The latest version of the International Monetary Fund’s global financial stability report raises its estimates of the likely bank losses and capital needs.

The IMF report estimates that to keep private sector credit growing, even modestly, while strengthening bank capital ratios, about US$675 billion in capital would be needed by the major global banks over the next several years. Also, with default rates still rising and the recent heightened market distress, declared losses on U.S. loans and securitized assets are likely to increase to about US$1.4 trillion, it said, which is significantly higher than previous estimates.

“With the economic slowdown spreading, financial institutions will increasingly face losses on non-U.S. assets as well,” it notes. “In some European countries, too, these difficulties are being accentuated by weakening local housing markets.”

The IMF report says, “The far-reaching nature of the events that are unfolding is illustrated by the fact that within a period of one week, large stand-alone investment banks disappeared from the U.S. financial landscape. While the long-run implications are not certain, financial sectors are likely to consolidate, new business models will need to be found, and firms will operate with less leverage in the foreseeable future.”

It calls on the authorities of the affected countries “to address the issue in a consistent and coherent manner” to help restore financial stability. The precise measures will inevitably differ across countries, it says, adding that they should address “the principal challenges arising from the strains of deleveraging: namely, improving funding availability, cost, and maturity to stabilize balance sheets; injecting capital to support viable institutions with sound underpinnings that are currently unable to provide adequate credit; and buttressing troubled assets by using public sector balance sheets to promote orderly deleveraging.”

The report also includes a chapter on the issue of fair value accounting. It concludes that, despite the trouble inflicted by fair value accounting, fair value “is still the way forward”, but it adds that “further enhancements of FVA methodologies are needed to help mitigate the exaggerated effects of some valuation techniques.”

“A key challenge will be to enrich the FVA framework so that it can contribute to better market discipline and financial stability. The various accounting, prudential, and risk management approaches to valuation should be reconciled so that they work together to promote a more stable financial system. Importantly, this will require adjustments on the part of all three disciplines to ensure consistency,” it says.

IE