IMF warning: Many European banks on shaky ground

BERLIN

The International Monetary Fund said the weaker tier of Europe's banks are facing pressure on multiple fronts, from thin capital reserves -- which help absorb losses in sudden downturns -- and shaky investments still held on their balance sheets to unstable sources of financing.

The warning comes as European Union officials struggle to shore up confidence in government finances and banks. Greece and Ireland have already needed bailout loans to avoid defaulting on their debts, and Portugal has also asked for help from the EU bailout fund.

"Incomplete policy actions and inadequate reforms of the banking sector have left segments of the global banking system vulnerable to further shocks," the IMF report said. "Many institutions -- particularly weaker European banks -- are caught in a maelstrom of interlinked pressures that are intensifying risks for the system as a whole."

The EU banking regulator is trying to boost confidence in the continent's banks by putting 90 of them -- the bulk of Europe's banking system -- through stress tests that measure what would happen to their finances if the economy took a sudden downturn. A similar exercise last year was deemed to easy, and passed Irish banks that later failed.

The purpose of the tests is to push banks that flunk to ask investors to put up more capital and strengthen their finances, or else cut back risky loans and investment to levels that their capital buffer could handle. Results are expected in June.

The IMF report outlined other problems facing the world's financial system, such as too much household debt in the United States, and emerging economies' problems in handling new inflows of investment without overheating.

Policy makers globally have pushed banks to raise more capital and introduced new safeguards, the IMF said in its twice-yearly report on the stability of the global financial system, but said more needs to be done to guard against a new financial crisis.

The Washington-based international organization especially underlined the interlocking financial problems afflicting the 17 nations that share the 12-year-old euro currency.

Government and bank finances are closely related because European governments, especially Ireland, have incurred heavy expenses bailing out failed banks. In turn, questions about European governments' big deficits and ability to pay are undermining bank holdings of government bonds.

Some banks -- like Italy's Intesa Sanpaolo and Germany's Commerzbank -- have already started strengthening their capital buffers ahead of the stress tests.

But other banks -- especially in Ireland and Greece -- remain addicted to last-resort financing from the European Central Bank because they are unable to raise enough money by borrowing normally. The ECB has so far not come up with a comprehensive way of getting those banks off life support.

Banks in different countries are in trouble in different ways. Greece and Ireland are suffering after their governments needed to be bailed out to avoid defaulting on their bonds, which would have dealt another blow to the banking system since many banks hold the bonds.

Spain's cajas, or savings banks, lost heavily in the collapse of the country's real estate boom, while some German banks are regarded as thinly capitalized.

Some of Germany's regional banks -- or Landesbanken -- rely heavily on a type of capital that won't be counted during the European stress tests, raising the possibility they might fail.

Those banks are scrambling to exchange the capital in question in question -- nonvoting holdings put up by local governments or savings banks as capital -- into a capital backstop that would be allowed by the European Banking Authority. It's not clear whether they can accomplish that before the tests.

The IMF said entire swathes of the European banking system are cut off from normal financial financing now, relying on short-term borrowing from the ECB and the repo market, a source of short-term credit that can dry up rapidly in times of trouble.

"A number of banks in Europe -- including nearly all banks in Greece, Ireland, Portugal, many of the small and mid-size Spanish cajas, and some German Landesbanken -- have lost cost-effective access to term-funding markets," the report says.

The bank cited too much debt all around as a problem -- indebted households with less to spend and indebted governments whose now-shaky bonds sit on the balance sheet of banks and threaten to undermine them in case they fall in value or default.