The Eurozone debt crisis has had a “direct impact” of €200bn on EU banks in terms of sovereign credit risk, it said.
Links between financial institutions compound these risks – and have led to some entire countries losing access to private capital markets, according to the report.
Two solutions are needed, says the IMF. “Credible fiscal consolidation”, to deal with the sovereign debt problems, and “enhancing the robustness of banks”, to limit the systemic risks to the financial industry and wider economy.
That means banks need to shore up their balance sheets and beef up their capital buffers, which the IMF said should help to break the link between banks and risky government debt.
Fiscal consolidation will clearly impact on the banks: “If a country’s fiscal measures are successful in restoring the long-term sustainability of its public finances, its sovereign risk premium will come down, and this will reduce pressures on banks.” However, banks must help themselves with prudent behaviour and not just hope sovereigns’ positions improve.
In particular, the report singles out banks that rely heavily on the wholesale markets for funding.
“Heightened uncertainties” and “the need to convince markets” of their stability means there banks need larger capital buffers if they are to retain or regain access to the funding they rely on.
The IMF is concerned that Europe’s politicians lack the ability to deal with the crisis, which it says is very much in a “political phase”.