In its Global Financial Stability Report released on Wednesday, the International Monetary Fund (IMF) warned that banks in Europe were too weak to generate sustainable profits even if the region saw strong economic growth.

The international crisis lender also said that the banks' weak profitability, caused by ultra low interest rates and subdued growth in the eurozone, could further erode their financial buffers and undermine their ability to support economic recovery.

"In Europe, about one third of the system - representing some $8.5 trillion [7.5 trillion euros] in assets - remains weak and unable to generate sustainable profits," said IMF economist Peter Dattels as he presented the 113-page report in Washington.

Therefore, European banks needed "urgent and comprehensive action" to address a legacy non-performing loans and bloated, inefficient business models, he said. "We've found that a cyclical recovery helps but is not enough," he added, and called for the closure of weak banks as well as for the European banking sector to shrink in general.

Below book values

The IMF warning comes as commercial bankers, central bankers, finance ministers and other policymakers have converged on Washington this week for annual meetings with the IMF, the World Bank and the Institute of International Finance, a global trade group.

The Fund also noted that stock valuations of many banks were well below their book values, as investors had doubts about capital levels and business models. "Since the start of the year, the market capitalization of advanced economy banks has fallen by almost $430 billion, increasing the challenge of addressing banking system vulnerabilities, particularly for weaker European banks," the report said. 

Deutsche Bank is such a case in point. Germany's biggest lender saw its share price fall by more than 40 percent this year, in large part on fears for the health of the bank. Deutsche faces billions in US settlement costs over its sales of toxic mortgage-backed securities prior to the financial crisis and has repeatedly failed stress tests.

"Deutsche Bank is among banks that need to continue to adjust to convince investors that its business model is viable going forward and has addressed the issues of operational risk arising from litigation," Dattels said, adding that German authorities were closely monitoring Deutsche's health.

Fewer risks

Despite the weakness in Europe, the IMF found that overall risks to global financial stability had declined since its last report in April. The recovery in commodity prices had aided some emerging markets and fears over China's economic slowdown had been eased by government policies, it said 

The initial shock of Britain's vote to leave the European Union was also well absorbed by markets and had not turned into a global contagion, with the fallout now looking "more local than global."  

But trouble was brewing in the medium-term, according to the global crisis lender, and banks, retirement funds and insurance companies needed to continue to clean their portfolios and adjust to an era of low growth and low rates.

uhe/kd (Reuters, AFP, dpa)