The New Global Financial Safety Net: Struggling for Coherent Governance in a Multipolar System

Abstract

Since the late 1990s and particularly since the great financial crisis of 2007-09, the global financial safety net has expanded from barely more than one institution – the International Monetary Fund (IMF) – to a much larger, though geographically patchy, web comprising the IMF, regional financial arrangements, and central bank swap lines. This raises two issues. The first relates to the adequacy and reliability of the new safety net, the second to the incentives that it creates for sovereign borrowers and private borrowers and lender. This essay analyzes the second issue. Financial crises typically involve some combination of solvency and liquidity problems. International crisis lending could therefore give rise to moral hazard at the expense of the international taxpayer who bears fiscal losses if the loans are not fully repaid. It could also hurt the domestic taxpayer, if the expectation of crisis lending facilitates excessive capital flows to poorly governed countries. Finally, it curt hurt countries that suffer negative spillovers in a crisis. These problems do not necessarily imply that international rescues are a bad idea. But they do suggest that insolvent countries should not normally have access to crisis lending, and that the incentives created by crisis lending deserve to be taken seriously. Since the early 2000s, the IMF has attempted to do this by becoming more selective in its large-scale lending, creating special facilities for countries with strong policies and fostering contractual debt restructuring mechanisms that make it easier to say no. But as the financial safety net has become both larger and more fragmented, these efforts have become less relevant for the system as a whole. Some RFAs – particularly in Europe – have emphasized co-lending with the IMF as a possible solution. However, the experience of the European RFAs and the IMF in Greece has demonstrated the limits of this approach. In the absence of strong RFA-internal lending policies, pressures associated with regional rescues may put too much strain on the IMF as an “anchor” of the RFA. Furthermore, since the IMF is senior to the RFA, co-lending with the IMF does not prevent moral hazard at the expense of the RFA. The essay makes two recommendations that would help to reconcile crisis lending with good incentives in the new multipolar environment. First, access to central bank swap lines should be extended to major emerging markets and smaller industrial countries that pass the pre-qualification test associated with access to the IMF’s “flexible credit line” (FCL). This would both create good policy incentives and increase the attractiveness of the FCL as a key to unlocking access to emergency central bank liquidity, with IMF funding acting only as a backstop. Second, RFA co-lending with the IMF is no substitute for RFA-internal commitment devices that prevent lending in unsustainable debt cases unless there is a debt restructuring at the same time. The credibility of such commitments requires legal frameworks — bond contracts, but also changes to relevant international treaties — that make debt restructurings more manageable and less hazardous from the perspective of sovereign borrowers than has been the case in the past. RFAs should promote such frameworks at the regional level, with the Euro area leading the way. RFAs whose main concern is private rather than sovereign debt crises may also want to condition large-scale support on the quality of domestic frameworks for financial sector supervision, regulation and crisis resolution. This step would go beyond current IMF lending policies, but is appropriate given the junior status of RFAs.

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