WASHINGTON, Oct 5 (Reuters) - European banks need "urgent and comprehensive action" to address legacy non-performing loans and bloated, inefficient business models that threaten to cripple them with too-low profits, the International Monetary Fund said on Wednesday.
In its latest assessment of global financial stability, the IMF said weak profitability in a low-interest-rate, low-growth environment could erode European banks' buffers over time, undermining their ability to support an economic recovery and weakening stability.
The warning comes as questions swirl through financial markets over Deutsche Bank. Germany's largest lender has been engulfed by a crisis of confidence since the U.S. Department of Justice last month demanded up to $14 billion to settle claims that Deutsche missold U.S. mortgage-backed securities before the financial crisis - an amount viewed as major drain on its capital.
Though the IMF report does not single out specific banks by name, Deutsche's health is expected to be a key topic of discussion when commercial bankers, central bankers, finance ministers and other policymakers converge in Washington this week at meetings of the IMF, the World Bank and the Institute of International Finance, a global trade group. Among those in attendance will be Deutsche Bank's chief executive, John Cryan.
"In the euro area, excessive nonperforming loans and structural drags on profitability require urgent and comprehensive action," the IMF said in the report. "Reducing nonperforming loans and addressing capital deficiencies at weak banks is a priority."
The report said many European banks are still struggling with high levels of impaired assets and low profitability, due to loan problems left over from the last financial crisis. Even if a cyclical recovery were to gain steam in the region, profitability would be too low for many banks to regain health and resolve problem assets, it said.
The report recommended that European regulators and policymakers strengthen insolvency regimes to allow banks to foreclose on legacy non-performing loans more quickly, while weaker banks need to be consolidated into stronger ones and costs need to be reduced.
"There are simply too many branches with too few deposits and too many banks with funding costs well above their peers," the IMF's deputy direct of monetary and capital markets, Peter Dattels, said in a statement. "Addressing these business model challenges is vital to ensure sustainable profitability."
Adoption of these measures, along with regulatory changes that boost confidence without a massive increase in capital requirements, could boost European banks' profitability by $40 billion annually. Combined with a cyclical recovery, they could boost the share of European banks considered "healthy" to 72 percent from 17 percent last year.
Despite the weakness in Europe, the IMF found that overall risks to global financial stability have declined since its last report in April. The recovery in commodity prices has aided some emerging markets and fears over China's economic slowdown have been eased by government policies aimed at shoring up growth.
The initial shock of Britain's vote to leave the European Union was well absorbed by markets and did not turn into a global contagion, the IMF said, adding that fallout now looked "more local than global." (Reporting by David Lawder; Editing by Leslie Adler)