IMF Warns Of New Global Credit Crunch Threat

The International Monetary Fund (IMF) has raised the prospect of a second credit crunch worldwide as European banks slash their balance sheets in the face of the euro crisis.

The Washington-based organisation said it expected the world's biggest banks to slash their size by $2.6 trillion (£1.6 trillion) by the end of next year.

That represents a 7% squeeze in the size of their combined balance sheets.

It will mean businesses in Britain and throughout Europe are likely to face even more trouble borrowing from banks.

The IMF said it expected a quarter of this balance-sheet crunch to come in the form of lower bank lending, with the rest involving selling off assets and securities.

It said the squeeze was already well underway, with banks having reduced their balance sheets by $580bn in the final quarter of last year.

The IMF also said "there is a risk that a large-scale reduction in assets by European banks could lead to a credit crunch" of the kind seen in the early stages of the credit crisis in 2008/09.

In this scenario, it said, banks could shed $3.8 trillion, or 10%, of their total assets and world economic growth would be 1.4% lower than it forecast in its World Economic Outlook report earlier this week.

The warning will cause concern in the UK, where small and medium sized businesses are still struggling to raise cash, which in turn has caused many to lay off staff.

The IMF said that although euro area nations such as Spain and Italy would be most affected by the squeeze, Britain would suffer a near 1% fall in bank credit even on the basis of its conservative forecast.

It said: "Small and medium-sized enterprises (SMEs) are likely to be most affected.

"Even where credit is maintained, corporate borrowers could face elevated borrowing costs."

The warning came in the Global Financial Stability Report, published at the IMF's Spring summit in Washington DC.

IMF financial stability chief Jose Vinals said: "So far current policies have prevented a generalized 'credit crunch', but we still anticipate a considerable squeeze on credit which will impede growth."

He said that the European Central Bank's emergency LTRO lending scheme had helped soothe euro financial markets, but said it was too early to assume the crisis had been averted.