## _021809 — 1. Coverage. This paper provides an initial assessment of the flaws in the global

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### Coverage: purpose and scope
- Purpose: provides an initial assessment of the flaws in the global architecture exposed by the crisis and potential solutions.
- Definition of "architecture": official mechanisms that facilitate global financial stability and the smooth flow of goods, services, and capital across countries.
- Role of the Fund: serves as something of a fulcrum due to universal membership, mandatory bilateral Article IV consultations, and lead role in crisis lending.
- Scope of discussion: overview of key facets of the architecture and first steps to make the system in general and the Fund in particular more effective.

### Surveillance — Context
- Objective: identify domestic and cross-border vulnerabilities that could spark systemic disruptions.
- Primary mandate: Fund’s surveillance over the global economy and countries’ policies.
- Other institutions with similar functions: Bank for International Settlements (BIS), Organization for Economic Cooperation and Development, World Bank (from a more specialized perspective).
- Post-Asia crisis developments:
  - Greater focus on financial analysis.
  - Creation of the Financial Sector Assessment Program (FSAP) by the Fund and World Bank to examine macro-financial linkages.
  - Creation of the Financial Stability Forum (FSF) to promote information exchange and cooperation in financial supervision and surveillance across major financial centers.
- Assessment: None of these arrangements provided sufficiently robust warnings in the run up to the crisis.

### Surveillance — Problems and evidence of missed warnings
- Warnings before the crisis were generally too scattered and unspecific to attract domestic or collective policy reaction.
- Some prescient warnings existed about US banking model and housing market, but official warnings were insufficiently specific, detailed, or dire to gain traction with policy makers.
- Box 1 — Quality of IMF Warnings in the Lead Up to the Crisis:
  - Multilateral surveillance publications (WEO, GFSR) and bilateral surveillance reports (Article IVs, FSAPs) identified many key developments and vulnerabilities but failed to deliver effective, actionable messages.
  - Selected WEO themes:
    - (i) global imbalances (since Spring 2002)
    - (ii) low global interest rates/high risk taking (Spring 2005)
    - (iii) elevated global house prices (continuous, notable early warnings in Spring 2003 and Spring 2004) with emphasis on global synchronization/risks (Fall 2004) and a US-specific warning (e.g., Fall 2005)
    - (iv) excessive reliance on external funding by EU accession countries (from Spring 2004)
    - (v) impact of globalization on inflation (Spring 2006)
    - (vi) financial system feedback to economic cycles (Fall 2006)
    - (vii) European housing market valuations (Fall 2007)
  - Selected GFSR themes:
    - (i) market complacency/“search for yield” (e.g., Fall 2003)
    - (ii) lack of information on holders of risk (e.g., Spring 2004)
    - (iii) increasing leverage and complexity of credit products (Spring 2005)
    - (iv) dependence on continuous liquidity (Spring 2006)
    - (iv) subprime lending and housing markets (Fall 2005, also Spring 2007)
  - Bilateral surveillance identified:
    - (i) institutional weaknesses (especially through FSAPs)
    - (ii) low interest rates
    - (iii) wholesale funding risk
    - (iv) expansion of credit risk transfer products
    - (v) risk of house price corrections
    - (vi) mounting international exposures, in particular through interbank markets
    - (vii) lack of information on ultimate holders of risk
  - Missed or underestimated by surveillance:
    - (i) risk of a house price collapse
    - (ii) danger from dispersed/unseen risk
    - (iii) housing-financial feedbacks
    - (iv) spillover from subprime mortgages to finance more broadly and on to the real economy
    - (v) limits of inflation targeting
    - (vi) risk of systemic failure
  - Overall key weaknesses:
    - Failure to uncover aggregate implications of individual risks—macro-financial issues often viewed in isolation; spillovers and feedbacks inadequately explored.
    - Lack of follow-through—when flagged risks (e.g., in 2002–03) failed to materialize, concerns were downplayed rather than amplified; exploration of “tail risks,” “what if” questions, and “known unknowns” were inadequate.
    - Optimistic bottom-line assessments and hedged messages encouraged complacency—analysis often inclined to believe “this time is different.”
- Box 2 — Warnings by Others in the Lead Up to the Crisis:
  - BIS Annual Reports (from 2004 onward) flagged global imbalances, liberalized financial systems prone to instability, low interest rates distorting behavior, risks from structured products, credit rating concerns, mortgage-backed security investor exposures, spillovers to derivatives markets, problems with “originate to distribute” model, and banks retaining significant credit risk.
  - US Office for the Comptroller of the Currency Annual Credit Underwriting Surveys (2004–2007) warned of imprudent credit decisions, need for enhanced credit risk management, weakening underwriting standards, and concerns about rapid housing appreciation.
  - Bank of England Financial Stability Reports (from 2005) flagged “search for yield” and mounting vulnerabilities on borrowers’ and financial institutions’ balance sheets.
  - FSF reports (2003–06) emphasized need for improvements in risk management, disclosures, supervisory approaches, credit rating agency conflict management, and highlighted risks from household indebtedness, inflated housing prices, leveraged buyouts, complexity of financial instruments, and global imbalances.
  - Independent commentators noted downside risks: Paul Krugman and Robert Shiller (mid-2005), Kenneth Rogoff (early 2006), Nouriel Roubini (early 2006 onward).
  - Additional surveillance failings highlighted:
    - Lack of specificity in warnings as securitization sliced and sold risk, with analysis often coded and embedded in lengthy discussions.
    - Failure to diagnose that risk remained with the core banking system, partially reflecting insufficient data; securitized instruments often sold to affiliated entities (special investment vehicles) facilitating lower capital support and higher leverage and systemic risk.
    - Missed interlinkages between macroeconomic risks and financial market developments; surveillance underrated combined risk from growing financial complexity and rising leverage.
    - Silo culture of specialized surveillance with limited cross-institution engagement and incomplete integration of macroeconomic and financial analysis at the Fund.
    - Rosy bottom line: optimistic view on advanced countries and financial innovation led to insufficient focus on “tail risks”; Fund repeatedly warned about external risks via global imbalances but tended to mute messages as imbalances continued to rise; missed key connection to looming dangers in the shadow banking system. By early 2008, the Fund warned on bank losses with a pessimistic outlook, but by then it was too late.

### Surveillance — Proposed solutions
- Aim: a less fragmented and more pointed surveillance system to allow warnings to gain traction with policy makers.
- Core components:
  - A joint Fund–FSF early warning system:
    - Integrate the Fund’s macro-financial expertise with the FSF’s regulatory perspective for a holistic view of evolving global concerns.
    - Canvass outside opinions at the start (macro-financial analysts, policy makers, market players, academics).
    - Focus exercise on organizing common themes into a limited number of key vulnerabilities, risks, and evolving trends.
    - Final presentation should focus on policy advice to mitigate risks or, where issues are partially understood, on need for further analysis and better data to enable concrete policy options later.
  - Emphasizing systemic risks from all quarters:
    - Fund vulnerability exercise to be expanded to advanced economies and integrated with the early warning exercise.
    - Renewed emphasis on advanced country risks implies new perspectives on concerns such as large current account deficits and corresponding capital inflows.
    - Underscores need to resolve vulnerabilities from continuing imbalances, currency misalignments, and capital flows between the Fund’s largest members.
  - Better integrating Fund financial analysis with macroeconomic work:
    - Greater emphasis on integrating financial sector work into the WEO and Article IVs.
    - New analytic tools and the new macro-financial unit in the Research department to enhance understanding of macro-financial links.
    - FSAPs to be sharpened: move from comprehensive domestic assessments and formalized standards assessments to more risk-based and thematic assessments with greater emphasis on external links and spillovers (including, possibly, regional reports).
    - FSAP participation should be made mandatory for all systemically important countries.

### Policy coordination and Fund governance — Context
- Effective surveillance and crisis resolution require policy responses discussed by those with authority and legitimacy to respond.
- Institutional separation: Fund’s mandate given to the Board while ministers and governors with power to act sit on the advisory International Monetary and Financial Committee (IMFC).
- Consequence: mandate and power separated; rigid structures led policy coordination to drift to smaller, nimbler groups (notably the G7).
- Limitations: G7’s authority extends over an increasingly limited share of the world economy, constraining its ability to initiate policy actions and resolve global tensions.
- Conclusion: nobody is clearly in charge.

### Policy coordination and Fund governance — Problems
- Lack of global policy coordination stoked the crisis, reflecting limitations of available structures.
- Fragmentation of surveillance produced a failure to communicate some risks clearly; collective action proved elusive even when serious concerns were raised (e.g., disorderly unwinding of global imbalances).
- Absence of an effective forum where relevant policy makers could actively engage contributed to poor coordination.
- Examples and dynamics:
  - IMFC in 2006 endorsed a broad strategy comprising fiscal consolidation in the US; structural reforms in Europe and Japan; measures to boost domestic demand and currency flexibility in emerging Asia; increased spending by oil producers.
  - Fund’s Multilateral Consultation sought more specific policy commitments but met only limited success; G7 communiqués sometimes more direct but yielded little concrete action.
  - After the 2008 crisis intensified, initial policy response was not collaborative or coordinated, worsening propagation across the global financial system:
    - Countries adopted government guarantees to protect banks’ assets and liabilities, pressuring neighboring countries and exposing them to deposit-run risks unless they adopted guarantees.
    - Network of government support in advanced countries put pressure on emerging market banks.
    - US actions initially focused on domestic support despite market prices suggesting significant dollar funding pressures for European banks and emerging markets.
    - Countries ring-fenced assets when cross-border entities failed, reflecting absence of clear burden sharing mechanisms for international banks.
  - When cooperation was finally sought, an improvised forum emerged: The first ever G20 Leaders meeting convened, followed by thematic working groups whose membership extends beyond the G20.

### Policy coordination and Fund governance — Proposed reforms
- Reforms to strengthen the Fund’s ownership and effectiveness:
  - Rebalancing quota shares sooner than envisaged at the last quota review so that they reflect better the evolving world economy, giving emerging and developing countries greater sense of ownership and alleviating doubts about the Fund serving their interests.
  - Moving to a more representative Board and IMFC, less tilted toward advanced countries.
  - Giving IMFC ministers and governors a high profile forum for focused interactive deliberations and policy follow-up to enhance policy engagement and political legitimacy on key issues such as early warnings and response.
  - Other governance reforms: advancing accountability and the effectiveness of decision making; creating a truly open, transparent and merit-based system for selecting Fund management.

### Cross-border financial regulation — Context and problems
- Context: As internationally active banks grew, regulation and supervision increasingly required cross-border cooperation; colleges of supervisors were set up but proved fragile in turmoil.
- Problems identified:
  - Thresholds for intervention: Regulatory capital and other metrics trigger corrective action differently across jurisdictions (US-style prompt corrective action vs. European-style supervisory discretion), leading to different intensity of oversight across subsidiaries or branches and potential regulatory arbitrage.
  - Materiality of risks: Costs of failure vary across stakeholders; in crisis parents may call in liquidity and capital from abroad harming host systems. Example: Italian-owned banks comprise one-fifth of the Polish market but their assets account for only 4 percent of Italian banking assets.
  - Resolution tools and safety nets: No harmonized ex-ante rules governing cross-border bank resolution or burden sharing. Supervisors prioritize taxpayers, minimizing liabilities to nonresidents and maximizing control of assets (examples cited: US “domestic depositor preference” and “single-entity approach”; UK ring-fencing of Icelandic bank assets; German freezing of Lehman’s assets).

### Cross-border financial regulation — Proposed solutions
- Progress needed on improving prior agreements on coordination; colleges of supervisors and codes of conduct (in which the Fund can play a role) will help.
- Coordinated risk monitoring and intervention:
  - Codify closer home-host collaboration and explicit agreement on thresholds and associated actions to address vulnerabilities early, initially applied to major internationally active banking groups.
  - Make supervisory colleges more inclusive to help avoid protectionism.
- A harmonized resolution framework:
  - A fully harmonized regime is exceedingly complicated; possible ways forward include an international banking charter spelling out procedures for joint risk assessment, remedial action, and burden sharing, or, short of a charter, agreement among home and host supervisors with supervisory colleges as arbiter.

### Financing: facilities and resources — Context and problems
- Context: Resources available to the public sector and the Fund have failed to keep up with the growth of international flows of trade and financial assets. Fund facilities remain focused on loans tied to conditionality despite demand for contingent credit instruments and liquidity lines. Many countries self-insure via reserve accumulation.
- Problems identified:
  - Absence of standing dollar liquidity facilities: Felt in interbank markets; response was slow for mature markets and slower and more limited for emerging markets. Temporary central bank swap lines were limited and admission criteria opaque.
  - Absence of large insurance mechanism for emerging market countries: Access to adequate liquidity and financing in hard times and flexible repayment terms is lacking; without insurance, excessive reserve buildup may distort global current account balances.
  - Stigma of Fund lending: Members resist approaching the Fund due to political stigma, allowing problems to fester. Evidence includes demand for “Fund-type” support from other institutions (e.g., World Bank providing balance of payments assistance via development policy loans to some East European members; Fed swap lines for some emerging markets).

### Financing: proposed reforms and design considerations
- Reform the Fund’s financing toolkit to include an effective crisis prevention instrument and alleviate stigma; tailor lending to members’ policy strength by reforming conditionality and allowing flexibility on access levels and repayment terms.
- Consider establishing an effective crisis prevention instrument for high-performing members and clarify scope for high-access precautionary arrangements for others.
- Specific design considerations:
  - Liquidity for strong performers: New crisis prevention instrument should provide assurances to members with strong policy track records and sound fundamentals of rapid, large and upfront access to Fund resources with no ex post conditionality; available to address all types of balance of payment problems. Key design issues include length of arrangement and whether to cap access in the absence of an actual external need. Under the most flexible design, lending against an actual need would not be ruled out.
  - Adequate precautionary borrowing: Formalize and clarify criteria for high access precautionary arrangements, establish unambiguous modalities for frontloading access and customizing program design based on policy track record and required adjustment; a key design issue is whether to establish a ceiling on access to avoid undue tying up of Fund resources.
  - Improving conditionality: Tailor conditionality to members’ policies and fundamentals, relying more on ex-ante than ex-post conditionality where justified.

### Financing: capacity issues and near-term resource options
- Problems with lending capacity:
  - The Fund’s available resources (some $200 billion prior to the crisis) appear constrained as the situation has turned.
  - The Fund can draw on up to $50 billion more through standing borrowing arrangements with members, but questions remain whether cumulative resources will be sufficient.
  - New commitments totaling $48 billion have been provided since end-September 2008, with substantial additional assistance in the pipeline.
  - Stress in other emerging markets, particularly in Eastern Europe, and the unprecedented complexity, breadth and scale of this crisis suggest significant further potential demand.
- Near-term and longer-term solutions:
  - Prompt temporary action is needed; borrowing under bilateral loan agreements—as recently done with Japan for $100 billion—is the most effective near-term option, though other variants (such as placing paper with central banks) could be explored.
  - Expansion or enlargement of existing multilateral borrowing arrangements (the General/New Arrangements to Borrow) may be considered by participants as a longer-term solution.
  - A general quota increase—based on an updated quota formula—would permanently increase the Fund’s own resources.
  - More innovative options—such as an SDR allocation, together with some post-allocation mechanisms to temporarily transfer liquidity to members with the greatest need—could also provide additional reserves.

### Conclusions — Bottom line
- The crisis revealed flaws in key dimensions of the global architecture but provides a unique opportunity to fix them.
- Surveillance must be reoriented to ensure warnings are clear, successfully connect the dots, and provide practical advice to policy makers.
- An effective forum for policy makers with the ability and mandate to lead responses to systemic concerns is key.
- Ground rules for cross-border finance need strengthening.
- Resources available for liquidity support and easing external adjustment should be augmented and processes for using them better defined so they are more readily available when needed.
- These are ambitious undertakings, but the crisis provides an opportunity to make progress on seemingly intractable issues; the moment should not be missed.

*Source: _021809 - 1. Coverage. This paper provides an initial assessment of the flaws in the global*

### 1. Coverage. This paper provides an initial assessment of the flaws in the global

### _021809 - 1. Coverage. This paper provides an initial assessment of the flaws in the global

### Coverage
- Purpose: provides an initial assessment of the flaws in the global architecture exposed by the crisis and potential solutions.
- Definition of "architecture": official mechanisms that facilitate global financial stability and the smooth flow of goods, services, and capital across countries.
- Role of the Fund: serves as something of a fulcrum due to universal membership, mandatory bilateral Article IV consultations, and lead role in crisis lending.
- Scope of discussion: overview of key facets of the architecture and first steps to make the system in general and the Fund in particular more effective.

### Focus — key areas of failure
- Four key areas where the existing architecture failed as vulnerabilities produced a crisis:
  - Surveillance of global economic developments and policies did not give sufficiently pointed warnings about the risks building up in the international financial system.
  - Coordination of macroeconomic policies across governments did not produce the international leadership needed for a concerted response to the global risks identified.
  - Regulation and supervision of internationally active financial institutions did not provide a sufficiently robust framework to allow problems to be resolved smoothly.
  - Arrangements for international public liquidity and loans to support adjustment did not fill gaps adequately as the crisis spread, reflecting shortcomings in design and size.

### II. SURVEILLANCE — Context
- Objective: identify domestic and cross-border vulnerabilities that could spark systemic disruptions.
- Primary mandate: Fund’s surveillance over the global economy and countries’ policies.
- Other institutions with similar functions: Bank for International Settlements (BIS), Organization for Economic Cooperation and Development, World Bank (from a more specialized perspective).
- Post-Asia crisis developments:
  - Greater focus on financial analysis.
  - Creation of the Financial Sector Assessment Program (FSAP) by the Fund and World Bank to examine macro-financial linkages.
  - Creation of the Financial Stability Forum (FSF) to promote information exchange and cooperation in financial supervision and surveillance across major financial centers.
- Assessment: None of these arrangements provided sufficiently robust warnings in the run up to the crisis.

### II. SURVEILLANCE — Problem
- Warnings before the crisis were generally too scattered and unspecific to attract domestic or collective policy reaction.
- Some prescient warnings existed about US banking model and housing market, but official warnings were insufficiently specific, detailed, or dire to gain traction with policy makers (Boxes 1–2).

- Box 1 — Quality of IMF Warnings in the Lead Up to the Crisis:
  - Multilateral surveillance publications (WEO, GFSR) and bilateral surveillance reports (Article IVs, FSAPs) identified many key developments and vulnerabilities but failed to deliver effective, actionable messages.
  - Selected WEO themes:
    - (i) global imbalances (since Spring 2002)
    - (ii) low global interest rates/high risk taking (Spring 2005)
    - (iii) elevated global house prices (continuous, notable early warnings in Spring 2003 and Spring 2004) with emphasis on global synchronization/risks (Fall 2004) and a US-specific warning (e.g., Fall 2005)
    - (iv) excessive reliance on external funding by EU accession countries (from Spring 2004)
    - (v) impact of globalization on inflation (Spring 2006)
    - (vi) financial system feedback to economic cycles (Fall 2006)
    - (vii) European housing market valuations (Fall 2007)
  - Selected GFSR themes:
    - (i) market complacency/“search for yield” (e.g., Fall 2003)
    - (ii) lack of information on holders of risk (e.g., Spring 2004)
    - (iii) increasing leverage and complexity of credit products (Spring 2005)
    - (iv) dependence on continuous liquidity (Spring 2006)
    - (iv) subprime lending and housing markets (Fall 2005, also Spring 2007)
  - Bilateral surveillance identified:
    - (i) institutional weaknesses (especially through FSAPs)
    - (ii) low interest rates
    - (iii) wholesale funding risk
    - (iv) expansion of credit risk transfer products
    - (v) risk of house price corrections
    - (vi) mounting international exposures, in particular through interbank markets
    - (vii) lack of information on ultimate holders of risk
  - Missed or underestimated by surveillance:
    - (i) risk of a house price collapse
    - (ii) danger from dispersed/unseen risk
    - (iii) housing-financial feedbacks
    - (iv) spillover from subprime mortgages to finance more broadly and on to the real economy
    - (v) limits of inflation targeting
    - (vi) risk of systemic failure
  - Overall key weaknesses:
    - Failure to uncover aggregate implications of individual risks—macro-financial issues often viewed in isolation; spillovers and feedbacks inadequately explored.
    - Lack of follow-through—when flagged risks (e.g., in 2002–03) failed to materialize, concerns were downplayed rather than amplified; exploration of “tail risks,” “what if” questions, and “known unknowns” were inadequate.
    - Optimistic bottom-line assessments and hedged messages encouraged complacency—analysis often inclined to believe “this time is different.”
  - Note: This Box draws on and updates findings of the Fund’s 2008 Triennial Surveillance Review, which focused on bilateral surveillance of Germany, Switzerland, the United States, and the United Kingdom, supplemented by an internal informal review of multilateral surveillance messages.

- Box 2 — Warnings by Others in the Lead Up to the Crisis:
  - Several organizations and commentators provided warnings with differing degrees of clarity and concern; many failed to achieve traction with policy makers.
  - The BIS Annual Reports (from 2004 onward) emphasized: global imbalances; liberalized financial systems prone to instability; low interest rates distorting behavior; danger of either “overt inflation ... [or] implications of growing debt levels”; need for macro-financial stabilization frameworks; risks from rapid turn in the credit cycle; vulnerability of untested structured products; credit ratings potentially underestimating loss exposures; mortgage-backed security investor exposures; medium-term risks; problems with household balance sheets and US mortgage markets; spillovers to credit default swap and other derivative markets (before July 2007); “market risk and leverage”; problems with the “originate to distribute” model; banks retaining significant credit risk on their books.
  - US Office for the Comptroller of the Currency Annual Credit Underwriting Surveys (2004–2007) warned: imprudent credit decisions from ambitious growth goals; need for enhanced credit risk management; accountability for relationship managers; “the worst of loans are made in the best of times”; need to keep pace with new products and emerging concentrations; rapid housing appreciation raising concerns about price volatility and overvalued markets; by 2006 credit risk was increasing with continued weakening of underwriting standards.
  - Bank of England Financial Stability Reports (from 2005) flagged issues similar to the GFSR: while the short-run outlook remained good, “search for yield” and mounting vulnerabilities on borrowers’ and financial institutions’ balance sheets gave cause for concern—later challenged the GFSR’s April 2008 loss estimates as too high.
  - FSF reports (2003–06) highlighted need for improvements in risk management, disclosures, investor due diligence, supervisory approaches, and credit rating agency conflict management; in September 2006 highlighted risks from household indebtedness, inflated housing prices, rapid growth in leveraged buyouts and debt-financed acquisitions, growing complexity of financial instruments, and global imbalances; urged market participants to consider implications of reversal of benign conditions, including less liquid markets.
  - Independent commentators noted downside risks:
    - mid-2005: Paul Krugman and Robert Shiller noted potential for a drop in US house prices
    - early 2006: Kenneth Rogoff outlined risks including danger of house price collapse and a test from a dollar collapse
    - early 2006 onward: Nouriel Roubini warned of global and US house price bubble collapse and global slowdown, louder from October 2006 predicting a US hard landing and lack of decoupling
  - Additional surveillance failings highlighted:
    - Lack of specificity in warnings as securitization sliced and sold risk, with analysis often coded and embedded in lengthy discussions.
    - Failure to diagnose that risk remained with the core banking system, partially reflecting insufficient data; securitized instruments often sold to affiliated entities (special investment vehicles) facilitating lower capital support and higher leverage and systemic risk.
    - Missed interlinkages between macroeconomic risks and financial market developments; surveillance underrated combined risk from growing financial complexity and rising leverage.
    - Silo culture of specialized surveillance with limited cross-institution engagement and incomplete integration of macroeconomic and financial analysis at the Fund.
    - Rosy bottom line: optimistic view on advanced countries and financial innovation led to insufficient focus on “tail risks”; Fund repeatedly warned about external risks via global imbalances but tended to mute messages as imbalances continued to rise; missed key connection to looming dangers in the shadow banking system. By early 2008, the Fund warned on bank losses with a pessimistic outlook, but by then it was too late.

### II. SURVEILLANCE — Solutions
- Aim: a less fragmented and more pointed surveillance system to allow warnings to gain traction with policy makers.
- Core components:
  - A joint Fund–FSF early warning system:
    - Integrate the Fund’s macro-financial expertise with the FSF’s regulatory perspective for a holistic view of evolving global concerns.
    - Canvass outside opinions at the start (macro-financial analysts, policy makers, market players, academics).
    - Focus exercise on organizing common themes into a limited number of key vulnerabilities, risks, and evolving trends.
    - Final presentation should focus on policy advice to mitigate risks or, where issues are partially understood, on need for further analysis and better data to enable concrete policy options later.
  - Emphasizing systemic risks from all quarters:
    - Lesson: tail risks can come from a wider range of sources; global surveillance must adapt.
    - Fund vulnerability exercise to be expanded to advanced economies and integrated with the early warning exercise.
    - Renewed emphasis on advanced country risks implies new perspectives on concerns such as large current account deficits and corresponding capital inflows.
    - Underscores need to resolve vulnerabilities from continuing imbalances, currency misalignments, and capital flows between the Fund’s largest members.
  - Better integrating Fund financial analysis with macroeconomic work:
    - Greater emphasis on integrating financial sector work into the WEO and Article IVs.
    - New analytic tools and the new macro-financial unit in the Research department to enhance understanding of macro-financial links.
    - FSAPs to be sharpened: move from comprehensive domestic assessments and formalized standards assessments to more risk-based and thematic assessments with greater emphasis on external links and spillovers (including, possibly, regional reports).
    - FSAP participation should be made mandatory for all systemically important countries.

### III. POLICY COORDINATION AND FUND GOVERNANCE — Context
- Effectiveness condition: surveillance and crisis resolution require policy responses discussed by those with authority and legitimacy to respond.
- Institutional separation: Fund’s mandate given to the Board while ministers and governors with power to act sit on the advisory International Monetary and Financial Committee (IMFC).
- Consequence: mandate and power separated; rigid structures led policy coordination to drift to smaller, nimbler groups (notably the G7).
- Limitations: G7’s authority extends over an increasingly limited share of the world economy, constraining its ability to initiate policy actions and resolve global tensions.
- Conclusion: nobody is clearly in charge.

### III. POLICY COORDINATION AND FUND GOVERNANCE — Problems
- Lack of global policy coordination stoked the crisis, reflecting limitations of available structures.
- Fragmentation of surveillance produced a failure to communicate some risks clearly; collective action proved elusive even when serious concerns were raised (e.g., disorderly unwinding of global imbalances).
- Absence of an effective forum where relevant policy makers could actively engage contributed to poor coordination.
- Examples:
  - Warnings over 2002–06 about global imbalances were taken seriously and echoed in IMFC and G7 communiqués; IMFC in 2006 endorsed a broad strategy comprising:
    - fiscal consolidation in the US
    - structural reforms in Europe and Japan
    - measures to boost domestic demand and currency flexibility in emerging Asia
    - increased spending by oil producers
  - Fund’s Multilateral Consultation sought more specific policy commitments but met only limited success; G7 communiqués sometimes more direct but yielded little concrete action.
  - After the 2008 crisis intensified, initial policy response was not collaborative or coordinated, worsening propagation across the global financial system:
    - Countries adopted government guarantees to protect banks’ assets and liabilities, pressuring neighboring countries and exposing them to deposit-run risks unless they adopted guarantees.
    - Network of government support in advanced countries put pressure on emerging market banks.
    - US actions initially focused on domestic support despite market prices suggesting significant dollar funding pressures for European banks and emerging markets.
    - Countries ring-fenced assets when cross-border entities failed, reflecting absence of clear burden sharing mechanisms for international banks.
  - When cooperation was finally sought, an improvised forum emerged:
    - The first ever G20 Leaders meeting convened, followed by thematic working groups whose membership extends beyond the G20.
    - This choice reflected perceived flaws of alternatives: IMF’s formalistic ways that discourage senior engagement; FSF and G7 lacking legitimacy to discuss broader country issues and lacking dedicated capacity for analysis and follow up.

*Source: _021809 - 1. Coverage. This paper provides an initial assessment of the flaws in the global*

### 8. Solutions. Stronger global policy coordination is both needed and possible. The current

### 8. Solutions. Stronger global policy coordination is both needed and possible. The current

### Stronger global policy coordination: rationale and institutional reforms
- The scale of this crisis should help overcome barriers to coordination, since coordination constrains governments' freedom of action and is engaged in sparingly except in crises.
- The emerging market crises of the late 1990s gave rise to the FSF and the Standards and Codes initiative; this broader crisis should prompt similarly ambitious changes, including securing engagement by top policy-makers.
- An efficient and representative body of top policy makers is needed for effective collaboration on policies to address systemic risks.
- The Fund has near universal membership, the mandate to promote global financial stability, and a strong independent staff, but faces disaffection from parts of its membership that erode credibility and relevance.
- Reforms needed to strengthen the Fund’s ownership and effectiveness:
  - Rebalancing quota shares sooner than envisaged at the last quota review so that they reflect better the evolving world economy, giving emerging and developing countries greater sense of ownership and alleviating doubts about the Fund serving their interests.
  - Moving to a more representative Board and IMFC, less tilted toward advanced countries.
  - Giving IMFC ministers and governors a high profile forum for focused interactive deliberations and policy follow-up to enhance policy engagement and political legitimacy on key issues such as early warnings and response.
  - Other governance reforms: advancing accountability and the effectiveness of decision making; creating a truly open, transparent and merit-based system for selecting Fund management.

### IV. Cross-border financial regulation — Context and problems
- Context: As internationally active banks grew, regulation and supervision increasingly required cross-border cooperation; colleges of supervisors were set up but proved fragile in turmoil.
- Problems identified:
  - Thresholds for intervention: Regulatory capital and other metrics trigger corrective action differently across jurisdictions (US-style prompt corrective action vs. European-style supervisory discretion), leading to different intensity of oversight across subsidiaries or branches and potential regulatory arbitrage.
  - Materiality of risks: Costs of failure vary across stakeholders; in crisis parents may call in liquidity and capital from abroad harming host systems. Example: Italian-owned banks comprise one-fifth of the Polish market but their assets account for only 4 percent of Italian banking assets.
  - Resolution tools and safety nets: No harmonized ex-ante rules governing cross-border bank resolution or burden sharing. Supervisors prioritize taxpayers, minimizing liabilities to nonresidents and maximizing control of assets (examples cited: US “domestic depositor preference” and “single-entity approach”; UK ring-fencing of Icelandic bank assets; German freezing of Lehman’s assets).

### IV. Cross-border financial regulation — Proposed solutions
- Progress needed on improving prior agreements on coordination; colleges of supervisors and codes of conduct (in which the Fund can play a role) will help.
- Coordinated risk monitoring and intervention:
  - Codify closer home-host collaboration and explicit agreement on thresholds and associated actions to address vulnerabilities early, initially applied to major internationally active banking groups.
  - Make supervisory colleges more inclusive to help avoid protectionism.
- A harmonized resolution framework:
  - A fully harmonized regime is exceedingly complicated; possible ways forward include an international banking charter spelling out procedures for joint risk assessment, remedial action, and burden sharing, or, short of a charter, agreement among home and host supervisors with supervisory colleges as arbiter.

### V. Financing: facilities and resources — Context and problems
- Context: Resources available to the public sector and the Fund have failed to keep up with the growth of international flows of trade and financial assets. Fund facilities remain focused on loans tied to conditionality despite demand for contingent credit instruments and liquidity lines. Many countries self-insure via reserve accumulation.
- Problems identified:
  - Absence of standing dollar liquidity facilities: Felt in interbank markets; response was slow for mature markets and slower and more limited for emerging markets. Temporary central bank swap lines were limited and admission criteria opaque.
  - Absence of large insurance mechanism for emerging market countries: Access to adequate liquidity and financing in hard times and flexible repayment terms is lacking; without insurance, excessive reserve buildup may distort global current account balances.
  - Stigma of Fund lending: Members resist approaching the Fund due to political stigma, allowing problems to fester. Evidence includes demand for “Fund-type” support from other institutions (e.g., World Bank providing balance of payments assistance via development policy loans to some East European members; Fed swap lines for some emerging markets).

### V. Financing: facilities and resources — Proposed solutions
- Reform the Fund’s financing toolkit to include an effective crisis prevention instrument and alleviate stigma; tailor lending to members’ policy strength by reforming conditionality and allowing flexibility on access levels and repayment terms.
- Consider establishing an effective crisis prevention instrument for high-performing members and clarify scope for high-access precautionary arrangements for others.
- Specific design considerations:
  - Liquidity for strong performers: New crisis prevention instrument should provide assurances to members with strong policy track records and sound fundamentals of rapid, large and upfront access to Fund resources with no ex post conditionality; available to address all types of balance of payment problems. Key design issues include length of arrangement and whether to cap access in the absence of an actual external need. Under the most flexible design, lending against an actual need would not be ruled out.
  - Adequate precautionary borrowing: Formalize and clarify criteria for high access precautionary arrangements, establish unambiguous modalities for frontloading access and customizing program design based on policy track record and required adjustment; a key design issue is whether to establish a ceiling on access to avoid undue tying up of Fund resources.
  - Improving conditionality: Tailor conditionality to members’ policies and fundamentals, relying more on ex-ante than ex-post conditionality where justified.

### V. Financing: capacity issues and near-term resource options
- Problems with lending capacity:
  - The Fund’s available resources (some $200 billion prior to the crisis) appear constrained as the situation has turned.
  - The Fund can draw on up to $50 billion more through standing borrowing arrangements with members, but questions remain whether cumulative resources will be sufficient.
  - New commitments totaling $48 billion have been provided since end-September 2008, with substantial additional assistance in the pipeline.
  - Stress in other emerging markets, particularly in Eastern Europe, and the unprecedented complexity, breadth and scale of this crisis suggest significant further potential demand.
- Near-term and longer-term solutions:
  - Prompt temporary action is needed; borrowing under bilateral loan agreements—as recently done with Japan for $100 billion—is the most effective near-term option, though other variants (such as placing paper with central banks) could be explored.
  - Expansion or enlargement of existing multilateral borrowing arrangements (the General/New Arrangements to Borrow) may be considered by participants as a longer-term solution.
  - A general quota increase—based on an updated quota formula—would permanently increase the Fund’s own resources.
  - More innovative options—such as an SDR allocation, together with some post-allocation mechanisms to temporarily transfer liquidity to members with the greatest need—could also provide additional reserves.

### VI. Conclusions — Bottom line
- The crisis revealed flaws in key dimensions of the global architecture but provides a unique opportunity to fix them.
- Surveillance must be reoriented to ensure warnings are clear, successfully connect the dots, and provide practical advice to policy makers.
- An effective forum for policy makers with the ability and mandate to lead responses to systemic concerns is key.
- Ground rules for cross-border finance need strengthening.
- Resources available for liquidity support and easing external adjustment should be augmented and processes for using them better defined so they are more readily available when needed.
- These are ambitious undertakings, but the crisis provides an opportunity to make progress on seemingly intractable issues; the moment should not be missed.

* _021809 - 8. Solutions. Stronger global policy coordination is both needed and possible. The current*

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_Source: https://www.imf.org/-/media/websites/imf/imported-publications/external/np/pp/eng/2009/_021809.pdf_