Learning from the Crisis: Future IMF Lending Role

IMF Blog, April 22, 2010

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In October 2008, following Lehman’s bankruptcy, emerging markets experienced large sell-offs and investors fled, undermining “decoupling” theories.
The IMF, with strong support from its membership, provided large and upfront financial assistance to help countries weather the crisis.
The IMF overhauled its lending toolkit, notably by establishing the Flexible Credit Line (an instrument allowing countries with very strong policies to tap IMF resources unconditionally).
The membership committed to tripling its resource base.
These actions contributed to putting out the fire and set emerging market spreads on a downward trajectory.

The recent crisis increased perceptions of volatility and contagion risks, prompting calls to strengthen the global financial safety net.
Key elements and responsibilities:
- Increasing resilience to shocks of countries receiving capital flows through improved policies; adequacy of reserves is important but benefits have diminishing returns.
- Avoiding excessive risk-taking through better supervision in countries generating capital flows.
- Leveraging financing vehicles: central bank swap lines, regional financing arrangements (e.g., the Chiang Mai initiative), multilateral development bank lending, and IMF financial assistance.
Comparative roles of facilities:
- Central banks: natural advantage in alleviating short-term liquidity pressures; swap lines recycled dollar liquidity during the recent crisis.
- Regional financing arrangements: by pooling reserves, can help address idiosyncratic shocks.
- Multilateral development banks (e.g., the World Bank): primarily support long-term growth.
- IMF: provides countercyclical lending, distinguished by global reach, preferred creditor status, large resources, and ability to catalyze private lending through agreed policy frameworks.

Further leverage the IMF’s unique characteristics to enhance crisis prevention capability.
Flexible Credit Line (FCL):
- Used by Mexico, Colombia, and Poland during the recent crisis.
- Could be made more effective by lengthening its duration (currently six months) and making country qualification more predictable.
Precautionary Credit Line (PCL) proposal:
- Option to introduce a new crisis prevention instrument for well-performing countries that do not qualify for the FCL.
- Would provide upfront access to financing as in the FCL but would allow for some (light and focused) policy conditionality.
Systemic crisis management and firewalling:
- IMF should be able to proactively erect a firewall to protect innocent bystanders from virulent systemic shocks.
- Rationale for improvement:
- National central bank responses are necessarily ad hoc; a transparent and predictable standing facility is needed.
- Systemic crises have global reach; a global solution is preferable to national or regional responses.
- The nature of the next systemic crisis may differ, and central banks may not be called into action.
- Multicountry Swap Line (MSL) proposal:
- A mechanism enabling the IMF to make a unilateral and simultaneous offer of short-term liquidity lines to a limited set of systemically important countries with strong policy track records.

Enhanced IMF financing instruments increase crisis prevention and mitigation capacity but raise moral hazard concerns for some observers.
Distinction by shock type:
- Less moral hazard when IMF lending addresses “exogenous” shocks (shocks not influenced by the country or its creditors), e.g., a systemic liquidity shock affecting “innocent bystanders” as in the MSL.
- Greater moral hazard concerns for idiosyncratic shocks.
Policy on conditionality:
- Financial assistance to members with weaker track records needs to be subject to the observance of policy conditions.
- Instruments providing upfront financing should be dedicated exclusively to countries with stronger policy track records.

The IMF will undertake further work to distill specific proposals on revamping the IMF lending toolkit by the fall.
Ongoing solicitation of feedback is welcomed.

Authored by Reza Moghadam — April 22, 2010.