WASHINGTON, Sept 21, (Agencies): The International Monetary Fund says the global financial system faces more challenges than at any point since the 2008 financial crisis.
Europe’s debt crisis is spreading to its banks, which hold government debt and may be forced to pull back on lending to conserve cash, the lending organization said Wednesday.
The US economy is being restrained by its depressed housing market. Many homeowners owe more on their mortgages than their homes are worth. That has limited their ability to spend and is holding back growth.
The IMF urged European banks to raise more capital to shore up their finances. If necessary, governments should provide it. And it said the US government should help homeowners reduce their mortgage debt.

“Risks are elevated, and time is running out to tackle vulnerabilities that threaten the global financial system and the ongoing economic recovery,” the IMF said in its semi-annual Global Financial Stability report. The crisis in Europe is entering a dangerous new phase. Fears are growing that Greece may default on its debts. That would destabilize other debt-laden European countries, such as Spain and Italy. It would also cause substantial losses at French, German and other banks.
European leaders should quickly implement an agreement reached in July that provides the region’s bailout fund with more flexibility, the IMF said.
The agreement allows the bailout fund to purchase bonds issued by debt-strapped countries such as Greece and Ireland, and would make it easier for Europe to resolve its debt crisis. And Europe’s larger banks, which hold substantial amounts of Greek and other troubled government bonds, should boost their capital reserves, the IMF said. That would protect them in case the bonds lose more of their value or Greece defaults on its debts.
The capital should come from private markets, the IMF said. But if that isn’t available, governments should provide the funds. European banks face potential losses of $274 billion (200 billion euros) from shaky government bonds, and $410 billion (300 billion euros) if the risk of losses on loans to other banks were included. The IMF said the figure didn’t represent the amount of capital banks needed to raise.

Demand
In the US, about one-quarter of homeowners owe more on their homes than they are worth. Reducing that debt burden would improve consumer demand and support growth.
“Restoring confidence in the stability of the US housing market is the key to bolstering the prospects for US banks,” which have been hurt by slower growth, the report said.
But US lawmakers are focused on cutting spending rather than enacting new programs to aid homeowners. And President Barack Obama didn’t include any new measures to bolster the depressed housing market in a jobs package he proposed earlier this month.
The IMF’s recommendations also face stiff resistance in Europe.
The fund’s stance that European banks need more capital is at odds with that of the European Central Bank. The president of the ECB, Jean-Claude Trichet, has said that banks have trillions in securities they can pledge as collateral for loans from the ECB.
European stress tests earlier this year flunked eight banks and found 16 with barely enough capital to weather a new downturn. Governments have in many cases resisted pushing for recapitalization, instead disputing the methodology of the tests.
Recapitalization of banks can be a painful process, since shareholders are pressed to put up more money or see their holdings diluted, and share values can fall sharply. Hard-pressed governments are reluctant to put up the money themselves, after pouring billions of taxpayer euros into bank rescues during the earlier years of the crisis.
On Tuesday, the IMF sharply cut its growth forecasts for the global economy, the United States and Europe for this year and 2012. The 187-member group is holding its annual meeting at the end of this week in Washington. The meeting brings together finance ministers and central bankers from around the world.

The IMF estimated the eurozone debt crisis has directly cost banks in the European Union 200 billion euros ($237.7 billion) in sovereign credit risk in the past two years.
Of the 200-billion-euro total, 60 billion euros comes from the sovereign debt in Greece, 20 billion euros from Ireland and Portugal, and 120 billion euros from Belgium, Spain and Italy.
Considering the magnitude of these risks, and that “markets are likely to remain volatile,” the IMF warned that accessing capital on the markets may prove impossible.
Many analysts say that Italy or Spain could be the next dominoes to fall in the escalating eurozone crisis, which so far has witnessed massive bailouts for debt-ravaged Greece, Ireland and Portugal.
On Wednesday, Lloyd’s of London said it had slashed its exposure to European government debt and pulled cash out of some of the region’s banks amid the deepening eurozone crisis.
“Given the uncertainty around the eurozone, it’s only natural that we would seek to reduce any potential downside risk,” Lloyd’s Finance Director Luke Savage told Dow Jones Newswires.
“As a result, we’re not holding government debt of any peripheral EU country and have sought to reduce our exposure to banks in these countries.”
The IMF devoted a large section in the report to Italy, the third-largest economy in the eurozone that holds the second-largest largest debt pile, of more than 1.9 trillion euros.
“Given the systemic size of the bond markets in Italy and the sovereign funding needs there, these risks have become key drivers of market conditions, increasing the potential for spillovers across different asset markets,” the IMF said.
Italy’s debt “remains highly sensitive to a rise in funding costs.”
On Tuesday, the IMF’s chief economist, Olivier Blanchard, called on the eurozone to be ready to help Italy if “the markets start believing that Italy’s debt is not sustainable.”