IMF 2016 Financial Stability Report Warns Banks To Adapt To "New Era"

Alongside their October annual meeting, the IMF has released its 2016 Global Financial Stability Report. This year the report includes a number of warnings and is somewhat pessimistic that global growth will improve anytime soon. Below are some excerpts from the IMF press conference on this. I used bold type to indicate some key points.
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"MR. DATTELS (MMF): Thank you, everybody, for being here this morning. Today, we find ourselves in a low-growth, low-rate, era characterized by increased political and policy uncertainty. This is creating many challenges for banks, policymakers, and corporates, in all parts of the world. Failure to adapt to this new era could undermine the health of financial institutions and add to the pressures of financial and economic stagnation. This report analyzes these challenges and offers solutions to foster stability in this new era.

First, some good news. Short‑term risks have declined."          . . . . .

"But medium‑term risks are building because we're entering a new era of challenges. Low, uneven, and unequal growth is opening the door to more populist and inward looking policies, leading to a loss of political cohesion and a rise in policy uncertainty in some countries. This could increase volatility and undermine growth.

A striking outcome of this weak economic environment and heavy reliance on unconventional monetary policies is that markets expect negative policy rates in the euro area and Japan to last through the end of this decade. The weak outlook has pushed hopes for normalizing monetary policies well into the future. As a result, almost 40 percent of advanced economy government bonds carry negative yields. This is unprecedented! Financial stability now depends on how well financial institutions adapt to this new era." 

. . . . 

"Markets have serious concerns about the ability of many banks to remain viable and healthy. Equity valuations are well below the book values of many banks as the focus of investors has shifted from the level of capital to the business models that banks need to maintain that capital through profits. This is the fundamental reason why some banks have come under pressure this year.

The question that we raise in this report is whether an economic recovery is sufficient to restore sustainable profitability. Or, are the problems more deep‑rooted and structural?"

To answer this question, we conducted a detailed bottom‑up analysis of some 280 banks, covering about 70 percent of U.S. and the EU banking systems. We found that a cyclical recovery helps, but is not enough. . . . "

. . . . 

"First, European banks need to resolve the legacy of nonperforming loans. This requires supportive policy action to strengthen insolvency and recovery regimes to reduce foreclosure times. If this were to be achieved, it would turn the capital cost of removing nonperforming loans from balance sheets of some 80 billion euros to a benefit of capital of about 60 billion euros. Progress has been made, more is needed.

Second, European banks need to become more efficient. There are simply too many branches with too few deposits and too many banks with funding costs well above their peers. Addressing these business model challenges is vital to ensure sustainable profitability.

Third, weak banks will have to exit and some banking systems will have to shrink. This will ensure a vibrant banking system that supports economic recovery.

Fourth, policymakers will have to complete regulatory reforms to reduce uncertainty without an across‑the‑board increase in capital requirements. Procyclical outcomes must be avoided.. . . . "

. . . . .

"Can emerging markets achieve a smooth deleveraging? In a new era of weak global growth, commodity prices and reduced global trade, substantial debt reduction will take a long time. Under our baseline scenario, indebtedness declines only gradually, returning to 2014 levels only by 2021." 


"Let me conclude. The action is needed now to ensure that the financial system adapts to this new era and remains healthy. These measures are also necessary to avoid sliding into financial and economic stagnation. They form part of the Fund's three‑pronged strategy of structural, fiscal, and monetary policies within and across countries and over time, and sustained growth and financial stability. 

Thank you very much. We will happily take your questions." 



QUESTIONER: In this report, you talk about markets having questions over the viability of some banks, but you don't name any names here. I wonder if you could talk a little bit about Deutsche Bank, which has come under questions in the market over its financial strength after the request for fines against it. Is Deutsche Bank viable? Will it need a bailout?


MR. DATTELS: As we focus on in the report, many banks need to adapt to this new era of low growth and low rates, as well as a changing regulatory and market environment. We have one-third of the banks struggling to show sustainable profitability. So let me break that down a little bit, which I think is helpful.

We can break it down ultimately into three groups. Banks with legacy challenges owing to high nonperforming loans; banks that have been restructured, taken over by the government and recapitalized, but still struggling to find their footing; and third, investment banks that are in the transition away from dated business models that relied heavily on large scale balance sheets.

Deutsche Bank, we can say, is in the midst of this latter challenge. It is in that third bucket of banks that need to continue to adjust to convince investors that its business model is viable going forward, that it has addressed the issues of operational risk arising from litigation and so on. I think that is the new environment that we are in, and I'm sure that those challenges will be met. 


QUESTIONER: Just to follow‑up on that, Pete. I know it wasn't your division, but a few months ago the IMF came out and said Deutsche Bank posed a systemic risk to the global markets, that was before a lot of what we have talked about today really came into focus. So I would like to press you a little bit on Deutsche Bank in particular. In light of what you just said, do you think that it poses a systemic risk to the financial markets?

MR. DATTELS: What you are referring to is the Germany’s Financial Sector Assessment Program from June, and that report highlighted that Deutsche Bank is a large and interconnected bank and is therefore systemically important, domestically and globally. In that context, we are confident the German and European authorities are monitoring the situation and working to ensure that the financial system remains resilient. 

. . . .


"QUESTIONER: Firstly, in your previous report, the one in April you gave a figure for nonperforming loans, I think it was around 900 billion euros and you also broke down that figure a bit. You said 350 of that was Italy. I wonder if you could give us an update on some of those figures? . . 


MR. DATTELS: As for nonperforming loans, we have updated some of the numbers in the text. We are seeing a gradual reduction, with the ECB having put in targets for the banks that are under its direction for a sharper reduction in nonperforming loans, and that is certainly the case in a number of countries. But, the actual level, the overall level remains high and much more progress needs to be made.

QUESTIONER: Is the EUR 900 billion figure still relevant?

MR. DATTELS: That is still broadly correct. I can circle back and provide you with that."

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