By Peter OBIORA InvestAdvocate
Lagos (INVESTADVOCATE)-The Executive Board of the International Monetary Fund (IMF) has endorsed stress tests for Euro Zone Banks to assess the potential capital needs of the banking sector, complemented with a clear strategy for addressing capital shortfalls.
This is coming on the heels of the IMF’s Executive Board Article IV consultation with the Euro Area.
As part of the IMF’s Executive Board assessment, directors recognised that the first priority is to restore sound bank balance sheets to revive credit.
According to them, immediate steps include full recognition of losses, recapitalisation of weak but viable banks, and closure or restructuring of non-viable banks. ”In this context, directors supported plans to conduct a comprehensive balance sheet assessment followed by stress tests to assess the potential capital needs of the banking sector, complemented with a clear strategy for addressing capital shortfalls,” the IMF said.
However, they emphasised the benefits of involving an independent third party in ensuring the transparency and credibility of the exercise. Apart from involving an independent third party, the directors emphasised the importance of a credible backstop, including through direct recapitalisation by the European Stability Mechanism (ESM), and looked forward to early agreement on the matter.
According to the executive board assessment, directors urged further progress toward a fuller banking union to help reduce fragmentation. They affirmed that stepped-up efforts are needed to adopt the enabling legislation for the Single Supervisory Mechanism (SSM), agree on the Bank Recovery and Resolution Directive, and make progress on the Deposit Guarantee Scheme Directive.
The IMF stressed the importance of establishing a strong, centralised Single Resolution Mechanism (SRM), with the independent power to trigger resolution and make decisions on burden sharing.
The Executive Board assessment agreed on the need for a flexible, differentiated pace of fiscal adjustment within a credible medium-term framework and as a result of this, they welcomed the recent extension for some countries to meet fiscal deficit targets.
They noted that additional flexibility may still be needed in some cases, especially if that available fiscal space is used to implement deeper structural reforms or recapitalise viable banks. ”In the longer run, it would be desirable to facilitate greater fiscal risk sharing.
Directors urged further structural reforms at all levels, with a view to enhancing the growth potential and further rebalancing demand within the euro area,” the IMF said.
The IMF had fortnight ago advised the Euro Area to recapitalise frail but viable banks as part of the area’s task to address important tail risks, stabilised financial markets and grow its economies.
The IMF said faced with high funding costs; weak banks are unable to recognise losses. ”This perpetuates uncertainty about the quality of their assets, hinders fresh private capital injections, and ultimately restrains credit. To reverse these dynamics, bank losses need to be fully recognised, frail but viable banks recapitalised, and non-viable banks closed or restructured,” the IMF said.
