European banks should be required to disclose their exposure to the US subprime market, the International Monetary Fund said on Monday.
However, it cautioned that regulators should not overlook the benefits of financial market innovation that have been “a powerful source of growth” for the continent.
Launching its inaugural Regional Economic Outlook in London, the IMF said that the European economy was resilient enough to withstand the turbulence in financial markets but it also warned regulators not to “throw the baby out with the bath water” as they moved to learn from the credit squeeze by improving risk assessment.
Michael Deppler, director of the European department, expected “a moderate slowing with risks ahead”. These included a prolonged downturn in the US housing market and rising oil and commodity prices.
“Downside risks stem from a concern about the losses associated with US-based structured products turning out to be larger [than expected], which ends up constraining banks in their lending capacity, then things could get sticky,” he said.
Otherwise the IMF left unchanged its forecasts for Europe – embracing both European Union and non-EU countries – from last month’s World Economic Outlook, of growth slowing from 3.7 per cent this year to 3.2 per cent in 2008.
Growth rates in advanced countries are projected to fall from 2.7 per cent to 2.2 per cent and in emerging European economies, from 6.3 per cent to 5.7 per cent over the same period.
Mr Deppler ascribed Europe’s resilience to “generally sound macroeconomic policies”. European economies were less exposed to a housing downturn than the US and did not have a sub-prime mortgage market problem.
“Housing markets in Spain, UK and Ireland are at one end of the spectrum but for the continent as a whole, it is reasonably balanced,” he said. “There is no corresponding problem with lending to Europeans that we can detect.”
He called on policymakers to require banks to be more transparent. Lack of transparency regarding which banks were most exposed to US subprime assets had sapped confidence and contributed to the drying up of liquidity, he said.
However, he warned against over-zealous regulation which might impede innovation. “It’s important that the need to repair the malfunctioning of the market does not end up with the baby being thrown out with the bath water,” he said.
“Financial innovation is an important source of strengthened performance over the medium term and as such must be allowed – and indeed encouraged – to flourish,” the report said.
The IMF said the European Central Bank’s main interest rate had been “appropriately kept on hold in view of downside risks associated with the financial turmoil”. But Mr Deppler said rates might have to go up to counter rising inflationary pressure once those risks had dissipated. The ECB has raised its main rate eight times in the past two years but left it unchanged at 4 per cent last week.
