The world must prepare for a protracted period of turbulence in the financial sector with far-reaching consequences for global growth, the International Monetary Fund says today.

The world body says that the US sub-prime mortgage meltdown and other forms of risky credit that have caused massive liquidity problems show the need for wide-ranging change in the way that financial markets are run.

In its latest Global Financial Stability Report, published today, the IMF sets out a menu of reforms that regulators, investors and financial institutions must make to deal with the credit squeeze.

But it gives warning that "downside risks have increased significantly" to the pace of economic growth.

Even if those risks fade, the implications of the market turbulence will be "significant and far-reaching", it says.

The Stability Report says: "The potential consequences of this episode should not be underestimated and the adjustment process is likely to be protracted.

"Credit conditions may not normalise soon, and some of the practices that have developed in the structured credit markets will have to change."

The IMF calls for reforms in five areas:

More accurate and timely information is needed about how risks are managed and how banks manage their off-balance sheet vehicles. That task is made more complicated by the volume and complexity of information that could be made available.

Securitisation and financial innovation need to be re-examined, particularly whether the incentives for mortgage companies to monitor their risks need to change.

Ratings agencies should be scrutinised. The report says: "Ratings of complex structured products may have become too connected to facilitating origination." Equally, investors should be more careful to "look behind the ratings".

Banks that hold thinly traded complex products need to reconsider how they can price them to factor in the risk of a drop in liquidity.

Finally, banks need to realise that their risks may be larger than they would like, because the potential damage to their reputation can force them to accept losses on to their balance sheet even if they had attempted to offload the risk elsewhere.

The report concludes that "policymakers now face a delicate balancing act" to ensure that companies strengthen their systems for managing risk.

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