(Reuters) The International Monetary Fund urged the European Union to quickly set up an agency that would close or salvage troubled banks across the continent as part of an effort to shed a mountain of bad debt impeding economic recovery.
The recommendation - one of a long list to address structural faults in the world economy - comes as European Union lawyers raised concerns about the plan to set up a so-called banking union.
Banks in euro-zone countries hit hardest by the debt crisis were forced to raise interest rates on risky loans to clients who had difficulty paying already, further worsening the chance they would get their money back, the IMF said.
"Investors' faith in euro-area bank balance sheets must be restored ... and banking union completed," the IMF said in its Global Financial Stability Report on Wednesday.
"Otherwise, the euro area risks entering a lengthy, chronic phase of low growth and balance sheet strains," it said in the report, which comes out twice a year.
The EU should also conduct rigorous probes - so-called stress tests - into the health of its banking sector, the IMF said, and identify ahead of time who would fill any capital shortfalls, in order to lend the exercise more credibility.
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