Losses from the credit crisis by financial institutions worldwide are expected to balloon to almost $1 trillion (£507 billion), threatening to trigger severe economic fallout, the International Monetary Fund said yesterday.

In a grim assessment of the deepening crisis delivered days before ministers from the Group of Seven leading economies meet in Washington, the IMF warns governments, central banks and regulators that they face a crucial test to stem the turmoil.

“The critical challenge now facing policymakers is to take immediate steps to mitigate the risks of an even more wrenching adjustment,” it says in its twice-yearly Global Financial Stability Report.

The IMF sounds an alert over the danger that banks’ escalating losses, along with credit market uncertainties, could prompt a vicious downward spiral as they weaken economies and asset prices, leading to higher unemployment, more loan defaults and still deeper losses. “This dynamic has the potential to be more severe than in previous credit cycles, given the degree of securitisation and leverage in the system,” the Fund argues.

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

• Citigroup set to sell debt to private equity firms

• IMF boss says pressure grows for crunch action

• IMF’s blame list to top global crisis meeting

Multimedia

• Read the IMF report in full

• The toll according to the IMF

• Full coverage of the credit crisis

It says that it is clear that global financial upheavals are now more than just a shortage of ready funds, or liquidity, but are rooted in “deep-seated fragilities” among banks with too little capital. This “means that its effects are likely to be broader, deeper and more protracted”, the report concludes.

“A broadening deterioration of credit is likely to put added pressure on systemically important financial institutions,” it adds, saying that the risks have increased of a full-blown credit crunch that could undercut economic growth.

The warning came as Kenneth Rogoff, a former chief economist at the IMF and currently Professor of Economics at Harvard University, said that there was a “likely possibility” that the Fund will have to coordinate a global policy package to prop up the US economy. “They [the US] would not go for a conventional bail-out from the IMF. The IMF could not afford it – they have around $200 billion, which the US would burn through in a matter of months. It would be a package where various countries would try and prop up global demand to cushion the US economy.” He added: “The US is going to be looking for help to prevent this banking and housing problem from getting worse.”

The report also highlights the threat posed by the rapid spread of the credit crisis from its roots in the US sub-prime home loans to more mainstream lending markets worldwide.

While banks have so far declared losses and writedowns over the crisis totalling $193 billion, the IMF expects the ultimate toll to reach $945 billion.

Global banks are expected to shoulder about half of the total losses – between $440 and $510 billion – with the rest being borne by insurance companies, pension funds, hedge funds and money market funds, and other institutional investors, predominantly in the US and Europe.

Most of the losses are expected to stem from defaults in the US, with $565 billion written off in sub-prime and prime mortgages and a further $240 billion to be lost on commercial property lending. Losses on corporate loans are projected to mount to an eventual $120 billion and those on consumer lending to $20 billion.

Explore Economics

• Pre-Budget Report 2008

• Budget 2009

• World Economic Forum

• The Times MPC

Times Recommends

• C&G axed - 1,660 jobs to be lost
• UK house prices rise 1.1% as buyers return
• Mixed reaction to US banks repaying bailouts