“China has recently started to address the problem by increasing banks’ provisions for non-performing loans. The question is how fast is the increase in non-performing loans going to be in the future and it is very important that the authorities remain vigilant so that banks adequately provision now before things get more complicated,”

The world risks a slide into a fresh financial crisis leading to global recession if governments and policymakers mishandle growing market stability risks, the International Monetary Fund warned yesterday.

José Viñals, the fund’s head of financial stability, told the Financial Times that its bad scenario “does not rely on extreme assumptions at all”, merely that risk premiums rise further, corporate defaults rise in emerging economies and there is a worldwide decline in appetite for riskier assets.

The effects would consign the world to growth rates sufficiently weak to be termed a global recession.

“If we don’t get it right we could set the clock back in terms of growth,” Viñals added.

In its twice-yearly global financial stability report, the IMF simulated the effects of the current financial fragilities in emerging economies turning sour from another shock to confidence or a policy mis-step.

“Shocks may originate in advanced or emerging markets and, combined with unaddressed system vulnerabilities, could lead to a global asset market disruption and a sudden drying up of market liquidity in many asset classes,” the report warned.

In these circumstances, spending growth would slow sharply in emerging and advanced economies leading to a shortfall in output of 2,4 percent by 2017 compared with the baseline IMF forecasts.

With those forecasts already weak, it would imply global growth would face the strong possibility of falling below 2 per cent for a year, the standard definition of a global recession, although one that would fall short of another crisis on the scale of 2008.

“Our central scenario is not a crisis. The downside scenario is not a global crisis but a situation in which we would have significant losses in terms of GDP,” Mr Viñals said.

The risks have worse implications than those simulated in the fund’s economic forecasts and highlight the need, he added, for policymakers to address the financial stability vulnerabilities in the world.

These stem mostly from emerging markets, with advanced economies less likely to cause a crisis but not immune from strains in poorer countries.

A binge on credit is coming to a head in emerging markets, the fund warned, saying the emerging economies are “in the late-stage of a credit cycle” with debt levels significantly in excess of expected levels given growth in these economies.

“In emerging markets, we are in the late stages of a credit cycle . . . There is about $3 trillion of overborrowing or excess credit extended now,” Mr Viñals said.

Relative to the size of its economy, China is the most exposed with excess credit equivalent to 25 percent of national income.

“China has recently started to address the problem by increasing banks’ provisions for non-performing loans. The question is how fast is the increase in non-performing loans going to be in the future and it is very important that the authorities remain vigilant so that banks adequately provision now before things get more complicated,” said Mr Viñals.

Were there to be a serious crunch starting in China, worse than that simulated by the IMF, Britain would be at the sharp end of contagion because the Asia exposure of UK-based banks such as HSBC and Standard Chartered make it more vulnerable than most.

“One would have to see something (bad), which is really a tail-risk, and [which] would affect more the British banks that are most exposed,” he added.

“Market liquidity, which is not low at present, is nevertheless much less resilient than we would have liked”

In advanced economies, the greatest risks come from the Fed’s probable decision to raise interest rates, which the fund urged be done in a way that did not spook markets. Globally, the IMF highlighted the risk that markets would dry up if there were any shock to confidence.

“Market liquidity, which is not low at present, is nevertheless much less resilient than we would have liked,” Viñals said.

To prevent risks crystallising more than they already have, the IMF called for urgent action to quell some of the storms threatening to rage in financial markets and stop risks becoming reality.

It said the Fed should communicate carefully its interest rate intentions and the eurozone should throw light on non-performing loans in its banking sector.

It urged China to take “great care” as it moved to a new economic model less reliant on debt and investment.

‘‘Apart from more provisioning against bad debt, the fund also urged the authorities to stop intervening in the stock market and to move more quickly towards a market based economy that relied “less on moral persuasion to guide banks’ lending activities and allow loan policies and interest rates to be determined by commercial considerations” — Online.

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