Many European banks need bigger capital cushions to restore market confidence and help reduce the risk of another financial crisis, the International Monetary Fund said on Wednesday.

Banks globally face a $3.6 trillion wall of maturing debt coming due in the next two years. The rollover requirements are most acute for Irish and German banks, the fund said in its Global Financial Stability Report.

These bank funding needs coincide with higher sovereign refinancing requirements, heightening competition for scarce funding resources, the IMF said.

Increasing the quantity and quality of capital would provide a greater cushion against future losses and help restore access to funding markets, it said.

Overall, the IMF said global financial stability has improved over the past six months. The most pressing challenges in the coming months will be funding of banks and sovereigns, particularly in vulnerable euro area countries, it said.

U.S. banks built up capital buffers in 2009, when regulators completed a set of stress tests that revealed some large holes. But European banks still need to raise a significant amount of capital to regain access to funding markets, the fund said.

It is... imperative that weak banks raise capital to avoid a pernicious cycle of deleveraging, weak credit growth, and falling asset prices, it warned.

The European Central Bank's upcoming stress tests provide a golden opportunity to improve bank balance sheet transparency and reduce market uncertainty about the quality of assets on banks' books, the IMF said.

European banks won't be able to obtain all the necessary capital from markets, and public money may have to fill some of the gaps, it added. Banks could also cut dividend payouts and retain a larger portion of earnings.

Overall, a comprehensive set of policies -- including capital-raising, restructuring and where necessary resolution of weak banks, and increased transparency about banking risks -- is needed to solve banking system vulnerabilities, it said. Without these reforms, downside risks will re-emerge.

LIVING DANGEROUSLY

The IMF said banks' exposure to troubled sovereign debt is uncertain, which adds to the funding strains.

It said government debt was generally high and on a worryingly upward path in many advanced economies. It repeated its warning that the United States and Japan faced particularly dangerous debt dynamics.

Advanced economies were living dangerously with high debt burdens, and faced the difficult task of trying to pare deficits without choking off the economic recovery.

The Fund said government interest bills would likely rise, although the burden should generally remain manageable provided countries proceed with deficit reduction plans.

For 2011, Japan and the United States face the largest public debt rollovers of any advanced economy at 56 percent and 29 percent of gross domestic product, respectively.

While the United States and Japan continue to benefit from low current (borrowing) rates, both are very sensitive to a potential rise in funding costs, it said.

Japan International Monetary Fund