IMF sees European banks facing $4.5 trillion sell-off

The International Monetary Fund said European banks may need to sell as much as $4.5 trillion in assets through 2013 if policy makers fall short of pledges to stem the fiscal crisis, up 18 percent from its April estimate.

Failure to implement fiscal tightening or set up a single supervisory system in the timing agreed could force 58 European Union banks from UniCredit SpA to Deutsche Bank AG to shrink assets, the IMF wrote in its Global Financial Stability Report released today. That would hurt credit and crimp growth by 4 percentage points next year in Greece, Cyprus, Ireland, Italy, Portugal and Spain, Europe?s periphery.

?There is definitely a need for deleveraging in Europe,? said Michael Seufert, an analyst at Norddeutsche Landesbank in Hanover, Germany, with a ?negative? rating on the European banking sector. ?The danger is that this produced a downward spiral as the regulation gets stricter and stricter and the global economy cools, potentially meaning more writedowns for banks. States in the periphery are hit hardest.?

Asian stocks fell for a third day today on global growth concerns, with the MSCI Asia Pacific Index down 0.9 percent. The Stoxx Europe 600 Index declined 0.3 percent at 1:27 a.m. in Frankfurt and the euro was down 0.1 percent, trading at $1.2876.

?Credible Conditionality?

The Washington-based IMF earlier this week cut its global growth forecasts and warned of even slower expansion if European officials don?t address threats to their economies. While the European Central Bank?s plan to purchase bonds of debt-burdened countries has pushed down bond yield, officials are waiting for a bailout request from Spain before putting the program into action.

The European rescue mechanism and the ECB bond program ?must be regarded by markets as real, not ?virtual? and should be coupled with credible conditionality,? Jose Vinals, the director of the IMF?s monetary and capital markets department, said in prepared remarks for a press conference in Tokyo today.

ECB President Mario Draghi in July pledged to do ?whatever it takes? to preserve the monetary union, which has been battered by a three-year debt crisis triggered by Greece?s hidden budget shortfall. He said in September that the Frankfurt-based bank may buy the bonds of nations that submit to the conditions of a rescue loan to lower yields.

?QE-Type? Program

Jose Manuel Gonzalez-Paramo, a former ECB Executive Board member, said in an interview in Madrid that the central bank could offer more long-term loans such as the three-year operations it introduced last year or ease collateral rules to feed more liquidity into the European economy. There?s ?nothing that prevents the ECB from executing some QE-type? program, he said, referring to quantitative easing.

Still, Germany?s Bundesbank openly opposes Draghi?s plan to buy bonds on the secondary market, saying it comes too close to financing governments. ECB council member Jens Weidmann said in a speech in Frankfurt today that central banks ?have to remain independent and they have to have a mandate that puts the goal of stable money ahead of all others.?

Since Draghi?s pledge, the yield on Spain?s 10-year bond has fallen from above 7.6 percent to 5.8 percent today. Prime Minister Mariano Rajoy, who meets his French counterpart Francois Holland in Paris today, has said he is still weighing up whether his country needs a bailout since the ECB?s safety net has already offered investors some reassurance and lowered borrowing costs.

Economic Slump

Still, governments may find it more difficult to plug their budget gaps as the euro-region economy shows signs of a deepening slump. Euro-area services and manufacturing industries contracted in September and economic confidence dropped. Unemployment held at 11.4 percent in August, a record.

In France, industrial production unexpectedly increased in August, rising 1.5 percent from the previous month, when it advanced 0.6 percent, French statistics office Insee in Paris said today. Italian output also increased, rising 1.7 percent in August from July, a separate report showed.

The IMF said that ?both Spain and Italy have suffered large-scale capital outflows? in the 12 months through June, with $296 billion and $235 billion, respectively.

?Unless confidence in the euro area is restored, fragmentation forces are likely to intensify bank deleveraging, restrict lending, add to the economic woes of the periphery, and spill over to the core,? the IMF said.

Baseline Scenario

In April, the IMF forecast asset sales of $3.8 trillion in a ?weak policies scenario.? Since then, policy makers? delay in taking decisions to solve the crisis worsened funding pressures while the relief provided by the ECB?s program of unlimited three-year loans faded.

Under a baseline scenario that has governments follow up on their commitments, the IMF sees a reduction in bank assets of $2.8 trillion, compared with $2.6 trillion in April.

?Intensification of the crisis has manifested itself in capital outflows from the periphery to the core at a pace typically associated with currency crises or sudden stops,? the IMF said. ?Restoring confidence among private investors is paramount for the stabilization of the euro area.?

Bank deleveraging is being driven by five main factors, the IMF said. The impact of weaker earnings and higher asset impairments on capital level funding pressures from frozen interbank markets and declining deposits, growing trend for banks to match loan and deposit levels in some subsidiaries, pressure to increase domestic government bond holdings at the expense other assets as well as rising sovereign debt spreads.

$600 Billion

So far, the IMF estimates that deleveraging among sample banks has reached more than $600 billion in the year through June. Progress has been most pronounced among U.K. banks, which have cut non-core business, French banks, which have reduced U.S. dollar-denominated assets including structured products and Dutch banks, which have sold subsidiaries in the Americas, the IMF said. Efforts to raise capital cushions have helped strengthen balance sheets and prevent larger asset sales, it said.

Looking at other countries, the report stressed that the U.S. and Japan also face risks to financial stability.

?The present difficulties in the euro area provide a cautionary tale for Japan, given the latter?s high public debt load and interdependence between banks and the sovereign that is expected to deepen over the medium term,? the IMF said.

Australia, South Korea

While emerging markets have managed to weather global shocks so far, the IMF said many countries in central and eastern Europe are vulnerable to the European turmoil, while Asia and Latin America seem more resilient.

In Asian economic releases today, South Korea said its workforce expanded last month, with the unemployment rate unchanged from August at 3.1 percent. A report on Australian consumer confidence for October showed sentiment climbed.

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