IMF Executive Board Discusses Systemic Crises, Financial Linkages, and the Role of Global Financial Safety NetsPublic Information Notice (PIN) No. 11/98
July 25, 2011
Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case.
On June 27, 2011 the Executive Board of the International Monetary Fund (IMF) discussed a staff paper on the “Analytics of Systemic Crises and the Role of Global Financial safety Nets” and a companion background paper on "Mapping Cross-Border Financial Linkages—A Supporting Case for Global Financial Safety Nets."
In response to the 2008/09 global crisis, the IMF overhauled its lending toolkit and boosted its resources, strengthening its ability to pre-empt financial crises. These papers examine the global crisis against past systemic crises to assess if rising financial linkages across countries is a source of latent systemic instability, and ascertain if the global financial safety net (GFSN) is adequate to contain crisis and contagion risks arising from such systemic instability.
Cross border financial linkages have intensified over time and become more complex, although a few “core” advanced economies still dominate the web of linkages across asset classes and regions. Increased cross-border financial linkages promote risk diversification, reducing exposure to localized shocks, but they also facilitate transmission of shocks, making the global financial network more prone to systemic risk.
The papers identify four clusters of systemic crises since 1980 based on a new indicator: the 1982 Latin American debt crisis, the 1992/93 European Exchange Rate Mechanism crisis, the Asian/Russian/Long Term Capital Management crises of the late 1990s, and the 2008 global financial crisis. A large number of countries were affected in these crises, including a group of “crisis bystanders,” i.e., countries with relatively strong fundamentals for which likelihood of an idiosyncratic crisis would normally be low.
Analysis of policy responses to past systemic crises suggests that they tended to be mostly driven by domestic considerations rather than guided by global concerns, and to be reactive and uncoordinated. Lessons from the analysis suggest that to fortify management of systemic crises, improved bilateral and multilateral surveillance to minimize the likelihood of systemic crises could be complemented with enhancements to the financial safety net, especially proactive liquidity provision to mitigate the impact of systemic shocks.
Executive Board Assessment
Executive Directors welcomed the opportunity to discuss again the role of the Fund in managing systemic crises, building on lessons from past episodes and an analysis of cross-border financial linkages. Directors noted that the growing complexity of linkages among countries carries with it the risk of systemic instability, raising the odds of severe economic and financial distress and widespread contagion. As evidenced in past systemic crises, even those countries with relatively strong fundamentals and solid policy track records (the “crisis bystanders”) are not immune from the rapid and wide-spread transmission of shocks across national borders, especially when amplified by investors’ herding behavior.
Directors observed that the unprecedented policy response during the recent global crisis was commensurate with the scale of the crisis, which helped mitigate—and subsequently reverse—the loss of output and market confidence. More broadly, Directors recognized that major central banks had played a crucial role in providing hard currency liquidity during several systemic events, complementing efforts by the Fund and other international financial institutions. Although monetary policy decisions, in the context of the recent financial crisis, remained governed by central banks’ domestic mandates and objectives, these objectives happened to coincide with global interests. Going forward, greater predictability and coordination of policy responses to systemic events would be desirable, although a number of Directors were of the view that the unpredictable nature of shocks as well as moral hazard concerns would warrant flexibility in designing crisis response. A number of Directors also underscored the importance of maintaining an appropriate level of reserves as a safety buffer against external shocks.
Most Directors saw scope for exploring further enhancements to the global financial safety nets to provide timely and adequate liquidity to crisis bystanders and, more generally, to foster greater global cooperation, particularly involving regional financing arrangements, with many indicating their readiness to explore a range of options with an open mind. Nevertheless, many Directors called for a thorough assessment of the existing Fund instruments, including demand during the recent crisis, to inform a consideration of any changes to the toolkit. A number of Directors did not see gaps in the global safety nets at this time, noting that bilateral and regional financing arrangements had proved effective in the recent crisis, and that recent reforms of the Fund’s precautionary lending instruments and an augmented resource base have strengthened the ability of the Fund to support its membership during systemic crises.
Directors’ views varied on the modality for enhancing the Fund’s role in systemic crisis events. A number of Directors saw merit in considering a mechanism or a structured approach that would allow the Board to activate a set of appropriate policy actions, including the provision of short-term liquidity, once a systemic event is identified. While many Directors saw room for adapting existing precautionary facilities for such purposes, a number supported, or were open to, creating a new short-term liquidity facility. In this context, Directors offered specific suggestions for consideration in further work. These include revisiting aspects of existing facilities such as prequalification criteria, access, conditionality, and exit strategies; and establishing a special Poverty Reduction and Growth Trust-type account to finance a new facility.
Directors stressed that any reforms to the Fund’s toolkit would have to embed safeguards to Fund resources and minimize moral hazard. They also emphasized the need to assess carefully resource implications of any new proposals. Some Directors considered it worthwhile to explore ways to mobilize resources for emergency provision of short-term liquidity; however, a few others expressed a preference to work within the existing resource envelope.
Directors underscored that strengthening the global financial safety net goes hand-in-hand with efforts to better identify the buildup of systemic risks and improve crisis prevention. This requires effective and even-handed bilateral and multilateral surveillance, sound macroeconomic policies, and strong regulatory frameworks—including for cross-border resolution—as well as adequate supervision of the financial sector. The effectiveness of the Fund’s role in systemic crises also depends on close coordination with central banks, regional institutions, and other relevant international bodies.