(April 19, 2012) — The fallout of the financial crisis could herald the arrival of a new credit crunch, the International Monetary Fund has warned.
The act of banks deleveraging may bring about a similar drying up of credit as was seen in 2007-2008, the IMF said in its Global Financial Stability Report, published this month.
The report said: “There is a risk that a large-scale reduction in assets by European banks could lead to a credit crunch. These structural changes are healthy as they will lead, over time, to a stronger and more resilient banking system. However, there is a risk that large, simultaneous asset reduction by a number of European banks could have an adverse impact on the economy and the financial system.”
Banks began deleveraging in the aftermath of the financial crisis, partly to remain afloat and partly to comply with newly introduced regulation.
Deleveraging means they either lower the level of assets they hold by selling them, or increase the amount of capital held against these assets.
The IMF said European banking institutions were intending to make reductions in assets amounting to about $2 trillion in total.
The organisation ran a deleveraging scenario for each of the Eurozone economies and came up with a figure of 1.7% reduction in credit availability over two years for the whole region.
“That said, the decline in credit—after taking into account the second-round effects (from asset sales) on banks and the feedback effects from deterioration in the economy—could be more sizable and could increase if cyclical pressures rose,” the report said.
The effects of this pull back by large institutions could be mitigated by local banks’ ability to supply credit and the likelihood of other institutions supplying credit, directly through capital markets, for example.
These effects, however, are likely to impact corporate growth in the Eurozone, the IMF said.
“Euro area firms are particularly vulnerable to reduction in bank credit because of their greater reliance on banks for funding and often limited ability to adjust labor costs, at least compared with their US peers.
Outside of the core Eurozone nations, things could be a lot worse, the IMF warned: “Because domestic banks in peripheral economies are facing the greatest deleveraging pressures and have disproportionately large corporate loan portfolios, the potential impact on corporate financing may be especially pronounced there. Small and medium-sized enterprises are likely to be most affected.”
Felipe Villarroel, Analyst at TwentyFour Asset Management, said the IMF report “repeatedly mentions that the challenge (and the solution, of course) for the Eurozone is growth”.
The report said the Eurozone economy would shrink overall by 0.3% over 2012, hit mainly by contractions in Italy and Spain.
Villaroel remained upbeat: “Overall, in our opinion, we are in a much better place than we were a year ago which should mean that when – not if – the market goes back into crisis mode, the volatility and downside should be less severe than we experienced in July/Aug/Sept 2011. However, they will probably still be severe enough to need your hedges as crisis tools will not be deployed until markets overreact.”
As aiCIO reported last week, the IMF also slammed actuaries and governments for misjudging improvements in longevity that have since proved, and will continue to prove costly.