Time to Fix Causes of Financial Crisis, Says IMF

Global financial stability improving, but risks remain

Advanced economies need to tackle high debt and weak balance sheets

Emerging markets need to guard against overheating and financial imbalances

Policymakers have to strike the right balance and shift their focus away from policies that were put in place to treat the symptoms of the crisis toward measures that will treat the underlying causes. The challenge will be to repair the banking system and deal with high debt levels without jeopardizing financial stability and the nascent global economic recovery.

“The legacy of high debt burdens is weighing on economic activity and balance sheets, keeping risks to financial stability elevated,” said José Viñals, Financial Counsellor and head of the IMF’s Monetary and Capital Markets Department.

The latest Global Financial Stability Report gives policymakers a roadmap to focus their work on several fronts.

• Reduce high government debt burdens and strengthen balance sheets

• Clean banks’ balance sheets by resolving bad assets and increasing capital

• Write down distressed mortgage loans and reduce principal on mortgages that could benefit from modification

• Guard against overheating and the buildup of financial imbalances in emerging economies

The two-speed economic recovery—with advanced economies slowly gaining strength while emerging economies risk overheating—means governments face different challenges.

Unfinished business

High debt levels and excessive leverage, which is money borrowed to finance investments, are evident in a number of advanced economies—including among (i) banks lacking adequate capital to absorb losses and poor-quality assets, (ii) governments facing debt sustainability problems, and (iii) households whose houses are worth less than their mortgages.

Nearly four years after the start of the global crisis, confidence in the banking system has yet to be fully restored. Despite improvements to balance sheets, some banks—particularly in Europe—remain insufficiently capitalized, and subject to rising funding costs. To deal with these problems, a comprehensive set of policies is needed, including

• Increased transparency through more credible, rigorous stress tests

• Higher capital buffers

• Concrete plans to restructure or resolve failing banks, where necessary.

Government balance sheets also remain under strain in several advanced economies. Certain countries in Europe are especially at risk, as financial market...