The debt crisis and the eurozone banking system still represents a risk to global financial markets despite the recent political relief, warned the International Monetary Fund (IMF).
The major policy measures taken recently generated some much needed relief to financial markets in the eurozone, which promoted the partial reopening of bank funding markets and the recovery of stock prices, the IMF said in its recent Report on the Global Financial Stability.
In late 2011, the banking and bond markets in the eurozone government faced intense risks to financial stability, he said.
"While financial policy actions reduced bank financing pressures in the eurozone and helped stabilize markets sovereign risks to global financial stability remain high," says the report.
European banks remain under strong pressure from sovereign risk for the sluggish growth of the eurozone, the large number of requirements for the refinancing and the needfor strengthen protections of capital to restore investor confidence.
These pressures, together, have prompted an increased reduction in the size of balance sheets, which could cause "serious damage" to asset prices, credit supply and economic activity in Europe and beyond, said Washington-based agency.
Although most emerging economies have political space to address the deleveraging forces emanating from Europe, their resistance could be tested in a scenario of slowdown, especially in emerging Europe, the report said.
U.S. and Japan have yet to achieve political consensus to reduce the deficit over the medium term, perpetuating the latent risks to financial stability, he says.