Crisis of confidence

Five years after the beginning of the global financial crisis, the world economy is nowhere near recovery, according to the International Monetary Fund. Instead, things have only gotten worse due to politicians' failure to agree on an action plan, fueling market fears about default risks in Europe and the US.

"Financial stability risks have increased substantially, reversing some of the progress that had been made over the previous three years," said the head of the IMF's monetary and capital markets department, Jose Vinals, as he presented the latest Global Financial Stability Report in Washington on Wednesday. "So we are back in the danger zone."

This summer the US skirted perilously close to default during a standoff between Congress and President Barack Obama over deficit spending. Meanwhile, doubts are mounting that Europe will be able to save debt-saddled Greece, and investors are questioning the creditworthiness of Italy and Spain.

"Policymakers on both sides of the Atlantic have not yet commanded broad political support for the needed policy actions," Vinals said, "so markets have begun to question their resolve."

The world has entered "a new, political phase of the crisis," Vinals said, "a crisis of confidence … being driven by three factors - weak growth, weak balance sheets and weak politics."

Lost momentum

Vinals said the current economic recovery observed in the US and Europe is losing steam and becoming "increasingly fragile"

In its report, the IMF urged eurozone authorities to expand the scope of the European Financial Stability Facility (EFSF), originally designed to bail out countries, to provide cash-strapped banks with aid directly.

The EFSF was launched in May 2010 to stabilize eurozone members that ran into trouble. In July eurozone leaders agreed to allow it to recapitalize banks indirectly by issuing loans to governments. That plan needs to be ratified by the common currency union's 17 national parliaments, but thus far only France, Belgium, Italy and Luxembourg have done so.

"Some banks may need to do very little, but others - especially those heavily reliant on wholesale funding and exposed to riskier public debt - may need more capital," Vinals said.

The IMF estimated the eurozone sovereign debt strain has exposed EU banks to risks worth 200 billion euros ($274 billion). The increased pressure on banks could lead them to "curtail credit to the real economy, and thus worsen the economic drag," Vinals said. "Clearly, this must be avoided."

The IMF stressed, however, that the 200-billion-euro figure shouldn't be seen as a hard measure of capital shortfalls, but instead as a measure of how risk exposure had increased.

Author: Rolf Wenkel, Washington / hf
Editor: Sam Edmonds