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Struggling Slovenia was warned on March 20 by the International Monetary Fund that its three biggest banks could need about €1bn of capital as bad loans grow amid the country's recession.

Bad debt at Nova Ljubljanska Banka (NLB), Nova Kreditna Banka Maribor and Abanka Vipa accounted for 20.5% of their total loans in 2012, up from 15.6% a year earlier, the IMF said in a report. This is part of a mountain of bad debt at the mostly state-controlled banks, which amounts to around €7bn, or 20% of GDP. The problem is being compounded by the weak economy, which shrank 2.3% last year and will probably contract 2% in 2013, the IMF said.

"A negative loop between financial distress, fiscal consolidation and weak corporate balance sheets is prolonging the recession," the IMF said in the report. "Lenders need to be substantially recapitalized", as their deteriorating loan portfolio is eroding capital.

The new government of Prime Minister Alenka Bratusek has pledged to continue boosting bank capital by as much as €4bn as well as cutting the budget gap.

"Financing requirements are particularly pronounced in summer, with bank recapitalization needed soon and a large 18-month T-bill coming due in June," the IMF continued, estimating Slovenia needs to borrow €3bn this year. A large part of this will have to come from external financing, it added, which "highlights the importance of safeguarding market access."

Tim Ash of Standard Bank calls the IMF report a reasonable assessment of the challenges. "The Fund comes out in support of the bad bank approach, with the use of a sovereign holding fund to manage state assets. The figures mentioned in terms of bank recapitalisation costs are as expected, as are the sovereign financing needs. The Fund commends fiscal consolidation, and progress in labour market reform and pension reform. They actually argue that fiscal stabilisers might be better allowed to work in 2013, as growth underperforms and this hits budget reveneues, so they argue no need for additional fiscal measures, which is encouraging.

"The Fund does though call for a new approach to state ownership, and more to be done in terms of privatisation, and a move away from the idea that 'national interests' precludes state asset sales, and especially to foreigners ... so the Fund message to the Bratusek government is one of keep up the reform momentum of the previous Jansa and before that Pahor governments. Progress is in the right direction and a bail-out is not inevitable, i.e. Slovenia's options are in its own hands. But I guess they are better reforming while global markets still remain liquid and benign."