Banks need overhaul, but risk to recovery, IMF says

By Douwe Miedema

WASHINGTON, Oct 8 (Reuters) - A much-needed pruning of banksacross the world could stifle lending and dampen economicrecovery, the International Monetary Fund said on Wednesday.

To boost profits, banks need to raise prices in certainbusiness lines, pull out of others altogether, and put theirmoney where it yielded more, the Fund said.

"The transition to new business models could ... potentially(create) a headwind against the recovery," the IMF said in itsbiannual Global Financial Stability Report.

After the devastating 2007-09 financial crisis, regulatorsacross the world have forced banks to raise more shareholderequity as a buffer against losses, and to pull out of theriskiest investments and loans.

But the industry had been slow in finding new ways to makemoney, and the return on equity of banks representing 80 percentof the assets of the largest institutions now was lower thanwhat was required by shareholders, the IMF estimated.

An overhaul would not be easy, however, the IMF said, and itpleaded for ailing banks to be shut down.

"This would help relieve competitive pressures in a contextof excess capacity and allow viable banks to build and maintaincapital buffers and meet credit demand," it said.

In a model run, the IMF found that 20 percent of more than300 banks - measured by assets - would need to raise lendingmargins by more than 50 basis points on their entire loan book,a level it said was not realistic.

The largest transitions were needed in some euro areacountries, in the United Kingdom and in Japan. Many banks in theeuro area had been slow to adjust, and an upcoming test of theirfinancial health by the European Central Bank created a "goldenopportunity" to clean up balance sheets.

Banks should also stop selling products at low prices, oreven at a loss, to lure clients and try to sell them otherproducts, the IMF said. Regulators should encourage them toadopt more transparent pricing models.

The report also showed how banks had started pulling back,though only two - the UK's Royal Bank of Scotland andSwitzerland's UBS - had completely exited a business.

The fixed-income business, in which banks trade non-equityproducts for clients, showed the largest exodus, with banks suchas Goldman Sachs Group Inc, JPMorgan Chase & Co and Barclays PLC all selectively shrinking, the IMFsaid.

That business is under pressure as a result of some of thebiggest regulatory changes introduced after the crisis. (Reporting by Douwe Miedema; Editing by Jonathan Oatis)