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The global financial market remains sensitive to negative surprises, and can quickly shift back to crisis mode, warns the International Monetary Fund.

According to the IMF, rising public debt burdens, funding challenges for banks, and increased uncertainty about the next phase of the recovery have prevented a return of confidence.

In its "Global Financial Stability Report," IMF notes that banking systems face several structural vulnerabilities, as a result of incomplete reforms and highly leveraged balance sheets. In some countries, there are unprofitable and weakly capitalized banks that remain reliant on government or central bank support.

As the global financial system remains vulnerable, the report says policymakers need to take action on a number of fronts for the recovery to continue. They include addressing banks’ legacy problems, such as bad assets and nonperforming loans, and fixing structural problems in the banking sector in order to protect governments from further risks associated with public support of the banking system.

Other actions needed include raising more and higher quality capital by banks to provide a stronger buffer against future shocks.

IMF notes that the new Basel reforms to strengthen bank capital and liquidity are a substantial improvement over the rules in place before the crisis, but these apply only to a subset of the financial system, and they don’t yet include systemic institutions and the impact of the business cycle on how financial institutions function.

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