Europe needs tough bank tests to maintain recovery: IMF

(WASHINGTON) - The IMF pressed Europe on Monday to conduct credible stress tests on its banks so as to restore market confidence in a sector strained by a eurozone debt crisis threatening a modest recovery.

The eurozone's economy is expected to grow a modest 1.6 percent this year and 1.8 percent in 2012, the IMF said in its World Economic Outlook, a 0.1 percentage point improvement from a January update.

But the recovery is "gradual and uneven" within the 17-nation eurozone, with markets still "apprehensive" about the future of countries under sustained pressure from investors.

"For them what is needed at the euro area level is sufficient, low-cost, and flexible funding to support strong fiscal adjustment, bank restructuring, and reforms to promote competitiveness and growth," the IMF said.

The eurozone needs to restore "greater trust" in eurozone banks by launching "ambitious stress tests and restructuring and recapitalisation programmes," the IMF said, warning of a "lack of transparency" about their exposure.

"In the near term, continued strains in more vulnerable euro area sovereigns and banks pose a significant threat to financial stability and growth," the IMF said.

"This is mainly due to continuing weakness among financial institutions in many of the region's advanced economies and a lack of transparency about their exposures," it said.

The European Banking Authority (EBA) said last week it would conduct stress tests on 90 banks and apply tougher criteria.

Assessments done last year were roundly criticised because they gave most banks -- including those in bailed-out Ireland -- a clean bill of health.

"New stress tests that are more realistic, thorough, and transparent will increase clarity," the IMF said. "But they will be effective only if embedded in coordinated national strategies to deal with vulnerable institution."

After shelling out 110 billion euros for Greece and 67.5 billion for Ireland last year, European finance ministers agreed Friday to throw an 80-billion-euro lifeline to Portugal in return for more spending cuts and tax increases.

"The recovery in Europe has been gaining traction, despite renewed financial turbulence in peripheral countries of the euro area during the last quarter of 2010," the report said.

The IMF raised its growth forecast for Germany by 0.3 points to 2.5 percent this year and by 0.1 point to 2.1 percent in 2012.

The French economy will grow 1.6 percent this year and 1.8 percent in 2012, unchanged from the last forecast.

The Greek economy will shrink 3.0 percent this year but bounce back with 1.1 percent growth in 2012. Once dubbed the Celtic Tiger, Ireland will see growth of 0.5 percent in 2011 and 1.9 percent in 2012.

Spain, the eurozone's fourth biggest economy which launched deep spending cuts and reforms to fend off fears it will need a bailout, will record growth of 0.8 percent this year and 1.6 percent in 2012.

The EU was able to contain the crisis with "strong policy responses" at the national and EU level, including reforms, the Irish bailout and the European Central Bank purchase of weak sovereign bonds in secondary markets, it said.

But the IMF said that "further bold steps are needed to secure fiscal sustainability, resolve banking sector problems, reform EU policy frameworks, and rekindle growth."

The austerity programmes launched across Europe are "broadly appropriate" but some reform plans need to be strengthened "in the face of looming increases in pension and health spending."

The debt crisis highlighted the need for the eurozone to improve fiscal policy coordination in a 17-nation area of widely different economies, the IMF said.

"In many ways, the European Union and the euro area are at a crossroads. Popular support for the euro remains strong, considering the tensions created by sharing sovereign risk," the report said.

"But unless economies make a quantum leap toward a more integrated approach to fiscal policy and assume joint responsibility for financial stability, support for burden sharing may be much lower in future crises."