Europe must take "decisive action" to tackle the 900 billion euros ($956 billion) worth of non-performing loans (NPLs) the banks have on their books, the director of the Monetary and Capital Markets Department at the International Monetary Fund told CNBC.
The IMF's Jose Vinals said Monday that while important things had been done in Europe, and the euro zone in particular, to shore up the banking sector – such as regulations requiring banks to have a certain amount of capital – more needed to be done to clear up the bad loans.
Non-performing loans are loans that are in or close to default.
"Important things have been done, such as the increasing of capital of the banks, but there are still about 900 billion euros on NPLs that still need to be decisively tackled."
NPLs have been particularly prevalent in banking systems in southern euro zone countries including Italy, Portugal, Spain and Greece. Following the European Central Bank's asset quality review of 130 euro zone banks in October 2014, it found the total NPLs held by banks examined came to 879.1 billion euros.
These NPLs damage the entire economy, Vinals said, and could hamper Europe's tentative economic recovery.
"They capture capital and lower the profitability of the banks so the capacity of the banks to provide credit to the economy is lower. Banks with higher NPLs tend to have less willingness and ability to provide loans but Europe needs banks that lend to the corporate or household sector to support the recovery."
"Decisive action" needed to be taken on NPLs by European banking supervisors and also local authorities, he said, in terms of creating legal reforms on frameworks for debt restructuring. His comments come as in order to clean up a banking sector cluttered with 330 billion euros worth of NPLs, according to the IMF.
In terms of the wider global recovery, Vinals said it was too early to tell whether it had left the recession behind for good.
"What we have is a global recovery which is modest and uneven and doing slightly better in advanced economies, including the euro area and European Union, but which is not a vigorous recovery -- and emerging markets are losing strength."
In early October, the IMF trimmed its expected global growth forecasts for 2015 for a second time this year and warned that downside risks to the global economy appear "more pronounced." It forecast global growth of 3.1 percent in 2015 and growth of 3.6 percent in 2016.
Growth of that caliber depended on government policies, however, Vinals cautioned.
"One can only make that happen if one has an upgrade in the type of policies that governments put in place, for example, fiscal policies in those countries that have some room for maneuver to expand, like in Germany or the Netherlands, or structural reforms, which are something that most advanced economies and many emerging markets need."
- By CNBC's Holly Ellyatt, follow her on Twitter @HollyEllyatt. Follow us on Twitter: @CNBCWorld