European banks could be forced to sell as much as $US4.5 trillion in assets if the sovereign debt crisis escalates.
The International Monetary Fund says time is running out for European policy makers to implement a single supervisory system to firewall the already fragile banking sector.
According to the , the $US4.5 trillion asset contraction is up 18 per cent on an earlier estimate in April of $US3.8 trillion in a "weak policies scenario".
A failure to introduce fiscal tightening or a single regulatory system for banks could affect 58 banks across the EU from small institutions to giants like Deutsche Bank.
Even without a worst case scenario - a fracturing of the eurozone that could see the redenomination of currencies - the IMF is predicting a reduction of bank assets of US$2.8 trillion, provided governments follow up on their current commitments.
The IMF has estimated that in the year to June, European banks deleveraged by more than $US600 billion.
The IMF's financial counsellor and director Jose Vinals warns the forces of financial and economic fragmentation have widened.
"The stakes are high.
Confidence is still very fragile and risks have increased when compared to the last report in April," Mr Vinals said.
"Actions taken by the European Central Bank have helped remove investors' worst fears, but these policies will need to be further built upon at both the national and euro area level." The IMF's warning comes just a day after .
While emerging markets have weathered the fallout from Europe so far, the IMF warned that many countries in eastern Europe were vulnerable.
The IMF says emerging Asian nations also need to be on guard to avoid any European spillover.
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By business editor Peter Ryan | ABC – 6 hours ago
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