## _wp09116

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### I. Introduction — context and framing
- The Global Credit Crisis of 2008–09 highlighted urgent needs: strengthen supervision and regulation; support demand while preventing reemergence of global imbalance; upgrade IMF surveillance; streamline lending facilities; reconfigure IMF seats and votes.
- The paper offers eight “out-of-the-box” ideas under three headings: measures to buttress financial stability; steps to smooth the international monetary system; reforms of the IMF.
- Reform constraints noted: network effects, coordination problems, high transactions costs, and rarity of radical reform except after systemic disruptions.

### II.A Countercyclical IMF capital charges — findings and proposals
Findings and context
- IMF quota resources as of early 2009: some $200 billion.
- Additional tapping capacity via borrowing arrangements: $53 billion under GAB and NAB.
- G20 agreement to increase resources by a further $500 billion through, in the first instance, the New Arrangements to Borrow; at the time of writing, roughly half this amount has been promised by G20 leaders.
- SLF exposure: allows applicants to draw up to 500 percent of quota; potential claims of more than $450 billion from 44 emerging market members alone.
- Agreement in principle to authorize an additional $250 billion of Special Drawing Rights, to be issued in proportion with countries’ quota (SDRs are for members, not IMF resources).

Policy proposals (indexing and countercyclical charges)
- Index countries’ contributions to Fund resources and have them contribute annually; routinize quota expansion by tying contributions to growth metrics.
  - Example goal: increase the IMF’s real resources at an average annual rate of 3 percent, to reflect the 3 percent average real rate of growth of the global economy.
  - Contributions calculated as, say, 3 percent of the outstanding subscription plus an adjustment for global inflation (actual contributions in nominal terms).
- Make the additional capital charge countercyclical:
  - Example two-for-one formula: when global growth rises to 4 percent, countries might be asked to augment IMF real resources by 5 percent; when growth slips to 2 percent, they might be asked to augment IMF real resources by only 1 percent.
  - Implication: cutting contributions to zero when global growth fell to 1½ percent or less; symmetry suggests capping contributions at 6 percent when global growth rose to 4½ percent or higher.
- Index capital charges to national growth rates rather than global growth rates to focus countercyclical impulse on countries most in need.
- Adjust votes in the Fund annually in line with contributions to address fast-growing countries with chronically inadequate quotas and voting rights.

Implementation and legal notes
- Regularization would require enabling national legislation (example: U.S. Congress adoption for annual GDP-growth-based contributions).
- Routinized GDP-indexed quota increases would not substitute for a one-time redistribution to reflect 21st-century realities.

### II.B A Price-Based Scarce Currency Clause — findings and proposals
Problem and objectives
- The Scarce Currency Clause (SCC) exists but has never been invoked; political difficulty in authorizing members to impose tariffs or restrictions.
- Goal: automatic process to create incentives for surplus countries to adjust without ad hoc accusations of manipulation.

Automatic adjustment mechanisms proposed
- Require transfers to the Fund based on persistent surpluses:
  - Example rule: a country running a current account surplus in excess of 3 percent of GDP for three years might be required to transfer additional resources to the Fund at the end of every year in which that excess persisted.
  - Example transfer magnitude: transfer might equal one half of the current account surplus in excess of 3 percent of GDP.
- Alternative: tax on reserve accumulation:
  - Tax on the increase in foreign exchange reserves when reserves had been increasing for 3 years and the increase in the current year exceeded 3 percent of GDP.
- Gradual tax schedule option:
  - Tax all increases in foreign reserves starting at infinitesimal levels but rising fairly quickly as the increase in reserves rose as a share of GDP and as a function of its persistence.
- Design flexibility:
  - Charge might initially be set at a lower level and raised to, say, 50 percent over time.
  - Tax revenues need not be paid into the Fund; alternatives include the World Bank or the United Nations.
  - Compliance would require very strong international consensus and peer pressure.

Advantages and potential perverse effects
- Advantage: removes need for IMF or staff to label currencies as “manipulated” or “fundamentally undervalued.”
- Potential perverse effect: countries that undervalue to accumulate reserves could respond to transfers by undervaluing further to replace transferred reserves (relative price effect vs income effect).

### Reserve accumulation motive and policy lever (continued)
- If reserve accumulation is the primary motive, pairing a reserve-accumulation tax with guaranteed emergency liquidity (e.g., expansion of the IMF’s Flexible Credit Line) would weaken motive to hoard reserves.
- Tax could be written into the Articles of Agreement to avoid Executive Board decisions.
- Tax compliance concerns reiterated.

### Convertible SDRs
- Triffin problem summarized: dominance of a national currency (dollar) as reserve asset creates instability.
- Past institutional responses: creation of SDRs and Substitution Account proposals.
- Rehabilitating SDRs requires:
  - Deep, liquid markets in SDR claims.
  - Critical mass of issuance and trading.
  - A market maker (the IMF) prepared to buy and sell SDRs at bid-ask spreads comparable to U.S. treasury and agency markets and convert SDR liabilities into constituent currencies at those spreads.
  - Member agreement to defray subsidies required to seed liquidity.
- Institutional changes needed:
  - IMF ability to issue additional SDRs in periods of shortage.
  - Current rule: 85 percent of IMF voting power must agree before SDRs can be issued; this is a liquidity constraint.
  - Empower IMF management to decide on SDR issuance, making IMF more like a global central bank and international lender of last resort.

### Global Glass-Steagall
Diagnosis
- Conflict between banks’ core functions and incentives to engage in risky origination/distribution/investment, aided by deregulation and cross-border competition.

Proposal
- Reimpose Glass-Steagall-like restrictions internationally:
  - Commercial banking component: liabilities limited to retail deposits; assets limited to low-risk instruments (cash, short-term treasuries, commercial paper, adequately-collateralized small business loans, and conforming mortgages).
  - Investment/market component: permitted to invest in riskier assets; capital requirements, limits on leverage, disclosure, and mandatory financial disaster (capital) insurance.
- International coordination required to prevent cross-border arbitrage.
- Possible routes to coordination:
  - Incorporate restrictions into the Basle Committee’s Core Principles and monitor compliance through IMF/World Bank FSAPs.
  - Make restrictions obligations of IMF members.

### Global Systemic Risk Facility (GSRF) — Cat bonds and capital insurance
Concept and rationale
- Require banks to purchase capital insurance via Catastrophe ("Cat") bonds: pay premia in good times; large payout upon systemic event.
- Advantages: protection concentrated when needed; indexing to systemic events to limit moral hazard.

Design and implementation challenges
- Payoffs depend on rare events with limited data; valuation and underwriting costly.
- Moral hazard: availability of insurance could encourage risk-taking; must be coupled with stronger supervision.
- Trigger design: use independently verifiable indicators (e.g., Ted spread, index of bank shares) to avoid opportunistic reporting; basis risk remains.
- Correlation with other assets may reduce attractiveness to investors; structural variants (principal-protected tranches, extended maturity) are possible.

GSRF via IMF
- IMF or a multilateral institution could underwrite standardized systemic-risk bonds:
  - Economies of scale in research and underwriting.
  - As a non-profit underwriter, IMF could avoid private underwriter incentives to retain best risks.
  - IMF could condition payouts on supervisory outcomes and delegate parametric triggers to an independent agency.
- Risk aggregation and pooling could lower premiums relative to country-level schemes.
- Operational questions to resolve:
  - Who pays premia and who receives payouts (banks directly to IMF versus national regulators collecting premia).
  - Which banks participate and who decides payout recipients.

### Multilateral Insolvency Trust for International Banks
Problem and rationale
- No regime exists for cross-border bank insolvency; national fiduciaries face inconsistent priorities and potential asset runs.
- Existing cooperative initiatives (INSOL, UNCITRAL, IFEMA, ISDA) are helpful but limited.

Proposal: International Court of Insolvency
- Create a court analogous to the International Court of Justice, headed by experienced jurists appointing neutral administrators.
- Build on UNCITRAL’s Model Law on Cross-Border Insolvency.
- Make jurisdiction an obligation of IMF members with corresponding domestic legal implementation.
- Court supported by staff to gather asset-liability data; national regulators to provide information, potentially coordinated by the IMF.

### World Financial Organization (WFO) — global governance for prudential supervision
Motivation
- Inadequate international standards enforcement and spotty compliance during the crisis.
- Cross-border spillovers require stronger international governance.

WFO design features
- Modeled on WTO: establish principles for prudential supervision (capital/liquidity requirements, limits on concentrations, risk measurement, internal controls) without prescribing national institutional detail.
- Membership obligatory for countries seeking freedom of access to foreign markets for domestically-chartered financial institutions.
- Independent expert panels determine compliance and could authorize sanctions (e.g., restrict operations of banks and nonbank institutions chartered in offending countries).
- WFO would leave implementation choices to members but enforce compliance via sanctions and dispute mechanisms.

Initiation of cases and FSAP role
- Cases could be initiated by injured countries or by WFO independent panels reacting to ambiguous FSAPs.
- FSAPs remain a reference point; panels would perform “rating” decisions analogous to WTO dispute panels.
- Move to a WFO suggested after experience with a GATT-like predecessor.

### IMF governance — conventional and substantive reform proposals
Conventional agenda
- Revise quotas to give fast-growing countries louder voice.
- Relax 85 percent supermajority for substantial Article changes (suggested alternative: 80 percent).
- Revise voting procedures; downsize Executive Board (example aspiration: perhaps to 20 members).
- Open leadership selection process; transform IMFC into a Council per Article XII.

Substantive proposals
- Abolish the Executive Board:
  - Day-to-day decisions made by majority vote of managing director and deputy managing directors, akin to a central bank monetary policy committee.
  - Management appointed to long terms for insulation; greater transparency (e.g., delayed minutes or regular press conferences).
  - Abolish informal convention that managing director be European and first deputy American.
- Selection mechanisms suggested for a five-person management slate (regional slates, elections, or merit-based nominations).

Accountability and comparison to central banks
- Central banks’ expanded interventions demonstrate feasibility of independent institutions with strong accountability mechanisms.
- IMF independence concerns can be addressed with oversight committees and transparency.

Operational priorities and sequencing for reform
Near-term priorities
- Reform quotas and reconstitute/streamline Executive Board when political appetite returns.
- Transform IMFC into a Council that can issue binding instructions.
- Encourage additional countries, especially Asian, to join short-term liquidity instrument to eliminate stigma.
- Make Financial Sector Assessment Programs (FSAPs) mandatory; administer FSAPs regionally to include banks’ overseas subsidiaries and affiliates.

Sequencing (ten-year roadmap)
- Phase 1: strengthen FSAP process and streamline SLF.
- Phase 2: governance reform — start with conventional agenda, then consider ambitious reforms.
- Phase 3: implement remaining out-of-the-box proposals using enhanced legitimacy and efficiency from governance reforms.

Governance reform as prerequisite
- Without meaningful governance reform, emerging market members unlikely to agree to:
  - Indexed routine expansion of Fund resources.
  - Automatic contribution systems from chronic surplus countries.
  - IMF acting as secretariat to a World Financial Organization or supporting an International Court of Insolvency.
  - Pooling and underwriting subscriptions to a Capital Insurance Facility.
  - Coordinated Global Glass-Steagall measures or enhanced SDR role.

Final assessment
- Implementing many of the proposed measures, sequenced appropriately and preceded by governance reform, would make the international financial system materially safer.

*Prepared by Barry Eichengreen; WP/09/116 — Sections 1–4 (with bibliography in Section 5).*

### Section 1

### Out of the Box Thoughts about the International Financial Architecture

### I. Introduction — context and framing
- The Global Credit Crisis of 2008–09 underscored the urgency of reforming the international financial architecture, including strengthening supervision and regulation, supporting demand while preventing the reemergence of global imbalance, upgrading IMF surveillance, streamlining lending facilities, and reconfiguring IMF seats and votes.
- The paper contemplates more ambitious reforms over the next ten years, beyond the conventional consensus agenda.
- Reform is constrained by network effects and coordination problems: existing institutions and private-sector adaptations create high transactions costs for starting over; radical reform is rare and typically occurs after major systemic disruptions.
- The paper presents eight “out-of-the-box” ideas falling under three headings: measures to buttress financial stability, steps to smooth the operation of the international monetary system, and reforms of the IMF. These are not expected to be adopted in the short term but are proposals for consideration beyond the immediate crisis.

### II. A. Countercyclical IMF Capital Charges — findings and proposals
Findings and context
- As of early 2009, the Fund had some $200 billion of quota resources, and could tap an additional $53 billion through borrowing arrangements under the General Arrangements to Borrow (GAB) and New Arrangements to Borrow (NAB).
- The G20 Summit in early April agreed to increase those resources by a further $500 billion through, in the first instance, the New Arrangements to Borrow. At the time of writing, roughly half this amount has been promised by G20 leaders.
- By comparison, the new Short-Term Liquidity Facility (SLF), which allows applicants to draw up to 500 percent of quota, exposes it to potential claims of more than $450 billion from 44 emerging market members alone.
- In addition, there was agreement in principle to authorize an additional $250 billion of Special Drawing Rights, to be issued in proportion with countries’ quota. These will not be resources for the IMF itself, strictly speaking, but for its members.

Policy proposals
- Index countries’ contributions to Fund resources and have them contribute annually; routinize quota expansion by tying contributions to growth metrics.
  - Example goal: increase the IMF’s real resources at an average annual rate of 3 percent, to reflect the 3 percent average real rate of growth of the global economy.
  - Note: actual contributions would be in nominal terms; contributions calculated as, say, 3 percent of the outstanding subscription plus an adjustment for global inflation.
- Make the additional capital charge countercyclical (analogous to countercyclical bank capital ratios):
  - Example two-for-one formula: when global growth rises to 4 percent, countries might be asked to augment IMF real resources by 5 percent; when growth slips to 2 percent, they might be asked to augment IMF real resources by only 1 percent.
  - Implication: cutting contributions to zero when global growth fell to 1½ percent or less; symmetry suggests capping contributions at 6 percent when global growth rose to 4½ percent or higher.
- Index capital charges to national growth rates rather than global growth rates, so the countercyclical impulse is felt most strongly by countries most in need.
- Adjust votes in the Fund annually along with these contributions to address fast-growing countries with chronically inadequate quotas and voting rights.
Implementation and legal notes
- Regularization would require enabling legislation at the national level (e.g., the U.S. Congress would have to adopt legislation under which the U.S. would make annual contributions based on growth rates in GDP).
- Routinizing quota increases by indexing to GDP growth would not address the immediate need to redistribute current quotas to reflect 21st century realities; a separate one-time adjustment would be required.

### II. B. A Price-Based Scarce Currency Clause — findings and proposals
Problem and objectives
- There are longstanding worries about asymmetric pressure to adjust felt by deficit and surplus countries; the Scarce Currency Clause (SCC) in the IMF’s Articles of Agreement was designed to address this, but it has never been invoked.
- Authorizing members to invoke the SCC and impose tariffs or restrictions would be politically charged and difficult; a more efficacious long-run approach is an automatic process creating incentives for surplus countries to adjust.

Automatic adjustment mechanisms proposed
- Require transfers to the Fund based on persistent surpluses:
  - Example rule: a country that had run a current account surplus in excess of 3 percent of GDP for three years might be required to transfer additional resources to the Fund at the end of every year in which that excess persisted.
  - Example transfer magnitude: the transfer might equal one half of the current account surplus in excess of 3 percent of GDP.
- Alternative tax on reserve accumulation:
  - A tax on the increase in foreign exchange reserves when reserves had been increasing for 3 years and the increase in the current year exceeded 3 percent of GDP.
- More gradual tax schedule:
  - Tax all increases in foreign reserves starting at infinitesimal levels but rising fairly quickly as the increase in reserves rose as a share of GDP and as a function of its persistence.

Advantages and potential perverse effects
- Advantage: obviates the need for IMF staff or others to judge whether a currency is “manipulated” or “fundamentally undervalued”; no member would need to be cited as in violation.
- Potential perverse effect: a tax on countries that undervalued their currencies to accumulate more reserves, requiring transfers to the IMF, could encourage them to undervalue further to replace transferred reserves—i.e., a relative price effect and an “income effect” working in opposite directions.

*Prepared by Barry Eichengreen; WP/09/116 — Section 1*

### Section 2

### _wp09116 - Section 2

### Reserve accumulation motive and policy lever
- Some countries maintain highly competitive real exchange rates and run chronic external surpluses for reasons beyond reserve accumulation; Rodrik (2008) argues that so-called undervalued exchange rates are associated with rapid economic growth because they encourage manufacturing employment.
- If reserve accumulation "pure and simple" is the motivation for surpluses, marrying a tax on reserve accumulation to other reforms designed to guarantee emergency liquidity (for example, expansion of the IMF’s Flexible Credit Line) would weaken the motive and address the problem.
- The tax could be written into the Articles of Agreement so that collecting it would not require, inter alia, a decision by the Executive Board.
- Implementation considerations and design options mentioned in the source:
  - The charge might initially be set at a lower level and raised to, say, 50 percent over time (allowing members who wished to minimize it more time to adjust).
  - Tax revenues need not be paid into the Fund; they could equally well go to other multilateral bodies (World Bank for development assistance or the United Nations for peacekeeping operations).
  - Tax compliance cannot be assumed; a very strong international consensus (very strong peer pressure) would presumably be necessary to elicit compliance.

### Convertible SDRs
- Historical problem (Triffin): when a national currency (then predominantly the dollar) serves as the dominant source of incremental foreign exchange reserves, the system is intrinsically unstable—allowing the issuer (United States) to run chronic balance of payments deficits, weaken policy discipline, and foment inflationary/global financial bubbles.
- Past institutional responses:
  - Creation of Special Drawing Rights (SDRs) in 1969 and 1970s proposals for a Substitution Account to substitute SDRs for dollar reserves.
  - Debate over Substitution Account: to "bail out the dollar from short-term difficulties" versus to bring a "long-term structural improvement in the world monetary system" (Wallich (1980)); Bergsten (2007) resuscitated the Substitution Account idea in 2007.
- Rationale for rehabilitating SDRs as a global reserve alternative:
  - A composite reserve unit attractive to central banks could avoid problems associated with reliance on a single national currency and smooth the operation of the world monetary system.
  - For SDRs to be attractive, there must be deep and liquid markets in SDR claims so central banks can buy and sell reserve assets without moving markets or being noticed.
  - Commercializing the SDR requires a critical mass of SDR issuance by the IMF and by other entities (governments, banks, nonfinancial firms) and a critical mass of trading.
- Practical obstacles and requirements:
  - Historical private SDR activity (since 1975) was limited; dollar first-mover advantage impeded SDR commercialization (Sobol (1981–82); Allen (1993)).
  - To offer comparable liquidity and return to dollar debt securities someone would need to act as market maker and subsidize the market until scale and liquidity emerged; the obvious someone is the IMF.
  - The IMF could stand ready to buy and sell SDRs at bid-ask spreads comparable to those in U.S. treasury and agency markets and convert SDR liabilities into any of the constituent currencies at those spreads; subsidies would have a cost that members would have to agree to defray.
  - Institutional changes needed for SDRs to function as a true international currency:
    - The IMF would have to be able to issue additional SDRs in periods of shortage (analogous to the Fed providing dollar swaps in the second half of 2008).
    - At the moment, countries holding 85 percent of IMF voting power must agree before SDRs can be issued, which is not a recipe for liquidity.
    - IMF management would have to be empowered to decide on SDR issuance, making the IMF more like a global central bank and international lender of last resort.

### Global Glass-Steagall
- Diagnosis of the Global Credit Crisis:
  - Conflict between banks’ core functions (safe repository for household savings and operating the payments system) and the incentives to diversify into originating, distributing, and investing in risky assets, using wholesale funding and leverage.
  - Deregulation permitting banks to branch into new risky lines and intensification of cross-border competition (elimination of Regulation Q and Glass-Steagall restrictions in the United States; removal of capital controls; relaxation of restrictions on foreign banks) contributed to financial vulnerabilities.
- Proposal: reimpose Glass-Steagall-like restrictions (global coordination required)
  - Divide the financial system into two components:
    - Commercial banking component: liabilities limited to retail deposits; assets limited to low-risk instruments (cash, short-term treasuries, commercial paper, adequately-collateralized small business loans, and conforming mortgages). This would guarantee confidence in deposits, reduce bank-run likelihood, and ensure stability of the payments system.
    - Investment/market component: allowed to invest in riskier assets, provide loans to sub-investment-grade borrowers, take companies public; hedge funds and mutual funds would invest in these entities and their securities.
  - Additional safeguards for the second segment: capital requirements, limits on use of leverage, disclosure requirements, and requirements that firms purchase financial disaster (capital) insurance (discussed further in Section E).
  - If large entities in the second segment are to be rescued when failing, they should be regulated before the fact.
- International coordination imperative:
  - Reforms feasible only if coordinated internationally; otherwise cross-border arbitrage (e.g., Icelandic banks taking British deposits to invest in risky assets) undermines national measures.
  - Options for coordination:
    - Incorporate restrictions into the Basle Committee’s Core Principles for Effective Banking Supervision and monitor compliance through IMF/World Bank FSAP exercises.
    - Make restrictions an obligation of IMF members (more heavy-handed).
  - Less far-reaching approaches (e.g., limits on the range of activities per institution proposed by Adair Turner) still raise international coordination issues.
  - Same international coordination logic applies to proposals to limit institution size or apply heavier capital requirements as firms grow (too-big-to-fail concerns).

### A Global Systemic Risk Facility
- Proposal summary:
  - Following Kashyap, Rajan and Stein and others, protect against systemic risk by requiring banks to purchase capital insurance rather than hold additional capital at all times.
  - Mechanism: banks sell financial catastrophic (Cat) bonds, paying insurance premia equivalent to a bit of additional capital in good times in return for a large payout if systemic risk materializes.
  - Advantages:
    - Provides large protection when needed rather than small protection both when needed and when not.
    - Indexing payouts to systemic rather than bank-specific events limits moral hazard associated with the insurance.
- Key implementation requirement:
  - For this scheme to work there would have to be a counterparty prepared to put its own capital at risk.

*Source: _wp09116 - Section 2*

### Section 3

### _wp09116 - Section 3

### Cat bonds and capital insurance: design features, costs, and risks
- Concept: Catastrophe ("Cat") bonds transfer risk to investors who receive attractive returns if the bad realization does not occur but lose part or all of their investment in the event it does.
- Condition for attractiveness: Payoff in the bad realization must be larger than what can be mobilized by liquidating the assets in which banks’ insurance premia have been invested.
- Issuance costs and valuation challenges:
  - Payoffs depend on rare events with potentially unreliable data, rendering the instrument difficult to value.
  - Underwriters require substantial up-front costs for research on the distribution of risks and returns (geological surveys, weather studies), which can ration small countries out of the market.
  - Underwriter incentive: retain best risks while securitizing and selling off questionable ones, contributing to high premiums.
- Moral hazard and opportunistic reporting:
  - Availability of catastrophe insurance can encourage additional risk taking; capital insurance schemes should be married to strengthened supervision and regulation.
  - Opportunistic behavior if the trigger is reported or controlled by the insured can be addressed by indexing payoff to independently verifiable indicators (e.g., wind speed, rainfall, Richter Scale readings; or for financial Cat bonds, a global financial market indicator like the Ted spread or an index of bank shares).
  - Basis risk: external indicators (e.g., the Ted spread or bank-share indices) are imperfect proxies for capital needs and render insurance less effective; individual banks may not be too small to affect such global indicators.
- Correlation with other assets:
  - Cat bonds attractive when returns are uncorrelated with other financial assets (diversification).
  - For financial Cat bonds, returns will decline in the event of systemic risk, coinciding with declines in investors’ other investments; attractiveness to hedge funds, pension funds, sovereign wealth funds, and sophisticated private investors is uncertain.
- Structural variants:
  - Some Cat bonds include principal-protected tranches guaranteeing return of principal; triggers affect payment of interest and timing of principal repayment (example: extension from 3 to 10 years). Similar models could be applied to systemic-risk insurance.

### Proposal: Global Systemic Risk Facility (GSRF) via a multilateral institution like the IMF
- Rationale and potential advantages:
  - A multilateral institution could exploit economies of scale in underwriting research for standardized bonds, analogous to the World Bank’s Caribbean Catastrophe Risk Insurance Facility.
  - Could organize research on systemic risk and underwrite issuance of standardized bonds, potentially in cooperation with private reinsurers.
  - As underwriter and non-profit, the IMF could mitigate underwriter incentives to retain best risks.
  - An IMF-sponsored facility could reassure investors about moral hazard by conditioning payouts on supervisory outcomes (e.g., disqualification from payouts and paying further premia if an FSAP identified significant problems).
  - Parametric triggers should be delegated to an independent agency following transparent rules.
- Risk aggregation and pooling:
  - The IMF Systemic Risk Facility could act as a risk aggregator, allowing countries to pool country-specific risks into a diversified portfolio and substantially reduce premium costs relative to country-level schemes.
  - Observation: systemic risk and losses of bank capital have not affected all countries to the same extent even in the Global Credit Crisis.
- Barriers to private aggregation:
  - Unclear why institutional and individual investors cannot pool themselves; possible impediments include an "After you, Alphonse" problem where private issuers avoid being first and an under-investment externality where domestic insurers do not internalize cross-border benefits of insurance.
  - If such coordination failures exist, an IMF-organized global scheme could provide the necessary impetus (possibly without providing finance).
- Operational design questions needing resolution:
  - Who pays premia and to whom: banks directly to the IMF, with IMF paying banks in crisis; or premia paid to IMF by national regulators who decide participating banks, collect premia, and distribute payoffs?
  - Which banks would be covered and who decides participation and payout recipients remain to be specified.

### Multilateral Insolvency Trust for International Banks
- Problem statement:
  - Absence of a regime to deal with insolvency of major banks operating in multiple countries creates inconsistent priorities among national fiduciaries, risking mismatched treatment of preserving economic value versus settling claims and potential asset runs by competing fiduciaries.
  - Lehman Brothers case illustrates these difficulties.
- Existing cooperative initiatives:
  - INSOL International, Committee J of the International Bar Association, and UNCITRAL have commissioned working papers, organized meetings, and established working groups to encourage informal cooperation, foster recognition of foreign insolvency proceedings, and promote model legislation.
  - Financial firms promote standardized contract terms (e.g., IFEMA and ISDA Agreement) to standardize enforcement in insolvency.
  - Bilateral treaties and conventions exist in a limited number of cases.
- Universalism critique and a proposed international venue:
  - Universalism (single forum for international insolvency proceedings) faces the question of which national jurisdiction should host universal proceedings and whether national authorities can be trusted to fairly distribute assets to foreign creditors.
  - Proposal: an International Court of Insolvency analogous to the International Court of Justice, headed by experienced jurists appointing neutral administrators, guided by international law and building on UNCITRAL’s Model Law on Cross-Border Insolvency.
  - Jurisdiction could be made an obligation of IMF members, with corresponding domestic legal implementation required.
  - The court would need staff support to gather asset-liability data and other information for restructuring; national regulators would provide data, potentially coordinated by the IMF.

### World Financial Organization (WFO): global governance for prudential supervision
- Motivation:
  - Problems in one country's supervision and regulation can cause significant cross-border spillovers; existing mechanisms (FSF, Basel Committee, colleges of supervisors) were inadequate during the recent crisis.
  - International standards for supervision and regulation have been insufficiently demanding and compliance has been spotty due to lack of international sanctions.
- WFO design features and functions:
  - Analogy to WTO: WFO would establish principles for prudential supervision (capital and liquidity requirements, limits on portfolio concentrations and connected lending, adequacy of risk measurement systems and internal controls) without prescribing detailed regulatory structures.
  - Members would be obliged to meet international standards for supervision and regulation of their financial markets and institutions.
  - Membership would be obligatory for countries seeking freedom of access to foreign markets for domestically-chartered financial institutions.
  - Independent panels of experts would determine compliance; WFO would authorize imposition of sanctions on noncompliant countries.
  - Sanctions could permit other members to restrict operations of banks and nonbank financial institutions chartered in offending countries, creating incentives to comply.
- Addressing sovereignty concerns:
  - WFO would not dictate specific national regulatory measures; implementation specifics would be left to individual countries provided they comply with broad WFO principles.
  - The WTO precedent: dispute panels determine compliance with obligations, leaving members the choice to change laws or face sanctions and retaliation.

*Source: _wp09116 - Section 3*

### Section 4

### _wp09116 - Section 4

### World Financial Organization (WFO) model: initiation of cases and FSAP role
- WTO cases are initiated by a country that feels it has been injured by foreign trade policies; examples in finance could include other European countries objecting to Ireland’s blanket deposit guarantees or Icelandic banks’ offshore deposit-taking activities.
- In finance, injury is likely to be more diffuse and adverse financial repercussions more widespread; markets operate quickly, making ex ante correction more important.
- Alternative initiation mechanisms:
  - Cases could be initiated at the volition of the WFO’s panel of independent experts, who might convene a panel in response to an ambiguous FSAP.
  - Advantage over the FSF-IMF model: no need to imagine that the Fund could provide an up-or-down decision on the adequacy of national regulation; the “rating decision” would be outsourced to the independent panel of experts.
- The Basel Core Principles for Effective Banking Supervision are noted as the obvious reference when defining these principles.
- Transition note: The move to a WFO would presumably occur after some years of satisfactory experience with a GATT-like predecessor (if the history of the WTO is any guide).

### IMF governance: conventional reform agenda
- Broad consensus items for reform include:
  - Revising quotas to give fast-growing countries a louder voice and to reflect 21st-century realities.
  - Relaxing the 85 percent supermajority for substantial changes to the Articles of Agreement, new SDR issues and the like (perhaps to 80 percent) so no one country exercises a veto over key policy decisions and reforms.
  - Revising voting procedures to better balance interests of large and small countries.
  - Updating and downsizing the Executive Board, perhaps to 20 members, to streamline decision making and allow for more emerging-market representation.
  - Opening up the leadership selection process once and for all.
  - Transforming the International Monetary and Financial Committee (IMFC) of 24 finance ministers into a Council, as envisaged by Article XII of the Articles of Agreement, to provide oversight of the Executive Board through periodic meetings and written procedures.
- Observations on symbolic vs operational value:
  - Virtually all important operational decisions are made by consensus, not votes.
  - Consensus is formed in the shadow of voting rules, and the ability of a member’s representative to present arguments articulately can shape board decisions beyond expected voting-share influence.
  - Even if the supermajority requirement fell from 85 to 80 percent, the United States, with its 17 percent of total votes, could likely tip balances by rounding up a few allies with 3 percent of total votes between them.
  - Downsizing the Executive Board to 20 members may not significantly streamline decision making.
  - Changing the IMFC name to IMF Council and having it meet biannually may not substantially alter decision making by a Board that meets up to four days a week.

### IMF governance: substantive reform proposals
- Proposal: abolish the Executive Board.
  - Day-to-day decisions would be made by a majority vote of the managing director and deputy managing directors in the manner of a monetary policy committee of a central bank.
  - These individuals would have independence and autonomy to act quickly and take politically difficult decisions (e.g., publicly criticizing the exchange rate or fiscal policy of a large member or disbursing a large amount of money quickly).
  - Rationale: avoiding delays from obtaining approval of 24 mid-level bureaucrats, some of whom take instructions directly from their governments; facilitating radical departures from past policies when needed.
- Management team features:
  - Members should be appointed/elected to long terms to provide insulation from political pressures.
  - Management would need to be strongly accountable and more transparent about their decisions and criteria (e.g., delayed publication of minutes of deliberations or regular press conferences in the manner of the ECB).
  - The informal convention that the managing director should be European and first deputy American would have to be abolished.
  - Leadership selection should reward the most qualified candidates and ensure reasonable geographic and economic diversity.
  - Possible selection mechanisms for a five-person management slate discussed include:
    - Competing five-person slates comprising one North American, one Latin American, one African, one Asian and one European candidate voted on by the Board of Governors (noted as suboptimal).
    - Five regional candidates elected by respective regions followed by a second election by the entire membership to choose the managing director.
    - Candidates nominated and voted for without reference to nationality/national origin, with the candidate receiving the most votes becoming MD and the next four becoming deputies.

### Accountability and comparison to central banks
- Concerns against greater IMF independence include greater discretion, risk to taxpayer money, and complexity of decisions compared with central banks that "just set interest rates."
- Counterpoints based on the 2008–09 credit crisis:
  - National central banks have engaged in detailed interventions and purchased varied collateral as part of credit easing, exposing their balance sheets to potential losses.
  - Modern central banks do much more than set interest rates, creating pressure for stronger accountability mechanisms (e.g., oversight committees of U.S. Congress or committees of the European Parliament).
  - These developments have not made central bank independence intolerable or undesirable.

### Operational priorities and sequencing for reform
- Near-term, pragmatic actions the IMF can pursue:
  - Reform of quotas and reconstituting/streamlining the Executive Board once shareholders regain appetite.
  - Transforming the IMFC into a Council that can issue binding instructions to management and the board.
  - Enticing additional countries, Asian countries in particular, to sign up for its short-term liquidity instrument to eliminate stigma.
  - Making Financial Sector Assessment Programs (FSAPs) mandatory rather than at the volition of the member.
  - Administering FSAPs at the regional rather than the national level, first in Europe and then other parts of the world, to ensure FSAPs encompass banks’ overseas subsidiaries and affiliates.
- Sequencing strategy (ten-year roadmap concept):
  - First, pursue business as usual—strengthening the FSAP process and streamlining the SLF.
  - Next, proceed with governance reform, starting with the conventional agenda and then moving to more ambitious reforms.
  - Finally, leverage enhanced legitimacy and efficiency from governance reforms to implement remaining out-of-the-box proposals.
- Governance reform is framed as a prerequisite for major IMF roles:
  - Without meaningful governance reform, emerging market members would not agree to significant expansion of Fund resources (e.g., along the indexing scheme referenced earlier), automatic contribution systems from countries in chronic balance of payments surplus, the IMF acting as secretariat to a World Financial Organization or the latter using FSAPs for decisions, the IMF providing staff support to an International Court of Insolvency, pooling and underwriting subscriptions to a Capital Insurance Facility, coordinating a move to a Global Glass-Steagall Act, or enhancing the role of the SDR.
- Outcome: implementing many proposals in this sequencing would result in a safer financial world.

*Source: _wp09116 - Section 4*

### Section 5

### _wp09116 - Section 5

### Cited works in Section 5
- Nishimura, Kiyohiko, 2008, “A Proposal for Public Capital Insurance,” unpublished manuscript; Bank of Japan, November 22.
- Perotti, Enrico and Javier Suarez, 2009, “Liquidity Insurance for Systemic Crises,” www.ft.com, February 24.
- Raffer, Kunibert, 2005, “Considerations for Designing International Insolvency Procedures,” Journal of Law, Social Development and Justice, 1.
- Ramirez, Carlos, 1999, “Did Glass Steagall Increase the Cost of External Finance for Investment? Evidence from Bank and Insurance Company Affiliations,” Journal of Economic History, 59, pp. 372–396.
- Rodrik, Dani, 2008, “The Real Exchange Rate and Economic Growth,” Brookings Papers on Economic Activity, Fall, pp. 365–412.
- Sobol, Dorothy, 1981–82, “The SDR in Private International Finance,” Federal Reserve Bank of New York Quarterly Review, Winter, pp. 29–41.
- Triffin, Robert, 1960, Gold and the Dollar Crisis, (Yale University Press).
- Wallich, Henry, 1980, “The World Monetary System after the Postponement of the Substitution Account,” Intereconomics, July/August, pp. 163–167.

*Source: _wp09116 - Section 5 — https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2009/_wp09116.pdf*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2009/_wp09116.pdf_