Pressure on the banking sector has intensified, increasing the likelihood for a “grim scenario”, according to the Global Financial Stability Report published by the International Monetary Fund.
The worsening outlook has increased the risk of shrinking credit, slow growth and weakening balance sheets. Existing sovereign debt sustainability challenges, combined with concentrated short-term debt rollovers and an undiversified investor base, has put further pressure on some governments and banks in some eurozone countries.
“The forceful response at the national and supranational level to address sovereign risks and strengthen confidence in the financial system, including in particular through the provision of detailed information on bank balance sheets, helped to stabilize funding markets and mitigate risks,” the report says.
However, it warns conditions remain “fragile” and that the global financial system is still in a period of significant uncertainty, which is hampering the economic recovery.
Overall, conditions have weakened since the Global Financial Stability Report was published in April. The recovery is expected to continue, but the recent turmoil in sovereign debt markets in Europe has once again highlighted increased vulnerabilities of bank and sovereign balance sheets arising from the crisis.
The global financial system still needs to deal with the legacy problems in the banking sector, including, where necessary, recapitalisation, says the IMF, while the fundamentals of sovereign balance sheets need to strengthen and regulation requires clear reforms, building on the improvements proposed by the Basel Committee on Banking Supervision.