Europe risks systemic crisis: IMF

Greek bonds owned by European banks may cause a 'second credit crunch' if they are devalued in any way. Photo / AP

Europe remains highly vulnerable to another systemic banking crisis, itself sparked by the continuing sovereign debt problems in Greece and other distressed "peripheral" eurozone member states, the International Monetary Fund warned yesterday.

The IMF, which is funding about a third of the cost for the rescues of Greece, Ireland and Portugal, said: "Contagion to the core euro area, and then onwards to emerging Europe, remains a tangible downside risk."

In its latest Regional Outlook for Europe, the fund said: "Financial linkages between countries with sovereign debt troubles and the rest of Europe could potentially pose more risk to the outlook. Banks in the core countries of advanced Europe carry substantial exposure to the euro area periphery on their books, and a shock to confidence could spread quickly throughout Europe."

As with the original credit crunch in 2007, that could trigger a further collapse in already fragile business and consumer confidence, itself adding to banks' bad debts and creating a "negative feedback loop".

But this time the loop would be even harder to break as few European countries have much "fiscal headroom" to launch new stimulus packages or fund further sovereign bailouts or bank recapitalisations.

The European financial system remains highly vulnerable to systemic risk if the Greek and other government bonds owned by financial institutions are devalued in any restructuring of sovereign debt.

The intimate linkages between Europe's major banking groups - including the United Kingdom's - means that a crisis in Greece could soon prove a systemic risk to the entire continent, raising fears of a "second credit crunch".

"Financial spillovers from sovereign debt problems remain a tangible risk," the fund said. "It is urgent to implement agreed enhancements to the framework for crisis management in the euro area."

Looking forward to the European Union-wide "stress tests" to be run by the European Commission next month, the IMF urges European authorities to "deal with weak banks in a swift and effective manner" to "dispel lingering uncertainties about the overall health of the banking sector".

The stress tests "will only make a real difference if backed by a programme of recapitalisation, restructuring and resolution". The IMF has said that one-third of Europe's banks were operating with inadequate capital.

Those European banks with the highest exposure to Greek bonds are: BNP Paribas, Dexia, Commerzbank, SocGen, ING and RBS. The European Central Bank holds about 20 per cent of Greece's debt.

There is broad support for the UK Government's strategy to cut the budget deficit, but they add: "Despite some support from the depreciated pound and a rapid unfreezing of past investment decisions, stronger headwinds from a 'front-loaded' fiscal strategy and higher household debt levels will restrain growth."

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