## 1.  Income from Margin and Reserve Accumulation

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---

### I. Introduction and Implementation Progress
- Executive Board adopted package to reform the Fund’s income model in April 2008.
- New income model components:
  - creating an endowment funded with profits from a limited sale of the Fund’s gold holdings;
  - expanding the Fund’s investment authority to enhance expected return on the Fund’s investments;
  - resuming reimbursement of the General Resources Account (GRA) for the cost of administering the PRG Trust (subject to provisos described).
- Implementation status and timing:
  - Limited gold sales concluded in December last year.
  - Amendment to Articles to broaden investment authority became effective in February 2011.
  - Endowment expected to become operational in calendar year 2012.
  - A more transparent rules-based framework for assessing reserve adequacy and adjusting target for precautionary balances is being developed.
- Under new model, margin for the basic rate of charge should cover only intermediation (lending) costs and help build-up reserves (not cover all administrative expenses or meet a specific net income target).
- Since FY 2009 the margin has been set in line with principles endorsed in 2008, under the exceptional circumstances clause of Rule I-6(4).
- Staff proposes adoption of a new rule for setting the margin; proposed effective date: FY 2013 onwards.
- Executive Board set the margin on the rate of charge for FY 2012 at 100 basis points (decision not revisited by this paper).
- Next steps:
  - issuance of the midyear income review paper (early December) updating projections for FY 2012;
  - review early next year of adequacy of precautionary balances and update of medium-term projections and indicative target for precautionary balances;
  - annual income paper in April next year to review FY 2012 and FY 2013 income positions, including proposal for the margin under the new Rule I-6(4).

### II. Background: Basic Rate of Charge and Margin
- Basic rate of charge = SDR interest rate + margin (currently 100 basis points) + surcharges where applicable.
- Since 2005 margin is a fixed spread over the floating three-month SDR interest rate and under current Rule I-6(4) is set at the start of every financial year and reviewed at midyear.
- Prior to FY 2007, margin decisions primarily driven to cover total administrative expenses and accumulate reserves (net income target specified as a 5 percent increase in reserves under earlier rule).
- Exceptional circumstances clause added to Rule I-6(4) in April 2006 after a sharp decline in credit outstanding would have implied a margin over 350 basis points for FY 2007 under the old approach.
- Establishment of the Investment Account (IA) in April 2006 and April 2008 decisions to reform income model broadened income sources.

### III. Principles Endorsed for Setting the Margin (2008)
- Executive Board endorsed that:
  - The margin should be set in a stable and predictable manner;
  - The margin should be a margin over the SDR interest rate to cover the Fund’s intermediation costs and allow for a build-up of reserves (not cover the full range of Fund activities);
  - A mechanism should be developed to check that the margin is in reasonable alignment with long-term credit market conditions to ensure borrowing from the Fund does not become too expensive or too low relative to market borrowing costs.
- Since FY 2009 the margin has been set consistent with these principles, including:
  - covering estimated intermediation costs and allowing for reserve accumulation;
  - cross-check of alignment with long-term credit market conditions;
  - avoiding an overly mechanistic approach—judgment applied to pace of reserve accumulation, comparison with private market borrowing costs, and outlook for intermediation costs.

### IV. Proposed Framework for the New Rule (Summary)
- Key framework elements:
  - (i) the Fund’s intermediation costs;
  - (ii) operational lending income to cover intermediation costs and contribute to reserve accumulation;
  - (iii) a cross-check for alignment with long-term credit market conditions.
- New rule: margin set to cover intermediation costs and allow reserve build-up, with a cross-check against long-term credit market conditions.
- Proposed effective period: for FY 2013 onwards.

### V. Intermediation Costs: Definition, Estimation, and Recent Levels
- Intermediation costs comprise all costs related to the Generally Available Facilities (GAF): direct personnel expenses, direct travel costs, support and other administrative expenses, governance costs, and capital and depreciation expenses.
- Ongoing improvements to costing processes: ACES (Analytical Costing and Estimation System) expected to become fully operational during FY 2012 to improve comparability and monitoring; TRACES data available for FY 2012.
- Estimated intermediation costs:
  - Projected at about US$117 million for FY 2012.
  - Averaged about US$110 million over the past three years.
- Increase in number of GRA arrangements since FY 2009 contributed to higher intermediation costs; of current 23 GRA arrangements, eleven were approved in the current or last financial year and have an average term of 30 months.
- Savings and methodological refinements moderated intermediation cost increases:
  - Decline in support costs attributable to GAF due to refinements;
  - 2009 restructuring program produced savings in support costs;
  - Recent changes in travel policy reduced average mission costs.
- Flexible Credit Line (FCL) arrangements excluded from certain costing because they do not entail significant staff monitoring costs (three FCLs for Colombia, Mexico, and Poland excluded).

### VI. Estimating Intermediation Costs (methodology summary)
- Direct personnel expenses: derived from Time Reporting System (TRS) and successor TRACES together with standard personnel costs.
- Direct costs of mission travel: from Travel Information and Management System (TIMS).
- Support and other administrative expenses: allocated to GAF based on share of Fund’s total service delivery, excluding support and governance; remaining administrative expenses allocated based on share of total staff time.
- Governance costs: estimated as GAF-related portion of OED, OMD, SEC, and IEO combined estimated outturn using percentage of Executive Board meeting hours spent on GAF business as proxy.
- Capital and depreciation expenses: GAF portion derived based on GAF’s estimated share of the Fund’s estimated outturn for the internally financed portion of the administrative budget.
- Transition to TRACES/ACES and changes in definition/allocation of support affected comparability with earlier periods and resulted in lower GAF-related support costs in FY 2011 compared with earlier periods.
- ACES-based estimates will still need to be complemented with estimated capital and depreciation expenses.

### VII. Key Figures (Table 1 highlights; millions of dollars except where noted)
- Intermediation costs (A):
  - Actual FY 2009: 104
  - Actual FY 2010: 119
  - Actual FY 2011: 111
  - Projected FY 2012: 117
  - Steady State: 100
- Service charges (B):
  - Actual FY 2009: 126
  - Actual FY 2010: 164
  - Actual FY 2011: 205
  - Projected FY 2012: 268
  - Steady State: 16
- Costs to be covered by income from margin (A-B) (C):
  - Actual FY 2009: -22
  - Actual FY 2010: -45
  - Actual FY 2011: -94
  - Projected FY 2012: -151
  - Steady State: 84
- Income from margin (D):
  - Actual FY 2009: 19
  - Actual FY 2010: 15
  - Actual FY 2011: 34
  - Projected FY 2012: 82
  - Steady State: 1265
- Commitment fees (E) — table formatting preserved as in source:
  - E total:
    - Actual FY 2009: 5
    - Actual FY 2010: 12
    - Actual FY 2011: 7
    - Projected FY 2012: 25
    - Steady State: 42037
  - E.1 FCL:
    - Actual FY 2009: 0
    - Actual FY 2010: 12
    - Actual FY 2011: 5
    - Projected FY 2012: 22
    - Steady State: 2837
  - E.2 Other:
    - Actual FY 2009: 5
    - Actual FY 2010: 2
    - Actual FY 2011: 3
    - Projected FY 2012: 12
    - Steady State: 0
- Surcharges (F):
  - Actual FY 2009: 122
  - Actual FY 2010: 40
  - Actual FY 2011: 67
  - Projected FY 2012: 791,4350
- Potential reserve accumulation (D+E+F-C) (G):
  - Actual FY 2009: 340
  - Actual FY 2010: 1,112
  - Actual FY 2011: 1,954
  - Projected FY 2012: 2,871
  - Steady State: 108
- Potential reserve accumulation as a percent (of precautionary balances at beginning of FY) (H):
  - Actual FY 2009: 3.2%
  - Actual FY 2010: 10.0%
  - Actual FY 2011: 17.4%
  - Projected FY 2012: 22.9%
  - Steady State: 0.7%
- Actual reserve accumulation (I) (additions to reserves based on excess of net income excluding gold profits over total Fund expenses):
  - Actual FY 2009: 240
  - Actual FY 2010: 354
  - Actual FY 2011: 1,203
  - Projected FY 2012: 2,210
  - Steady State: 110
- Actual reserve accumulation (as a percent) (J):
  - Actual FY 2009: 2.3%
  - Actual FY 2010: 3.2%
  - Actual FY 2011: 10.7%
  - Projected FY 2012: 17.6%
  - Steady State: 0.7%
- Memorandum items (exact values):
  - Precautionary balances at the beginning of FY (in SDR billions): 6.9, 7.1, 7.3, 8.1, 10.0 (FY 2009, FY 2010, FY 2011, FY 2012 projection, Steady State)
  - Average Fund credit outstanding (in SDR billions): 12.4, 34.2, 53.7, 81.6, 10.0 (FY 2009–Steady State)
  - Number of active arrangements (average): 10, 19, 24, 23 (FY 2009–FY 2012 projection)
  - Average exchange rate U.S dollar/SDR: 1.54, 1.56, 1.54, 1.55, 1.55 (FY 2009–Steady State)

### VIII. Operational Lending Income — Service Charges and Commitment Fees
- Service Charges:
  - Levied at 50 basis points for each disbursement under a GRA arrangement.
  - Service charge income increased from around SDR 7 million (US$11 million) in FY 2008 to about SDR 133 million (US$205 million) in FY 2011.
  - Fund credit outstanding reached a historic high of SDR 80 billion at end-September 2011.
  - Service charges are paid in full at each disbursement and could be considered the first source of income to meet intermediation costs.
- Commitment Fees:
  - Commitment fee income has become much larger and more variable (see row E in Table 1).
  - Commitment fees are refundable if drawings are made under an arrangement; income recognized only at cancellation or expiration of the arrangement.
  - Introduction of Flexible Credit Line arrangements (FCLs) in 2009 increased the significance and variability of commitment fees.
  - Absence of a cap on access under the FCL and extension of the maximum FCL term to two years increase variability because fees for two-year arrangements are recognized only at the end of the two-year period.
  - Projected fees in FY 2012 and FY 2013 are some SDR 5 million and SDR 475 million, respectively; the FY 2013 figure results from recognition in income of commitment fees associated with two large two-year FCL arrangements approved during FY 2011, only at the expiration of the arrangements in FY 2013.
  - Current commitment fee schedule: 15 basis points for annual access of up to 200 percent of quota; 30 basis points for access between 200 and 1,000 percent of quota; and 60 basis points for access beyond 1,000 percent of quota.
  - Prior to 2009 reforms the commitment fee schedule was downward-sloping: 25 basis points for annual access up to 100 percent of quota and 10 basis points for amounts over 100 percent of quota.

### IX. Treatment of Commitment Fees in Margin Framework (Policy Options and Staff Proposal)
- Option A: Include commitment fees as a source of income to cover intermediation costs.
  - Risk: could give rise to large swings in the margin analysis and reduce stability/predictability of the margin.
- Option B: Include commitment fees as a source of income that contributes to reserve accumulation but exclude them from the analysis of the margin needed to cover intermediation costs.
  - Benefit: insulates margin-setting from volatility of commitment fees and better reflects that FCL and PCL fees primarily cover the cost of setting aside financial resources.
  - Implication: some income from non-FCL or PCL precautionary arrangement commitment fees would not be included in calculation of amount available to help cover intermediation costs, but these fees would still contribute to reserve accumulation.
- Staff proposes Option B: treat commitment fees as contributing to reserve accumulation rather than covering intermediation costs, to preserve a stable and predictable margin and recognize the purpose of FCL/PCL fees.

### X. Reserve Accumulation (mechanics, projections, and steady state)
- Margin contribution to reserve accumulation varies with lending cycle:
  - High lending cycles: margin and service charges likely well in excess of intermediation costs, providing build up of precautionary balances.
  - Low credit cycles: margin tends to be main source for intermediation costs and reserve accumulation likely lower.
- Implementation affecting actual accumulation:
  - New income model not yet fully in place: gold endowment not operational, reimbursement of GRA for PRG Trust expenses not resumed, precautionary balances below target.
  - Non-lending income reduced by current very low interest rates.
  - Consequently, lending income continues to cover a significant proportion of the Fund’s operating costs beyond intermediation costs.
- Example projections:
  - In FY 2012 projections potential reserve accumulation, after taking account of commitment fees and surcharges, is US$2.9 billion whereas actual reserve accumulation is US$2.2 billion.
- Steady state assumptions and outcomes:
  - Fund credit assumed to stabilize at about SDR 10 billion.
  - Commitments under precautionary lending instruments assumed to fall back and make a modest contribution to commitment fee income.
  - In steady state, reserve accumulation would be about US$110 million annually, assuming a margin of 100 basis points.
  - In the absence of commitment fees, reserve accumulation would be of the order of US$70 million.
- Margin tends to contribute more to reserve accumulation during high lending cycles because costs related to lending activities increase less than proportionately with lending levels; margin, service charges and commitment fees increase with access while staff time and travel are broadly similar regardless of access level.

### XI. Income and Expense Illustrative Figures (selected rows from Table 2; SDR and U.S. dollars)
- Average exchange rate U.S. dollar/SDR:
  - FY 2011: 1.54
  - FY 2012 projection: 1.55
- Operational income (A):
  - FY 2011 (Actual): 928 SDR; 1,429 US$.
  - FY 2012 (Projected): 1,168 SDR; 1,810 US$.
  - Of which: Lending income
    - FY 2011 (Actual): 835 SDR; 1,286 US$.
    - FY 2012 (Projected): 1,002 SDR; 1,553 US$.
- Expenses (B):
  - FY 2011 (Actual): 631 SDR; 972 US$.
  - FY 2012 (Projected): 668 SDR; 1,035 US$.
- Net operational income position (C = A - B):
  - FY 2011 (Actual): 297 SDR; 457 US$.
  - FY 2012 (Projected): 500 SDR; 775 US$.
- Gold profits:
  - FY 2011 (Actual): 3,100 SDR; 4,774 US$.
- Surcharges (assumed placed directly to reserves):
  - FY 2011 (Actual): 506 SDR; 779 US$.
  - FY 2012 (Projected): 926 SDR; 1,435 US$.
- Other (includes restructuring costs and IAS 19 timing adjustments):
  - FY 2011 (Actual): -22 SDR; -34 US$.
- Net income position (D):
  - FY 2011 (Actual): 3,881 SDR; 5,976 US$.
  - FY 2012 (Projected): 1,426 SDR; 2,210 US$.

### XII. Framework for Reserve Accumulation and Governance
- New framework shifts from explicit annual target of reserve accumulation to a medium-term outlook requiring Executive Board judgment.
  - No pre-determined pace of reserve accumulation is proposed.
  - Amount for reserve accumulation generated through the margin would be based on Executive Board judgment, accounting for level of precautionary balances relative to target/floor and expected contribution from other sources including surcharges.
- Regular updates on projected accumulation of precautionary balances are provided in the consolidated medium-term income and expenditure outlook papers twice a year.
- A Board discussion on adequacy of precautionary balances is planned for early 2012.

### XIII. Alignment with Market Conditions (Cross-check Mechanism)
- Purpose: ensure margin alignment with long-term credit conditions so Fund borrowing cost is neither too high nor too low relative to market costs faced by members.
  - Costs too high: could prevent early assistance and raise crisis resolution costs.
  - Costs too low: could disincentivize members from seeking market funding and reduce Fund lending resources.
- Cross-check uses long-term average market conditions rather than short-term market volatility.
- Past practice and proposed comparator:
  - Staff has used five-year JP Morgan EMBI yields and spreads to reflect emerging market members’ market borrowing costs.
  - Five-year maturity corresponds to maximum maturity of the Stand-by Arrangement and is the most liquid market; five-year averages bridge cyclical volatility.
  - EMBI does not include advanced countries, but recent spread data suggest it provides a sufficiently good proxy for these borrowers.
- Adjustment for Risk Premium:
  - Fund faces lower risks as a cooperative public policy institution due to policy conditionality and preferred creditor status, though risks remain.
  - EMBI spread of countries in the lowest quartile could be used as an indicator of conditions facing more creditworthy emerging markets and serve as a proxy for market conditions in the cross-check.

### XIV. Term Premium Adjustment: Rationale and Measurement
- Standard GRA financing carries a maturity of up to five years, yet members are charged based on the floating SDR interest rate, which is composed of three month instruments of the basket currencies designated by the Executive Board.
- Borrowers generally pay a premium for locking in longer-term financing at fixed rates; therefore a downward adjustment to market spreads (proxied by indexes of five-year, fixed interest rate instruments) is required to account for maturity difference.
- Term premium estimated as the difference between:
  - the weighted average of the yields on the five-year synthetic SDR bonds, and
  - the three-month synthetic SDR rate implicit in future market contracts over a five year period (the maturity of most Fund lending).
- Term premium averaged about 15 basis points over the period 2006-11 (see Table 3).
- Footnote specifics preserved:
  - SBA maturity is 3 1/4 – 5 years and is applied to each disbursement independently. The Extended Fund Facility (EFF) carries a longer maturity of 4 1/2 – 10 years.
  - Rule-T, adopted September 18, 1969 and amended November 23, 2005. Currently the interest rates on the 3 month Eurepo, Japanese Treasury Discount bills, and UK and US Treasury bills.

### XV. Empirical Cross-check with Market Spreads (selected reported observations)
- For potential Fund borrowers in 2006-2011, the average margin was 103 basis points (Table 3).
- At this level, the margin has in recent years been modestly lower than the EMBI spread for the lowest quartile of borrowers, adjusted for the term premia, of 143 basis points.
- Excerpted Table 3 elements (as presented in source):
  - Composite EMBI: 667402235
  - Countries in the lowest quartile: 260118159
  - n/a0.315
  - Composite EMBIn/a402220
  - Countries in the lowest quartilen/a118143
  - Memorandum item: Past users of Fund resources 4/507316233
  - Basic margin: 6869103
  - Note: SDR-equivalent rates are calculated using the currency weights in the SDR basket.
  - Note: Median spread, in SDR-equivalent basis points 1/
  - Note: Members with arrangements during the periods in heading. Median level of the SDR weighted U.S. dollar and euro EMBIG spreads for the members with Fund arrangements between 1996 and 2011.
  - Note: Table reports linear combination of spreads in EMBIG-U.S. dollar and EMBIG-Euro composites. Series were combined using the weights of the U.S. dollar and Euro in the SDR basket (normalized to 100). During the sample period, the combined EMBIG indices contained spreads for a total of 40 countries.
  - Note: Difference in yields between a five-year fixed-rate bond, and the five-year average 3-month interest rate as implied in futures market contracts, adjusted for the higher risk premium of instruments in future markets.

### XVI. Proposed new Rule I-6(4): Key Features and Principles
- Overarching principle:
  - Margin over the SDR interest rate to cover the Fund’s intermediation costs and allow for a buildup of reserves; margin not required to cover full range of Fund activities.
- Reserve accumulation:
  - No pre-determined pace of reserve accumulation; Executive Board judgment to assess appropriate amount, taking into account precautionary balances and expected contributions from surcharges and commitment fees.
- Analytical process and timing:
  - Analysis undertaken in context of annual review of the Fund’s income position and update of medium-term outlook for precautionary balances.
  - April annual income paper will include updates of Table 1 and sensitivity analysis for different margin levels (e.g., 50, 100, and 150 basis points).
  - Margin set for a period of two financial years starting with FY 2013, with comprehensive review before end of first year of each two-year period; adjustments only for fundamental changes.
- Stability and predictability:
  - Stability and predictability of the margin is a key principle.
- Market cross-check:
  - Cross-check to ensure reasonable alignment against credit market conditions; no precise formula prescribed—selection of benchmarks requires judgment.
- Exceptional circumstances clause:
  - Rule to include exceptional circumstances clause allowing Board to set margin on a basis other than that required to cover intermediation costs and allow reserve buildup under extreme stress conditions (as observed in FY 2007–08).

### XVII. Near-term Implementation Steps and Text of Proposed Decision (key excerpts)
- Near-term steps:
  - Midyear income paper on FY 2012 to update income projections under current Rule I-6(4).
  - Executive Board review of adequacy of precautionary balances early next year with updated medium-term income projections and indicative target.
  - April 2012 annual income paper to review FY 2012 and FY 2013 income positions and set margin for FY 2013-2014 under proposed new rule.
- Selected excerpts of proposed decision (effective May 1, 2012, amendment to Rule I-6(4)):
  - The rate of charge shall be determined as the SDR interest rate under Rule T-1 plus a margin expressed in basis points.
  - The margin shall be set at a level that is adequate (i) to cover the estimated intermediation expense of the Fund for the period under (b) below, taking into account income from service charges, and (ii) to generate an amount of net income for placement to reserves.
  - The appropriate amount for reserve contribution shall be assessed taking into account, in particular, the current level of precautionary balances, any floor or target for precautionary balances, and the expected contribution from surcharges and commitment fees to precautionary balances; provided, however, that the margin shall not be set at a level at which the basic rate of charge would result in the cost of Fund credit becoming too high or too low in relation to long-term credit market conditions as measured by appropriate benchmarks.
  - Notwithstanding the above, in exceptional circumstances, the margin may be set at a level other than that which is adequate to cover estimated intermediation expenses of the Fund and to generate an amount of net income for placement to reserves.
  - The margin shall be set for a period of two financial years. A comprehensive review of the Fund's income position shall be held before the end of the first year of each such two-year period and the margin may be adjusted in the context of such a review, but only if this is warranted in view of fundamental changes in the underlying factors relevant for the establishment of the margin at the start of the two-year period.

*Source: IMF Finance Department; content prepared by D. Andrews, M. Kumar, S. Bassett, G. Kabwe, L. Kohler, J. Mburu, S. Rodriguez, D. Nana, A. Perez, and D. Tavlykaev (all FIN).*

### 1.  Income from Margin and Reserve Accumulation .................................................................8

### 1.  Income from Margin and Reserve Accumulation

### I. Introduction and Implementation Progress
- Executive Board adopted package to reform the Fund’s income model in April 2008.
- New income model components:
  - creating an endowment funded with profits from a limited sale of the Fund’s gold holdings;
  - expanding the Fund’s investment authority to enhance expected return on the Fund’s investments;
  - resuming reimbursement of the General Resources Account (GRA) for the cost of administering the PRG Trust (subject to provisos described).
- Limited gold sales concluded in December last year; amendment to Articles to broaden investment authority became effective in February 2011.
- Endowment expected to become operational in calendar year 2012.
- A more transparent rules-based framework for assessing reserve adequacy and adjusting target for precautionary balances is being developed.
- Under the new model, the margin for the basic rate of charge should be set to cover only the Fund’s intermediation (lending) costs and help build-up reserves (rather than cover all administrative expenses and meet a specific net income target).
- Since FY 2009 the margin has been set in line with principles endorsed in 2008, under the exceptional circumstances clause of Rule I-6(4).
- Staff proposes adoption of a new rule for setting the margin; proposed effective date: FY 2013 onwards.
- Executive Board set the margin on the rate of charge for FY 2012 at 100 basis points (decision not revisited by this paper).
- Next steps:
  - issuance of the midyear income review paper (early December) updating projections for FY 2012;
  - review early next year of adequacy of precautionary balances and update of medium-term projections and indicative target for precautionary balances;
  - annual income paper in April next year to review FY 2012 and FY 2013 income positions, including proposal for the margin under the new Rule I-6(4).

### II. Background: Basic Rate of Charge and Margin
- Basic rate of charge = SDR interest rate + margin (currently 100 basis points) + surcharges where applicable.
- Since 2005 margin is a fixed spread over the floating three-month SDR interest rate and under current Rule I-6(4) is set at the start of every financial year and reviewed at midyear.
- Prior to FY 2007, margin decisions primarily driven to cover total administrative expenses and accumulate reserves (net income target specified as a 5 percent increase in reserves under earlier rule).
- Sharp decline in credit outstanding would have implied a margin over 350 basis points for FY 2007 under the old approach; exceptional circumstances clause was added to Rule I-6(4) in April 2006 to permit alternative basis for setting the margin.
- Establishment of the Investment Account (IA) in April 2006 and April 2008 decisions to reform income model broadened income sources.

### III. Principles Endorsed for Setting the Margin (2008)
- The Executive Board endorsed that:
  - The margin should be set in a stable and predictable manner;
  - The margin should be a margin over the SDR interest rate to cover the Fund’s intermediation costs and allow for a build-up of reserves (not cover the full range of Fund activities);
  - A mechanism should be developed to check that the margin is in reasonable alignment with long-term credit market conditions to ensure borrowing from the Fund does not become too expensive or too low relative to market borrowing costs.
- Since FY 2009 the margin has been set consistent with these principles, including:
  - covering estimated intermediation costs and allowing for reserve accumulation;
  - cross-check of alignment with long-term credit market conditions;
  - avoiding an overly mechanistic approach—judgment applied to pace of reserve accumulation, comparison with private market borrowing costs, and outlook for intermediation costs.

### IV. Proposed Framework for the New Rule (Summary)
- Key framework elements:
  - (i) the Fund’s intermediation costs;
  - (ii) operational lending income to cover intermediation costs and contribute to reserve accumulation;
  - (iii) a cross-check for alignment with long-term credit market conditions.
- New rule would have the margin set to cover intermediation costs and allow reserve build-up, with a cross-check against long-term credit market conditions.
- Proposed effective period: for FY 2013 onwards.

### V. Intermediation Costs: Definition, Estimation, and Recent Levels
- Intermediation costs comprise all costs related to the Generally Available Facilities (GAF): direct personnel expenses, direct travel costs, support and other administrative expenses, governance costs, and capital and depreciation expenses.
- Ongoing improvements to costing processes noted; ACES (Analytical Costing and Estimation System) expected to become fully operational during FY 2012 to improve comparability and monitoring.
- Estimated intermediation costs:
  - Projected at about US$117 million for FY 2012.
  - Averaged about US$110 million over the past three years.
- Increase in number of GRA arrangements since FY 2009 contributed to higher intermediation costs; of current 23 GRA arrangements, eleven were approved in the current or last financial year and have an average term of 30 months.
- Savings and methodological refinements have moderated intermediation cost increases:
  - Decline in support costs attributable to GAF due to refinements;
  - 2009 restructuring program produced savings in support costs;
  - Recent changes in travel policy reduced average mission costs.
- Staff will continue to refine methodology using TRACES and ACES; ACES-based estimates will improve comparability over time and monitoring within financial years.
- Note: Flexible Credit Line (FCL) arrangements excluded from certain costing because they do not entail significant staff monitoring costs (three FCLs for Colombia, Mexico, and Poland excluded).

### VI. Box 1 — Estimating Intermediation Costs (methodology summary)
- Direct personnel expenses: derived from Time Reporting System (TRS) and successor TRACES together with standard personnel costs.
- Direct costs of mission travel: from Travel Information and Management System (TIMS).
- Support and other administrative expenses: allocated to GAF based on share of Fund’s total service delivery, excluding support and governance; remaining administrative expenses allocated based on share of total staff time.
- Governance costs: estimated as GAF-related portion of OED, OMD, SEC, and IEO combined estimated outturn using percentage of Executive Board meeting hours spent on GAF business as proxy.
- Capital and depreciation expenses: GAF portion derived based on GAF’s estimated share of the Fund’s estimated outturn for the internally financed portion of the administrative budget.
- Transition to TRACES/ACES and changes in definition/allocation of support affected comparability with earlier periods and resulted in lower GAF-related support costs in FY 2011 compared with earlier periods.
- TRACES-based data available for FY 2012; ACES to be fully operational during current financial year; ACES-based estimates will still need to be complemented with estimated capital and depreciation expenses.

### VII. Key Figures and Table 1 Highlights (exact figures from Table 1)
- Intermediation costs (A):
  - Actual FY 2009: 104
  - Actual FY 2010: 119
  - Actual FY 2011: 111
  - Projected FY 2012: 117
  - Steady State: 100
  (millions of dollars)
- Service charges (B):
  - Actual FY 2009: 126
  - Actual FY 2010: 164
  - Actual FY 2011: 205
  - Projected FY 2012: 268
  - Steady State: 16
  (millions of dollars)
- Costs to be covered by income from margin (A-B) (C):
  - Actual FY 2009: -22
  - Actual FY 2010: -45
  - Actual FY 2011: -94
  - Projected FY 2012: -151
  - Steady State: 84
  (millions of dollars)
- Income from margin (D):
  - Actual FY 2009: 19
  - Actual FY 2010: 15
  - Actual FY 2011: 34
  - Projected FY 2012: 82
  - Steady State: 1265
  (millions of dollars)
- Commitment fees (E) and breakdown:
  - E total:
    - Actual FY 2009: 5
    - Actual FY 2010: 12
    - Actual FY 2011: 7
    - Projected FY 2012: 25
    - Steady State: 42037 (note: table formatting indicates a complex entry; source lists E. as "5 12 7 25 42037")
  - E.1 FCL:
    - Actual FY 2009: 0
    - Actual FY 2010: 12
    - Actual FY 2011: 5
    - Projected FY 2012: 22
    - Steady State: 2837
  - E.2 Other:
    - Actual FY 2009: 5
    - Actual FY 2010: 2
    - Actual FY 2011: 3
    - Projected FY 2012: 12
    - Steady State: 0
  (millions of dollars; table formatting preserved as in source)
- Surcharges (F):
  - Actual FY 2009: 122
  - Actual FY 2010: 40
  - Actual FY 2011: 67
  - Projected FY 2012: 791,4350 (table formatting indicates combined or complex entry)
- Potential reserve accumulation (D+E+F-C) (G):
  - Actual FY 2009: 340
  - Actual FY 2010: 1,112
  - Actual FY 2011: 1,954
  - Projected FY 2012: 2,871
  - Steady State: 108
  (millions of dollars)
- Potential reserve accumulation as a percent (of precautionary balances at beginning of FY) (H):
  - Actual FY 2009: 3.2%
  - Actual FY 2010: 10.0%
  - Actual FY 2011: 17.4%
  - Projected FY 2012: 22.9%
  - Steady State: 0.7%
- Actual reserve accumulation (I) (additions to reserves based on excess of net income excluding gold profits over total Fund expenses):
  - Actual FY 2009: 240
  - Actual FY 2010: 354
  - Actual FY 2011: 1,203
  - Projected FY 2012: 2,210
  - Steady State: 110
  (millions of dollars)
- Actual reserve accumulation (as a percent) (J):
  - Actual FY 2009: 2.3%
  - Actual FY 2010: 3.2%
  - Actual FY 2011: 10.7%
  - Projected FY 2012: 17.6%
  - Steady State: 0.7%
- Memorandum items (exact values):
  - Precautionary balances at the beginning of FY (in SDR billions): 6.9, 7.1, 7.3, 8.1, 10.0 (for FY 2009, FY 2010, FY 2011, FY 2012 projection, Steady State respectively)
  - Average Fund credit outstanding (in SDR billions): 12.4, 34.2, 53.7, 81.6, 10.0 (FY 2009–Steady State)
  - Number of active arrangements (average): 10, 19, 24, 23 (FY 2009–FY 2012 projection)
  - Average exchange rate U.S dollar/SDR: 1.54, 1.56, 1.54, 1.55, 1.55 (FY 2009–Steady State)

### VIII. Operational Lending Income (note from text)
- Operational lending income comprises the margin, service charges, and commitment fees.

*Source: IMF Finance Department; content prepared by D. Andrews, M. Kumar, S. Bassett, G. Kabwe, L. Kohler, J. Mburu, S. Rodriguez, D. Nana, A. Perez, and D. Tavlykaev (all FIN).*

### 15.      In addition to the margin, service charges on disbursements and commitment

### 15.      In addition to the margin, service charges on disbursements and commitment

### Service Charges
- Service charges are levied at 50 basis points for each disbursement under a GRA arrangement.
- Service charge income increased from around SDR 7 million (US$11 million) in FY 2008 to about SDR 133 million (US$205 million) in FY 2011.
- Service charges generally move in tandem with increases in the level of Fund credit outstanding.
- Fund credit outstanding reached a historic high of SDR 80 billion at end-September 2011.
- In practice, service charges are paid in full at the time of each disbursement and could be considered the first source of income to meet intermediation costs.

### Commitment Fees
- Commitment fee income has become much larger and more variable (see row E in Table 1, and Figure 4).
- Commitment fees are refundable if drawings are made under an arrangement; income is recognized only at the cancellation or expiration of the arrangement.
- Introduction of Flexible Credit Line arrangements (FCLs) in 2009 increased the significance and variability of commitment fees.
- Absence of a cap on access under the FCL and extension of the maximum FCL term to two years increase variability because fees for two-year arrangements are recognized only at the end of the two-year period.
- Projected fees in FY 2012 and FY 2013 are some SDR 5 million and SDR 475 million, respectively; the FY 2013 figure results from recognition in income of commitment fees associated with two large two-year FCL arrangements approved during FY 2011, only at the expiration of the arrangements in FY 2013.
- The current upward-sloping commitment fee schedule: 15 basis points for annual access of up to 200 percent of quota; 30 basis points for access between 200 and 1,000 percent of quota; and 60 basis points for access beyond 1,000 percent of quota.
- Prior to 2009 reforms the commitment fee schedule was downward-sloping: 25 basis points for annual access up to 100 percent of quota and 10 basis points for amounts over 100 percent of quota.
- The fee structure was designed to discourage unduly large precautionary access and contain related liquidity risks, balancing simplicity and cost recovery given finite Fund finances and opportunity cost of committing liquidity.

### Treatment of Commitment Fees in Margin Framework (Policy Options and Staff Proposal)
- Option A: Include commitment fees as a source of income to cover intermediation costs.
  - Risk: could give rise to large swings in the margin analysis and reduce stability/predictability of the margin.
- Option B: Include commitment fees as a source of income that contributes to reserve accumulation but exclude them from the analysis of the margin needed to cover intermediation costs.
  - Benefit: insulates margin-setting from volatility of commitment fees and better reflects that FCL and PCL fees primarily cover the cost of setting aside financial resources.
  - Implication: some income from non-FCL or PCL precautionary arrangement commitment fees would not be included in calculation of amount available to help cover intermediation costs, but these fees would still contribute to reserve accumulation.
- Staff proposes Option B: treat commitment fees as contributing to reserve accumulation rather than covering intermediation costs, to preserve a stable and predictable margin and recognize the purpose of FCL/PCL fees.

### Reserve Accumulation
- Contribution of the margin to reserve accumulation varies with the lending cycle.
  - During high lending cycles (current situation), income from the margin and service charges is likely to be well in excess of intermediation costs, providing build up of precautionary balances.
  - During low credit cycles, the margin will tend to be the main source of income for intermediation costs and reserve accumulation would likely be lower.
- Implementation status affecting actual accumulation:
  - The new income model is not yet fully in place: the gold endowment is not yet operational, reimbursement of the General Resources Account for PRG Trust expenses has not yet resumed, and precautionary balances remain below the target.
  - Non-lending income is reduced by current very low interest rates.
  - Consequently, lending income continues to cover a significant proportion of the Fund’s operating costs beyond intermediation costs.
- Example projections:
  - In FY 2012 projections the calculated potential reserve accumulation, after taking account of commitment fees and surcharges, is US$2.9 billion whereas the actual reserve accumulation is US$2.2 billion.
- Steady state assumptions and outcomes:
  - In the steady state, Fund credit is assumed to stabilize at about SDR 10 billion.
  - Commitments under precautionary lending instruments assumed to fall back and make a modest contribution to commitment fee income.
  - In the steady state, reserve accumulation would be about US$110 million annually, assuming a margin of 100 basis points.
  - In the absence of commitment fees, reserve accumulation would be of the order of US$70 million.
- The margin will tend to contribute more to reserve accumulation during high lending cycles because costs related to lending activities increase less than proportionately with lending levels; margin, service charges and commitment fees increase with access while staff time and travel are broadly similar regardless of access level.

### Income and Expense Illustrative Figures (FY 2011 Actual; FY 2012 Projected) — selected rows from Table 2 (millions of SDRs and U.S. dollars)
- Average exchange rate U.S. dollar/SDR for FY 2011 and FY 2012 is 1.54 and 1.55, respectively.
- Operational income (A):
  - FY 2011 (Actual): 928 SDR; 1,429 US$.
  - FY 2012 (Projected): 1,168 SDR; 1,810 US$.
  - Of which: Lending income
    - FY 2011 (Actual): 835 SDR; 1,286 US$.
    - FY 2012 (Projected): 1,002 SDR; 1,553 US$.
- Expenses (B):
  - FY 2011 (Actual): 631 SDR; 972 US$.
  - FY 2012 (Projected): 668 SDR; 1,035 US$.
- Net operational income position (C = A - B):
  - FY 2011 (Actual): 297 SDR; 457 US$.
  - FY 2012 (Projected): 500 SDR; 775 US$.
- Gold profits:
  - FY 2011 (Actual): 3,100 SDR; 4,774 US$.
- Surcharges (assumed placed directly to reserves):
  - FY 2011 (Actual): 506 SDR; 779 US$.
  - FY 2012 (Projected): 926 SDR; 1,435 US$.
- Other (includes restructuring costs and IAS 19 timing adjustments):
  - FY 2011 (Actual): -22 SDR; -34 US$.
- Net income position (D):
  - FY 2011 (Actual): 3,881 SDR; 5,976 US$.
  - FY 2012 (Projected): 1,426 SDR; 2,210 US$.

### Framework for Reserve Accumulation and Governance
- The new framework shifts from an explicit annual target of reserve accumulation to a medium-term outlook requiring Executive Board judgment.
  - No pre-determined pace of reserve accumulation is proposed.
  - The amount for reserve accumulation to be generated through the margin would be based on Executive Board judgment, taking into account factors including level of precautionary balances relative to target/floor and expected contribution from other sources including surcharges.
- Regular updates on projected accumulation of precautionary balances are provided in the consolidated medium-term income and expenditure outlook papers twice a year.
- A Board discussion on adequacy of precautionary balances is planned for early 2012.

### Alignment with Market Conditions (Cross-check Mechanism)
- Purpose: ensure margin alignment with long-term credit conditions so Fund borrowing cost is neither too high nor too low relative to market costs faced by members.
  - Costs too high: could prevent early assistance and raise crisis resolution costs.
  - Costs too low: could disincentivize members from seeking market funding and reduce Fund lending resources.
  - Appropriately priced lending incentives expected to encourage timely repayment.
- Cross-check uses long-term average market conditions rather than short-term market volatility.
- Past practice and proposed comparator:
  - Staff has used five-year JP Morgan EMBI yields and spreads to reflect emerging market members’ market borrowing costs.
  - Five-year maturity corresponds to maximum maturity of the Stand-by Arrangement and is the most liquid market; five-year averages bridge cyclical volatility.
  - EMBI does not include advanced countries, but recent spread data suggest it provides a sufficiently good proxy for these borrowers.
- Adjustment for Risk Premium:
  - The Fund faces lower risks as a cooperative public policy institution due to policy conditionality and preferred creditor status, though risks remain.
  - The EMBI spread of countries in the lowest quartile could be used as an indicator of conditions facing more creditworthy emerging markets and serve as a proxy for market conditions in the cross-check.
- Adjustment for Term Premium:
  - (Discussion continues beyond provided excerpt.)

*Source: IMF Finance Department content (excerpts as provided).*

### 31.      An additional adjustment is needed to take into consideration the term premium.

### _112211 - 31.      An additional adjustment is needed to take into consideration the term premium.

### Term premium adjustment: rationale and measurement
- Standard GRA financing carries a maturity of up to five years, yet members are charged based on the floating SDR interest rate, which is composed of three month instruments of the basket currencies designated by the Executive Board.
- Generally, a premium is charged to borrowers for locking in financing for longer periods at fixed interest rates; therefore a downward adjustment to market spreads (proxied by indexes of five-year, fixed interest rate instruments) is required to account for the maturity difference.
- The term premium is estimated as the difference between:
  - the weighted average of the yields on the five-year synthetic SDR bonds, and
  - the three-month synthetic SDR rate implicit in future market contracts over a five year period (the maturity of most Fund lending).
- The term premium averaged about 15 basis points over the period 2006-11 (see Table 3).
- Footnote specifics preserved:
  - SBA maturity is 3 ¼ – 5 years and is applied to each disbursement independently. The Extended Fund Facility (EFF) carries a longer maturity of 4 ½ – 10 years.
  - Rule-T, adopted September 18, 1969 and amended November 23, 2005. Currently the interest rates on the 3 month Eurepo, Japanese Treasury Discount bills, and UK and US Treasury bills.

### Empirical cross-check with market spreads
- For potential Fund borrowers in 2006-2011, the average margin was 103 basis points (Table 3).
- At this level, the margin has in recent years been modestly lower than the EMBI spread for the lowest quartile of borrowers, adjusted for the term premia, of 143 basis points.
- Table 3 elements (as presented):
  - Composite EMBI: 667402235
  - Countries in the lowest quartile: 260118159
  - n/a0.315
  - Composite EMBIn/a402220
  - Countries in the lowest quartilen/a118143
  - Memorandum item: Past users of Fund resources 4/507316233
  - Basic margin: 6869103
  - Source: Bloomberg, JP Morgan and Fund staff calculations.
  - Note: SDR-equivalent rates are calculated using the currency weights in the SDR basket.
  - Note: Median spread, in SDR-equivalent basis points 1/
  - Note: Members with arrangements during the periods in heading. Median level of the SDR weighted U.S. dollar and euro EMBIG spreads for the members with Fund arrangements between 1996 and 2011.
  - Note: Table reports linear combination of spreads in EMBIG-U.S. dollar and EMBIG-Euro composites. Series were combined using the weights of the U.S. dollar and Euro in the SDR basket (normalized to 100). During the sample period, the combined EMBIG indices contained spreads for a total of 40 countries.
  - Note: Difference in yields between a five-year fixed-rate bond, and the five-year average 3-month interest rate as implied in futures market contracts, adjusted for the higher risk premium of instruments in future markets.

### Proposed new Rule I-6(4): key features and principles
- Overarching principle:
  - The margin on the rate of charge should be set as a margin over the SDR interest rate to cover the Fund’s intermediation costs and allow for a buildup of reserves.
  - In contrast to the previous regime, the margin would no longer be required to cover the full range of the Fund’s activities; rather, it would be set so that projected lending income, i.e., service charges and income from the margin are at least sufficient to cover estimated intermediation costs.
- Reserve accumulation:
  - While the margin should also provide for a build-up in reserves, no pre-determined pace of reserve accumulation is proposed.
  - The amount for reserve accumulation to be generated through the margin would be based on a judgment of the Executive Board, taking account of relevant factors including the level of precautionary balances in relation to the target, and the expected contribution from other sources including surcharges and commitment fees.
- Analytical process and timing:
  - The analysis for setting the margin on the rate of charge will be undertaken in the context of the review of the Fund’s income position for each financial year and an update of the medium-term outlook for precautionary balances.
  - The annual April income paper will include updates of Table 1 with analysis on the projected reserve accumulation, and sensitivity analysis for different levels of the margin (e.g., 50, 100, and 150 basis points in recent years).
  - The margin would be set for a period of two financial years starting with FY 2013, with a comprehensive review before the end of the first year of each two-year period; adjustments would be made only if warranted by fundamental changes in the underlying factors.
- Stability and predictability:
  - Stability and predictability of the margin would be a key principle; this contrasts with the previous regime where frequent adjustments were necessary.
- Market cross-check:
  - The new rule includes a cross-check to ensure reasonable alignment against credit market conditions.
  - The rule does not prescribe a precise formula or benchmarks; selection of relevant benchmarks for comparison will require judgment to reflect the profile of recent Fund borrowers.
  - Concretely, analysis on long-term credit market conditions based on the relevant benchmark, currently the average EMBI spread adjusted for the credit and risk premiums (Table 3), will yield a result for comparison to the proposed margin.
- Exceptional circumstances clause:
  - The rule should include an exceptional circumstances clause to allow the Board to set the margin on a basis other than that required to cover intermediation costs and allow for a buildup of reserves should the framework encounter extreme stress conditions as observed in FY 2007‒08.

### Near-term implementation steps
- Midyear income paper:
  - Staff will shortly issue a paper on the midyear review of the Fund’s income position for FY 2012. Under the current Rule I-6(4), a midyear review is required to update income projections for the financial year and to consider whether there has been any change in the exceptional circumstances under which the margin was set at the beginning of the year. This paper is issued on a lapse-of-time basis.
- Review of precautionary balances paper:
  - The Executive Board is scheduled to review the adequacy of precautionary balances early next year. The staff paper will update medium-term income projections, including the pace of accumulation of precautionary balances, and will provide an updated medium-term indicative target for precautionary balances based on the new projections for Fund credit.
- Annual income paper:
  - In April 2012, the Executive Board will review the Fund’s income position for FY 2012 and FY 2013. At that time, the Board would set a margin for calculating the basic rate of charge for FY 2013-2014 based on the proposed new rule. Staff will prepare a full analysis under the framework and propose a margin for the two-year period. In the off-cycle year (e.g., April 2013) the staff paper would still include a full analysis, but a change in the margin would only be considered if the analysis indicated compelling underlying factors that are misaligned with the Board-endorsed principles.

### Text of the proposed decision (key excerpts)
- Effective May 1, 2012, Rule I-6(4) shall be amended to read as follows (excerpted):
  - The rate of charge shall be determined as the SDR interest rate under Rule T-1 plus a margin expressed in basis points.
  - The margin shall be set at a level that is adequate (i) to cover the estimated intermediation expense of the Fund for the period under (b) below, taking into account income from service charges, and (ii) to generate an amount of net income for placement to reserves.
  - The appropriate amount for reserve contribution shall be assessed taking into account, in particular, the current level of precautionary balances, any floor or target for precautionary balances, and the expected contribution from surcharges and commitment fees to precautionary balances; provided, however, that the margin shall not be set at a level at which the basic rate of charge would result in the cost of Fund credit becoming too high or too low in relation to long-term credit market conditions as measured by appropriate benchmarks.
  - Notwithstanding the above, in exceptional circumstances, the margin may be set at a level other than that which is adequate to cover estimated intermediation expenses of the Fund and to generate an amount of net income for placement to reserves.
  - The margin shall be set for a period of two financial years. A comprehensive review of the Fund's income position shall be held before the end of the first year of each such two-year period and the margin may be adjusted in the context of such a review, but only if this is warranted in view of fundamental changes in the underlying factors relevant for the establishment of the margin at the start of the two-year period.

*Source: _112211 - 31.      An additional adjustment is needed to take into consideration the term premium.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2011/_112211.pdf_