The International Monetary Fund on Wednesday lowered its estimate for global writedowns for banks and other financial institutions to roughly $3.4 trillion but warned that loan losses were set to rise as unemployment and associated delinquencies increase.

In April the IMF estimated in its Global Financial Stability Report that global bank losses could reach $4 trillion but said it cut the figure by $600 billion to reflect rising securities values and new methodology for calculating writedowns.

This improvement is welcome but there are still significant challenges ahead, particular for banks, said Jose Vinals, director for the IMF's monetary and capital markets division.

The report said that while banks have enough capital to survive, their earnings are not expected to fully offset writedowns expected over the next 18 months.

Vinals said banks were starting to make money again after severe losses in the face of the global financial turmoil but urged them to conserve their profits and not to pay dividends.

There is a temptation when you go back into profits to have the equity buybacks and the dividend payouts, he told a news conference in Istanbul before the start of the semi-annual World Bank and IMF meetings.

Capital conservation is something that is very important at this stage, said Vinals.

He said while bank balance sheets had been stabilized with the help of government support, they did not have enough capital to meet credit demand as economies recovered.

He said stronger action was needed to bolster bank capital and earnings capacity to ensure banks could support a recovery.

The Fund said while private-sector credit growth has contracted in big economies, overall borrowing needs have not slowed as quickly because of burgeoning government deficits.

The likely result is constrained credit availability, it said, adding that continued support by central banks may be required to alleviate this.

Using new methodology to calculate the writedowns, the IMF said bank losses on loans and securities holdings amounted to $1.3 trillion through the first half of 2009 but emphasized that about $1.5 trillion in writedowns still needed to be recognized.

The report said U.S. institutions were about 60 percent through their needed writedowns, while their euro area and British counterparts had recognized only 40 percent of losses.

DEAL WITH IT

It said loan losses are expected to account for around two- thirds of total writedowns between 2007 and 2010, with housing the hardest hit in the United States and foreign loans the big contributors to loan losses in Britain and the euro area.

The IMF urged authorities to deal with troubled assets still on banks' books, adding that reassuring stress test results and signs of economic stabilization have eased pressure to deal with the toxic debt.

Authorities, banks and investors need to persevere with these programmes, the IMF said, adding that in countries where banks were undercapitalized, such toxic assets should be ringfenced to reassure markets about future losses.

Only when this source of uncertainty has been substantially reduced can banks fully participate in providing credit for recovery, the IMF said.

The Fund said financial conditions in emerging markets have improved thanks to strong policies but estimated that companies faced foreign currency debt refinancing needs of $400 billion over the next two years.

(Editing by Jan Dahinten and Stephen Nisbet)

International Monetary Fund