Banks and other financial institutions around the world will eventually need to write down assets by $4.1 trillion in order for global financial stability to be restored, the International Monetary Fund said on Tuesday.
In its Global Financial Stability Report, the IMF said U.S. institutions were about halfway through their needed write-downs, while their euro area counterparts are still lagging.
Banks will bear about two-thirds of the write-downs, which are coming on $58 trillion of debt originated in the United States, Europe and Japan, the IMF said.
It was the first time the IMF report had included losses on loans and related securities originated in Europe and Japan, which will total about $1.3 trillion.
The report said banks needed larger capital injections to weather the expected losses and restore investor confidence in the battered financial system.
Banks worldwide have so far raised about $900 billion in capital, about half of it through government rescue loans.
Jose Vinals, director of the IMF's monetary and capital markets department, said continued decisive and effective action to clean up banks' balance sheets is needed to restore confidence and economic growth.
The deleveraging process is ongoing and high write-downs, together with market demands, will require financial institutions to hold more capital, he told a news conference.
Some of these capital needs could be satisfied directly with a conversion of (government) preferred shares to common shares, or indirectly with government guarantees to cover losses, Vinals said.
It may be appropriate in some cases for governments to temporarily nationalize financial institutions, he said, but exit strategies need to be communicated ahead of time to markets.
IMF SEES LOSSES MOUNTING
The IMF said it now expects the deterioration in U.S.-originated assets to reach $2.7 trillion, substantially more than the $2.2 trillion it forecast in January. The sharp increase reflects losses mainly between October and January.
Just a year ago, the fund was heavily criticized for estimating losses of just $1 trillion on bank assets. Sensibilities have changed. What seemed ludicrous now seems quite mild, the IMF's first deputy managing director, John Lipsky, said.
The IMF estimated that banks around the globe will need to write down about $2.8 trillion in loans and securities. So far, about one-third of that amount has been written down.
According to the fund, U.S. banks have written down about $510 billion in assets, putting them about halfway through the process of loan loss recognition. A further $550 billion in write-downs are expected over the next two years.
In the euro area, write-downs so far have totaled $154 billion, with another $750 billion expected through 2010. In Britain, bank credit losses have been $110 billion, with another $200 billion likely in 2009-10, the IMF said.
Europe has recognized its exposure to U.S. toxic assets but still in the pipe, if you like, is the economic deterioration that is taking place in Europe through the loan book and also its exposure to emerging Europe, which is now in decline, said Peter Dattels, chief of the IMF's global markets monitoring and analysis division.
The IMF estimated potential write-downs by Western banks through their subsidiaries and cross-border holdings of securities in emerging markets could amount to $340 billion.
Since the start of the crisis, market capitalization of global banks has more than halved to $1.6 trillion from $3.6 trillion.
The IMF estimated banks could need additional capital of between $275 billion to $500 billion in the United States, about $125 billion to $250 billion in Britain, and about $375 billion to $725 billion in the euro area.
The IMF said the size of total credit losses could be lower if forceful and well-targeted actions are taken.
It said banks in the United States, euro area and Britain are expected to post losses through 2010 before returning to modest levels of profit.
It took a similarly long period for banks to recover during the Great Depression and in Sweden's banking crises of the early 1990s, the IMF said. However, it said current write-downs are likely to be more severe than during those episodes.
(Additional reporting by Emily Kaiser; Editing by Leslie Adler)