Businesses and consumers are likely to find credit tougher to obtain and more expensive well into next year, an added problem for the global economy as it struggles to gain traction, the International Monetary Fund is warning.
The IMF is bracing for large "financing gaps" in the U.S., Europe and elsewhere because bank balance sheets remain so badly damaged in the aftermath of the credit crisis.
"Our scenarios envisage the supply of bank credit falling for the remainder of 2009 and into 2010, both in the United States and Europe," according to a twice-yearly IMF financial stability report slated to be released Wednesday at the fund's meeting in Istanbul.
"It appears that supply may fall short of even anemic private sector demand. As a result, pressure on funding rates could increase and the flow of credit to support recovery could be curtailed."
Shrinking credit serves as another challenge facing the global economy - along with industrial overcapacity, high unemployment, thrifty consumers and other factors - problems that could keep the recovery from gaining pace until late 2010 or beyond. Though excessive credit is widely blamed for much of the financial crisis, when even healthy businesses and consumers can't get loans, it's particularly tough for the economy to expand and create many new jobs.
Banks have begun to rebuild their capital bases, and many are seeing higher profits, but they are not anxious to extend credit, even to the dwindling pool of eager borrowers.
For consumers, this means there's less credit to buy cars or homes. And for businesses, it leaves capital markets as the main alternative for financing their activities.
Officials from the IMF, a global organization steering the financial system, and its sister lending organization, the World Bank, are meeting this week in Istanbul for the first time, along with finance ministers and central bankers from the Group of Eight. The meetings are normally held in Washington, where the fund and the bank are headquartered.
The IMF now estimates that total losses from the financial crisis will reach $3.4-trillion (U.S.), down from an earlier forecast of $4-trillion.
Banks worldwide are still facing another $1.5-trillion in loan losses, on top of $1.3-trillion worth of writedowns taken through the first half of this year, the IMF report said. The report also said U.S. banks have worked their way through about 60 per cent of the bad loans, while European and British banks are just 40 per cent done.
The report doesn't cover the Canadian market, but similar trends are also at work. Canadian households took out new loans (mortgages, lines of credit and so on) totalling about $38.8-billion (Canadian) in the first half of this year, compared to $56.2-billion in the same period last year, and $57.6-billion in the first half of 2007, according to Statistics Canada data compiled by Toronto-Dominion Bank.
While mortgage prices are low, the major Canadian banks have been raising prices on a number of loan products, from consumer lines of credit to business loans. Bank executives suggest the price increases will continue, as the banks seek to recover their profit margins in the wake of the financial crisis. Banks had to pay more to obtain funds to lend out during the crisis, crimping their margins.
For example, Toronto-Dominion Bank recently notified customers that it will be increasing the rate on home equity lines of credit (HELOCs) to prime plus one percentage point. A number of its competitors had already raised their prices on HELOCs.
Economists expect softer demand for loans as households cut their budgets and try to rebuild their retirement savings in the wake of the financial crisis.
While consumers aren't gobbling up as many new loans as they once did, business borrowing is actually contracting. The total amount of bank financing that Canadian households had in July was 9.7 per cent higher than a year ago, but the amount of credit banks had extended to business had shrunk by 1.7 per cent. The banking industry argues that the pace of business lending has dropped off quickly in recent months as the recession causes companies to draw down their inventories and delay capital spending.
The IMF pointed out that while the home mortgage market is on the mend, banks are facing rising losses on commercial real estate, and corporate and consumer loans. In the United States, for example, the rate of loan losses in those areas may not peak until late 2010.
The report acknowledged that the "extreme systemic risks" of the past year have abated. But the fund cautioned that complacency about repairing the damaged banking system remains a concern.
On the demand side, the IMF said it expects combined private sector - consumer and business - demand for loans to shrink this year and grow a mere 0.5 per cent next year in the United States.
That means that central banks worldwide will have to continue pumping large amounts cash into the system much longer than anticipated - either though low interest rates or unconventional easing techniques, such as purchasing mortgage bonds.
"An expansion of central bank balance sheets remains a policy option to supplement credit provision," the report said.
The fund also urged authorities to start thinking about how to unwind all their easy-money policies.
"While the time is not ripe for full-fledged disengagement from all the unconventional policies undertaken - indeed in some countries additional public resources may still be needed - it is time for policy makers to consider and articulate … [how]policies may be unwound," the report said.
China may be the first major economy to move away from easy money. Credit Suisse Group said in a report Tuesday that China may start increasing bank reserve requirements in the fourth quarter of this year and then raise rates by up to two percentage points next year.
The IMF also urged countries to move faster at taking toxic assets off banks' books. And as it has in the past, the IMF urged countries to continue co-ordinating their actions to prevent "potential negative spillovers."
The U.S. Federal Deposit Insurance Corp. said Tuesday that bank failures will cost it roughly $100-billion over the next four years. As a result, it wants financial institutions to prepay their premiums to cover a widening deficit at the agency, which insures deposits at member banks.
With files from reporter Tara Perkins in Toronto