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Rash of bank downgrades signals return to 'danger zone:' IMF

A televison camerman films the logo of the International Monetary Fund (IMF) at the organization's headquarters in Washington, DC, May 16, 2011.

SAUL LOEB/AFP/Getty Images

Europe's big financial institutions are under pressure to quickly secure tens of billions of euros of new capital, as the continent's spreading debt crisis increasingly engulfs the banking system.

The International Monetary Fund warned the global financial system is more vulnerable now than at any point since the financial crisis of three years ago, as Europe's debt crisis risks trigger a treacherous slide back into the widespread instability that prevailed during the darkest days of 2008.

"We are back in the danger zone," IMF director José Vinals said on the eve of a key meeting of global finance ministers and central bankers in Washington.

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"Some European banks urgently need to bolster their capital levels," the IMF said in its semi-annual Global Financial Stability Report.

Highlighting the growing financial risks in Europe, Standard & Poor's downgraded seven large Italian banks over the continent's sovereign debt woes – a day after it downgraded Italy's government debt.

The downgrades show financial market angst is spreading from troubled government finances to troubled banks.

In the U.S., meanwhile, Moody's Investors Service on Wednesday downgraded the debt ratings of the three largest U.S. banks – Bank of America, Citibank NA and Wells Fargo, citing a reduced likelihood that the United States government would ride to the rescue in the event of a failure.

The U.S. government is "more likely now than during the financial crisis to allow a large bank to fail should it become financially troubled, as the risks of contagion become less acute," Moody's analysts said in a statement on Bank of America and Wells Fargo.

U.S. banks are suffering a hangover from the deep housing slump and the recession, which wiped out trillions of dollars worth of Americans' wealth. Bank of America has improved its capital and liquidity positions, but the bank's mortgage portfolio contains risks, Moody's said.

European banks are caught in a more immediate squeeze. Saddled with large holdings of risky European sovereign bonds, they're facing woes, faltering capital bases and, now, an apparent run by foreign investors.

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The 187-member IMF urged the euro zone to move quickly to halt contagion by granting embattled banks access to an emergency fund. One way to do that would be to expand the mandate of the European Financial Stability Facility from country bailouts to bank bailouts.

"Public backstops, first at the national level and ultimately through the European Financial Stability Facility should be used to provide capital to banks as needed."

The IMF said the European sovereign debt crisis has delivered a €200-billion ($273.4-billion) hit to European banks, and a total of €300-billion including loans to other banks. The figure doesn't represent the amount of fresh capital the banks may need.

The IMF's Mr. Vinals said some banks may eventually need government bailouts or be forced into mergers with rivals if they can't raise private capital.

The danger is that without more capital and liquidity, many banks will simply cut lending to consumers and businesses, worsening Europe's economic tailspin, the IMF said.

Clearly, this must be avoided," Mr. Vinals told reporters in Washington.

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Some major depositors are pulling their deposits from European banks.

Insurer Lloyd's of London confirmed it's withdrawing deposits from banks in peripheral European countries, worried they may fail.

"If you're worried the government itself might be at risk, then you're certainly worried the banks could be taken down with them," Lloyd's finance director Luke Savage told Bloomberg News.

Likewise, German industrial giant Siemens AG pulled more than half-a-billion euros in cash deposits from an unidentified large French bank two weeks ago and transferred it to the safety of the European Central Bank, according to reports.

And the Bank of China has reportedly stopped doing some routine foreign exchange transactions with several European banks, including Société Générale SA, Crédit Agricole SA and BNP Paribas SA.

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About the Author
National Business Correspondent

Barrie McKenna is correspondent and columnist in The Globe and Mail's Ottawa bureau. From 1997 until 2010, he covered Washington from The Globe's bureau in the U.S. capital. During his U.S. posting, he traveled widely, filing stories from more than 30 states. Mr. McKenna has also been a frequent visitor to Japan and South Korea on reporting assignments. More

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