Financial turmoil could cost $1trn, warns IMF as global growth comes under threat

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The Independent Online

The International Monetary Fund warned yesterday that losses from the financial crisis could approach $1trn (£508bn) as the turmoil spreads and threatens global economic growth. The IMF's estimate of the losses from the crisis is the biggest yet and raises fears that the worst of the credit crunch is yet to come. So far banks have reported about $230bn in losses and write-downs.

Global banks are likely to shoulder about half of the potential losses, with insurance companies, pension funds, hedge funds and other institutional investors accounting for the balance, the IMF said. But losses at other institutions such as "monoline" bond insurers could reverberate back to the banking system, causing further carnage.

Strain is spreading from US sub-prime mortgages to other sectors such as commercial property, consumer credit and loans to companies, the IMF said, adding that there had been a "collective failure" to understand the dangerous levels of debt built up in the financial system.

A report by the IMF has called on banks to rebuild their balance sheets by raising capital or cutting back their assets to cope with the strains imposed by the crisis. The stress on financial institutions had increased risks of financial instability and could force them to further tighten credit.

At the start of the crisis, the impact was limited to financial institutions as banks hoarded cash to meet obligations caused by falling asset values. But central bankers are now panicking that the squeeze is spreading to the wider economy as cash-strapped banks rein in lending to consumers and companies, choking off the financial oil that keeps the economy working.

"It is now clear that the current turmoil is more than simply a liquidity event, reflecting deep-seated balance sheet fragilities and weak capital bases, which means its effects are likely to be broader, deeper and more protracted," the IMF said in its Global Financial Stability Report.

Yesterday's report came ahead of a gathering of world financial leaders at meetings of the IMF and the World Bank in Washington this weekend. The report warned that the impact of the crisis, so far largely confined to the US and other Western economies, could spread to emerging markets through funding channels and trade. The IMF is expected to reduce its growth forecast sharply today as the US slowdown takes its toll on the global economy.

The report blamed slack regulation by governments and "excessive risk-taking" by banks for the crisis. Financial authorities need to prepare for further shocks and make plans to support banks in crisis if losses threaten financial stability and the wider economy.

Faced with a near-meltdown at the investment bank Bear Stearns, the US Federal Reserve provided $30bn of support last month to ease a takeover of the bank by JP Morgan.

The IMF's assessment highlighted the potential for a vicious spiral as the financial crisis and economic slowdown feed off each other. Jaime Caruana, head of the IMF's monetary and capital markets division, said a big concern was what would happen to credit conditions in a US economic downturn, which could increase defaults on loans. But the report also warned that a contraction of credit "could bring a significant slowdown in US output growth in the following several quarters".

The crisis has stunned the financial world with its intensity and duration. A year ago the IMF predicted that reverberations from losses on US sub-prime mortgages would be limited. "Everybody has learnt a lot. We have all had to be a little bit humble on the analysis of the crisis, because it has been a very, very complex crisis," Mr Caruana said.

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