Even though bank balance sheets are on aggregate stronger than they were before the global financial crisis, a cyclical recovery won’t solve the problem of weak bank profitability, according to the International Monetary Fund.

In its latest Global Financial Stability Report, the IMF says short-term risks have abated since its previous assessment in April but medium-term risks are building because of low economic growth and prolonged low interest rates.

“Since the crisis, enhanced regulation and oversight have strengthened banks’ capital and liquidity buffers, making them safer,” the Fund said. “However, this new era of low growth and low rates threatens to undermine these gains.”

In particular, according to the report, weak bank profitability has emerged as “a looming financial stability challenge for many advanced economy banks,” one that a cyclical recovery will not be enough to address.

Euro-area banks are earning less than half their 2004-2006 average profits and the IMF said a third of European banks, with $8.5 trillion in assets, and a quarter of U.S. banks, with $3.2 trillion in assets, are so weak their problems could not be solved by a cyclical recovery.

“This suggests the need for fundamental changes in both bank business models and system structure to ensure a vibrant and healthy banking system,” the IMF said.

“A bold structural reform program,” the Fund recommended, should address the legacy issues of high nonperforming loans, corporate insolvency frameworks, and the weak tail of European banks; enhance operational efficiencies and strengthen business models; and consolidate and reduce excess capacity to support sustainable revenue and efficient allocation of credit.

As part of the updating of business models, some weak banks “will have to exit and banking systems will have to shrink,” the IMF said.

“This is important to ensure that the remaining banks have sufficient credit demand to foster a vibrant and healthy banking system that can grow and sustain its strengthened capital and liquidity buffers,” it added.

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