The global financial system remains "fragile," with sovereign debt posing a risk to markets and substantial losses expected from commercial real estate, the International Monetary Fund said.

Banks may need to significantly increase their capital to support the credit recovery and help sustain economic growth, the IMF said Tuesday in an update to its Global Financial Stability Report, last published in October. Emerging economies should be prepared to protect against capital inflows that are beginning to create asset bubbles and pressures on exchange rates, the IMF, of Washington, said.

As banking firms try to repair their balance sheets, the report said losses from commercial real estate are likely to "increase substantially." Credit markets are likely to remain impaired as banks tighten lending conditions while attempting to boost their capital.

"A combination of continued bank writedowns, funding and capital pressures and weak credit growth are expected to limit future bank profitability," the report said. "Even with overall improvement, however, the repair of the financial system is far from complete, and financial stability remains fragile."

Restarting credit flows remains a "major challenge," said Jose Vinals, director of the IMF's monetary and capital markets department, at a briefing in Washington. He said "substantial additional capital is required" to help stabilize the banking industry.

The IMF, which has rescued economies from Iceland to Pakistan during the financial crisis, did not update its forecast from last year that worldwide losses tied to distressed loans and securitized assets may reach $3.4 trillion by the end of this year. Still, the report said the "recovery in securities prices on banks' balance sheets suggests the estimate would be somewhat lower" if calculated again today.

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