The world's lender of last resort has issued a stark warning that a decade on from the financial crisis banks are still exposed to risky government debt.
The so-called "doom loop", in which banks hold too great a share of state loans on their balance sheets, is still a persistent issue for countries and regulators, the International Monetary Fund (IMF) said in a major report on financial stability, reports the Daily Telegraph.
The warning comes after fresh concerns about the doom loop's impact were raised by Italy's budget proposals. The country has the second highest debt-to-GDP ratio in the eurozone at 132 per cent, after Greece.
Italy's populist leaders are attempting to push ahead with a figure of 2.4 per cent deficit spending. With public finances already under strain the value of Italian bonds fell sharply on the news, driving up borrowing costs and putting pressure on Italian banks, which hold nearly 10 per cent of government debt. Markets across the EU fell as a result.
Overspending by a state pushes down the value of a country's debts, as seen during the Greek debt crisis. This devalues banks' balance sheets if they hold a large proportion of those government bonds. If banks then run out of liquidity, and need bailing out, it can add to a nation's deficit, looping back around and further driving down the value of its debts.
This creates a high degree of shared risk of financial instability.
The proportion of sovereign debt held by banks has continued rising, the IMF said.
"Holdings of government securities have risen in many countries, which could also signal persistence of the links between banks and sovereigns — an issue that will remain a challenge to authorities," the report added.
It added: "The sovereign-bank linkages have proven particularly potent in cases when the domestic banking system is heavily exposed to sovereign debt and where the debt itself is assessed to be high risk."
The lender also lashed out at credit ratings agencies, highlighting both their integral role within the 2009 financial crisis, and ongoing conflicts of interest.
The agencies, which include the likes of Standard & Poor's and Moody's, grade the risk attached to debt.
However, they are also paid by the issuer of the debt to perform that role. This created "well-recognised incentive problems" the IMF said.
Despite some efforts at reform, and the agencies' models having "weaknesses" and "failures", they "retain a central role in the financial system", it added.
The concerns in the IMF report follow clear hints from its head Christine Lagarde that it will cut its imminent forecast for global economic growth, citing concerns about the burgeoning trade war between the US and China.
Shadow banking and rising levels of global debts also presented major risks to the security of the world economy, the IMF warned.
Other effects from the financial crisis are still playing out, the IMF added. In a separate blog the lender said there was a significant impact on fertility rates in the wake of the 2008 crash, with a sharp decline in the number of babies produced by some countries.