IMF calls for action as euro crisis escalates

NEW YORK (CNNMoney) -- The International Monetary Fund urged euro area policy makers Wednesday to address the worsening crisis in the currency zone.

Eurozone authorities have made some progress, but "stronger more collective action" is needed, according to an IMF review of policies in the 17-nation currency union.

The current situation in the eurozone is "at critical state," said Mahmood Pradhan, deputy director of the IMF's European department, in a conference call with reporters.

Specifically, the IMF recommends forming a banking union with common deposit insurance and a mechanism to resolve failed banks.

Eurozone leaders agreed last month to move towards more integrated oversight of the financial system, but stopped short of a full fledged banking union.

The goal is to break the "pernicious" link between banks and governments, in which weak financial institutions threaten to drag down states, and vice versa.

"It is vital that they make more progress towards a banking union," said Pradhan.

The eurozone banking system is "fragmented," Pradhan added, as governments encourage domestic banks to maintain liquidity. As a result, Pradhan said a banking union is important to ensure that access to credit is spread more evenly across the euro area.

"We hope they will follow up with a deposit insurance and resolution framework," he said.

In addition to joint banking regulation, the IMF called for deeper fiscal integration in the euro area. A more centralized approach to national budgets could help "reduce the tendency for economic shocks in one country to imperil the euro area as a whole," the report states.

Eurozone leaders also need to take steps to boost economic activity, including structural reforms in uncompetitive regions and targeted spending in more well off nations.

The European Central Bank, which recently cut interest rates to an all-time low, can do more, the IMF said. Pradhan thinks the ECB could lower interest rates further, offer more low-cost loans or "scale up" its controversial bond buying program.

The IMF stressed that Eurozone leaders need to act quickly to ward off a deepening crisis that could have serious consequences for the rest of Europe and the global economy.

"The euro area is in an uncomfortable and unsustainable halfway point," the IMF said in its report. "While it is sufficiently integrated to allow escalating problems in one country to spill over to others, it lacks the economic flexibility or policy tools to deal with these spillovers."