An Organization for Economic Co-operation and Development committee has expanded its estimates of the possible losses caused by the credit crunch, and said that the current financial crisis demands fundamental reform of the financial system and its regulation.

Following a meeting this week, the OECD Financial Markets Committee stressed that priority should be given to private sector initiatives to speed up the recovery of financial markets, but government intervention may also be needed, it allowed. The committee endorsed the recent recommendations from the Financial Stability Forum and G7 designed to address the crisis, but added that a more modern and dynamic approach to financial regulation is needed.

After a meeting with private market participants to discuss the financial turbulence, the committee noted that there was a widespread view that the outlook for financial markets and stability remains uncertain, and they estimated that it will take 12 to 18 months for financial markets to recover. “This estimate reflects the “fear factor” that pervades markets at present and the likelihood that long-term investors may not return to markets within a short time frame,” it noted.

There are private sector initiatives to speed up the healing process, the OECD said, such as removing uncertainties related to asset valuations. It added that many private sector representatives acknowledge the need for regulatory initiatives too, but they also called for an enhanced dialogue to ensure that measures taken are both effective and efficient and do not constrain innovation.

The chair of the committee, Thomas Wieser, director general at the Austrian Ministry of Finance, suggested that the existing regulatory framework reflects the “simple” world before globalisation. “We need to ensure a cooperative framework for financial markets that takes account of new realities, and enhances stability, whilst retaining efficiency,” he said.

In 2007, the OECD estimated that losses from the crisis would amount to approximately US$300 billion. Now, using a different methodology, the OECD estimates that first round losses (not write-downs) could reach US$422 billion.

“If losses reach this level, the recapitalisation of banks would be essential to avoid the harsher economic impacts of deleveraging, including a pronounced drop-off in credit extension,” it said, adding that it could take six to 12 months for banks to grow themselves out of losses of this size, and longer if capital for actual expansion were required. “Limited credit availability over such a period would have severe economic consequences,” it warned.

The OECD also noted that the world is moving to a situation in which individuals bear more and more risks, not only in credit markets, but also insurance and pensions. “This situation calls for a new culture of risk awareness and financial education mechanisms that the OECD promotes,” it said.