follow-up to repair their balance sheets. The U.K.’s Darling said that estimates for closing the gaps in bank capital revealed by the stress tests range up to 700 billion euros. As the IMF stability report put it: “Although market sentiment regarding stressed euro-area banks and sovereigns has improved markedly, it may be running ahead of the necessary balance-sheet repair. Thus, European policy makers must push ahead with a rigorous and transparent assessment of the current health of the banking system, followed by a determined cleansing of balance sheets and the removal of banks that are no longer viable.” While European authorities have pledged to make this new stress test tougher than before, it is a tall order, given the timidity of both the European Commission and the ECB in addressing these issues so far.

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