IMF warns against big bank deleveraging in Europe

(WASHINGTON) - Growing pressure on European banks to clean up their books could deeply impact economic growth in the eurozone, the International Monetary Fund warned Wednesday.

Though Europe's policymakers have taken important steps to address the public debt crisis, the pressure on banks to reduce their balance sheets could have negative consequences on output, the IMF said in its twice-yearly Global Financial Stability Report.

Pressures from the eurozone debt crisis and regulatory needs to strengthen capital cushions to regain investor trust are driving a broader effort to reduce balance sheet size, the report said.

"The potential consequences of a synchronized and large-scale deleveraging warrant supervisory efforts to avoid serious damage to asset prices, credit supply, and economic activity in Europe and beyond."

"Against this backdrop, European policymakers need to build on recent improvements to implement the agreed reforms swiftly."

In the IMF's current forecast, economic growth will move from recession this year to a meager 0.9 percent expansion in 2013 as the 58 largest EU banks shrink their balance sheets by 7.0 percent or $2.6 trillion (2.0 trillion euros).

But in the case that governments fail to adequately implement announced reforms, ultimately banks could be forced to trim $3.8 trillion in assets to remain stable -- and that could result in shaving 1.4 percent from gross domestic product from the 2013 estimate.

IMF managing director Christine Lagarde on Tuesday called for the creation of a dedicated institution in Europe that could help to recapitalize the teetering banks of the region.

Lagarde said that "a pan-euro area facility that has the capacity to take direct stakes in banks would help," but gave no further details.

IMF economist Olivier Blanchard, in a publication released Tuesday, also urged Europe to boost efforts to shore up its banks.

"Partial public recapitalization of banks does not appear to be on the agenda anymore, but perhaps it should be," he wrote in the foreward of the IMF's semi-annual World Economic Outlook.

"To the extent that it would increase credit and activity, it could easily pay for itself -- more so than most other fiscal measures."