IMF estimates crisis losses at $1.4 trillion

In its latest Global Financial Stability Report, the IMF sets out what it sees as the root causes of the deterioration in the global financial system in recent months, as well as prescribing a number of measures to address structural weaknesses. Recommendations include comprehensive intervention by authorities to support financial markets, and a need for banks to hold considerably more capital during good times.

The IMF said the turning point in the US housing market default cycle had not yet been reached, causing it to revise its loss forecast. Furthermore, the report noted the situation had worsened due to an increasingly disorderly deleveraging process at financial institutions, tightening of monetary and financial conditions, reduced risk appetite and increasing credit, market, liquidity and emerging market risks.

Dominique Strauss-Kahn, the managing director of the IMF, urged national authorities to take collective action to solve the global credit crisis. “The time for piecemeal solutions is over. I therefore call on policymakers to urgently address the crisis at a national level with comprehensive measures to restore confidence in the financial sector,” said Strauss-Kahn. “At the same time, national governments must closely coordinate these efforts to bring about a return to stability in the international financial system.”

Despite extensive efforts by banks to shore up capital bases in the past year, the IMF estimates $675 billion will be needed by major global institutions over the next several years. “Most market participants, rating agencies and regulators agree that capital buffers will need to be higher than previously thought,” the report claimed.

The IMF suggested any regulatory requirement for banks to have higher capital ratios should be phased in so that it does not exacerbate the current downturn. Nevertheless, the report added that “if protection against the full magnitude of the downward cycle is desired, the simulations suggest that building up a capital cushion of some 30-40% above normal levels in good times would be required to absorb the most severe shocks.”

Government authorities should provide further financial assistance to institutions, the fund said, advocating the use of public sector balance sheets to prevent firesale liquidations that threaten to reduce bank capital. One possible means of doing this would be the establishment of government asset management companies (AMCs) to purchase or provide long-term funding for ‘problem assets.’

This recalls the approach several Asian countries - including China, Japan and Korea – took during the Asian financial crisis, when AMCs were set up to acquire (and resolve) huge portfolios of non-performing loans from local banks.

On a related point, the IMF called for greater judgement in the application of mark-to-market accounting rules during stressed periods, which “may avoid accelerating capital needs by reducing the pressure to value securities at low firesale prices.”

Government injections of capital at viable institutions could be justified in the current climate, the IMF said. However, to put in place the conditions for more competitive markets in future, the agency called for the “orderly resolution of non-viable institutions.”

See also: SEC to ease mark-to-market rules
Iosco says regulators should monitor and inspect rating agencies
BIS to modify Basel II rules