As finance ministers and central bank chiefs fly to Washington this week to confront the toll from global financial upheavals, yesterday’s analysis of the credit crisis from the International Monetary Fund offered them plenty with which to grapple.

Even as the fund forecast that the turmoil will tighten, it looked backwards, in search of the causes and culprits and forwards, in search of cures, short-term and long.

The study pins the blame for spawning worldwide turbulence variously on reckless banks and their bosses, careless investors, lax regulators, rating agencies that lacked rigour, and insufficiently austere central banks.

It concluded: “There was a collective failure to appreciate the extent of the leverage taken on by a wide range of institutions and the associated risks of a disorderly unwinding.

Oil is the key to world recovery

The shock of $140 oil has created inflationary and deflationary pressures that threaten world economy and policy tools

• Former President Bush energy adviser says oil is running out

BACKGROUND

• Oil is the key to world recovery

• Banks may need to pump billions into scheme

• UK economic growth weakest for three years

Related Internet Links

• Full credit crunch coverage

BACKGROUND

• Happy days are over for UK households

• Banks restrict mortgages by brokers

• Credit crunch halves lending at Nationwide

• JPMorgan to cut Bear Stearns jobs

• George Soros: Crunch will bite deeper in UK

Related Links

• IMF fears crunch losses could hit $1 trillion

• IMF boss says pressure grows for crunch action

Multimedia

• Read the IMF report in full

“Private sector risk management, disclosure, financial sector supervision and regulation all lagged behind the rapid innovation and shifts in business models, leaving scope for excessive risk-taking, weak underwriting, and asset price inflation.”

Banks overestimated the extent to which, by offloading loans through both “off-balance sheet vehicles”, unpoliced by regulators, and by selling them on through securitisation, they could then also offload their risks, the report finds.

“As risks have materialised, this has placed enormous pressures back on the balance sheets of banks”, as “a surprising amount of risk has returned to the banking system from where is was originally dispersed”.

The basic model underpinning the proliferation of complex structured finance was “flawed”, the report finds. Many investors were “too complacent about the risks they were taking on, relying too heavily on ratings agencies for assessing the risks to which they were exposed”.

Regulators and central banks do not escape rebuke either.

Regulators worldwide are told to re-examine the way that off-balance sheet activities and the adequacy of banks’ liquidity, or access to ready funds, is policed. Central banks are told that they must “reflect on the role that monetary policy may have played in fostering a lack of credit discipline”.

As ministers prepare to thrash out responses to the crisis, the IMF offers an extensive catalogue of short and long-term proposals.

In the short term, it calls for steps to hasten banks’ disclosure of losses and risks of further exposure, and for them to make rapid writedowns to “cleanse balance sheets”.

Banks with weak capital bases should also immediately seek to raise new funding “even if the cost of doing so appears high”.

The IMF calls for regulators to promote consistency in the way institutions account for losses. The report also backs the potential, and highly controversial, use of public funds to stem the crisis, should it escalate.

The IMF says it would be vital for as little public money as possible to be used and for shareholders of reckless banks to “bear the full brunt” lest public bailouts encourage future crises.

Yet it concludes: “National authorities may wish to prepare contingency plans for dealing with large stocks of impaired assets if writedowns lead to disruptive dynamics.”

In the longer term, the IMF concedes that the lessons from the turmoil will “decisively” reshape the use of complex financial engineering.

The report advocates measures to standardise complex securities, reform ratings systems, improve transparency, curb off-balance sheet vehicles, toughen liquidity regimes for banks and bolster supervision.

Yet as pressure builds for a crackdown, the IMF also urges caution against “a rush to regulate, especially in ways that would unduly stifle innovation or that would exacerbate the effects of the current credit squeeze”.

Explore Economics

• Pre-Budget Report 2009

• Budget 2009

• World Economic Forum

• The Times MPC

Times Recommends

• Lies and cover-up at MG Rover exposed by report
• High oil prices push manufacturing costs up
• Primark founder steps down as chief executive