CHAPTER VII Strengthening the Architecture of the International Monetary System
- International Monetary Fund
- Published Date:
- September 1998
Following the Mexican financial crisis of 1994–95, the IMF adopted several initiatives to strengthen the international monetary system and the IMF’s central role in the system. These included more intensive surveillance of financial sectors of member countries, closer monitoring of developments in capital markets, more candid policy discussions with country authorities, and greater emphasis on members’ dissemination of information—both to the IMF and to financial markets. The financial crisis in Asia, however, made clear that to meet fully the challenges posed by a global economy and global financial markets, more far-reaching measures were needed to tackle potential weaknesses in financial systems, prevent the emergence of inappropriate debt profiles, and ensure greater transparency in both public and private sector activity. Successful implementation of these measures would involve not only the commitment of individual countries, but also broad-based cooperative efforts of the entire international community, including the private sector.
In April 1998, the IMF’s Executive Board, reflecting on lessons learned from the Asian crisis and drawing on earlier discussions, identified a series of approaches for strengthening the international monetary system. These approaches were subsequently broadly endorsed by the Interim Committee, which sketched out a comprehensive framework for strengthening the architecture of the monetary system (see Appendix VI).
The Board discussion in April, as well as the Interim Committee communique, centered on five aspects of a strengthened international monetary system:
- reinforcing international and domestic financial systems;
- strengthening IMF surveillance;
- promoting more widely available and transparent data on member countries’ economic situation and policies;
- underscoring the central role of the IMF in crisis management; and
- increasing the involvement of the private sector in forestalling or resolving financial crises.
Strengthening Financial Systems
It is now well recognized that vulnerable and unstable financial systems can severely disrupt macroeconomic performance and that weak financial systems increase vulnerability to economic crises and deepen such crises when they occur. There was thus broad agreement in the Board that the IMF should work actively with other organizations and members to help members design improved banking and financial systems. Directors are also agreed that:
- Members should give priority to strengthening financial sector supervisory and regulatory frameworks and to establishing the independence of central banks. Sound financial systems also require strengthening governance, including in the corporate sector, and improving accounting practices to conform with international standards.
- The international community’s responsibility lay in ensuring that work continued in developing such standards for banking supervision, accounting and disclosure, auditing and valuation of bank assets, and guidelines for effective corporate governance. Increased international cooperation would also be required in areas beyond the establishment of standards, including in the sharing of information among regulators, especially among those with supervisory authority over institutions operating in major financial centers. Regulators also should seek and examine carefully information on flows from offshore centers and off-balance-sheet items, the lack of which could obscure analysis of a country’s exposure and delay the identification of potential balance of payments problems.
Directors recognized that the issues were complex and that both the IMF and the international community would need to develop expertise and devote resources to be able to offer detailed advice in each of the areas. They agreed that the IMF could play an important role, especially in its surveillance activities, by disseminating internationally agreed standards and encouraging members to adopt best practices. The Board noted that it would continue discussions on the scope of the IMF’s work in developing and disseminating international standards. At its April 1998 meeting, the Interim Committee endorsed this approach.
Strengthening IMF Surveillance
The Board, and subsequently the Interim Committee, reaffirmed the centrality of IMF surveillance in preventing crises. The measures taken after the Mexican financial crisis in 1994–95 were important in helping the IMF adapt its surveillance to the rapidly changing global environment, especially with respect to emerging market economies. At the same time, IMF surveillance needed reinforcing in a number of areas:
- The IMF should intensify its surveillance of financial sector issues and collaborate with other institutions, including the World Bank and the Bank for International Settlements, as well as with the private sector, to offer its members the best possible advice in this regard.
- IMF surveillance should pay more attention to capital account issues. Although the benefits for the world economy of an open and liberal system of capital movements were widely recognized, the sequencing and pace of capital account liberalization had to be monitored carefully. In particular, IMF surveillance should focus on the risks of potential large reversals of capital flows, the rapid accumulation of short-term debt, unhedged exposure to currency fluctuations, and the impact of selective capital account liberalization.
- IMF surveillance should pay greater attention to policy interdependence and the risks of contagion, and to the policies of countries of particular importance to the international monetary system.
- More frequent and systematic exchange of views with market participants was needed so that IMF surveillance was fully cognizant of market perceptions; in turn, this would enable markets to better understand IMF views and analyses. At the same time, such contacts must take into account the confidentiality of the IMF’s dialogue with members and ensure even handed dealings with market participants.
- Effective IMF surveillance depended crucially on the willingness of IMF members to take its advice. This implied, on the part of the IMF, the best analysis possible, as well as concentration on issues of importance to individual member countries.
- The IMF’s views must be communicated effectively to members, possibly through a series of incremental steps. A member could be asked to respond to the IMF’s concerns within a specified time, so that the member’s reaction could be brought expeditiously to the Board’s attention. In cases where a member’s policies appeared to depart from the advice of IMF staff, the nature of the concerns in question could be shared with the Board at an early stage, while protecting the confidentiality of the communication with the member. On this issue, the Interim Committee requested the Board “to develop a ‘tiered response,’ whereby countries believed to be seriously off course in their policies would be given increasingly strong warnings” by the IMF.
Greater Availability and Transparency of Information
The IMF actively encourages its members to be transparent with respect to information on economic developments and policymaking. Despite progress in members’ provision of data on core indicators to the IMF in a continuous and timely manner, both Directors and the Interim Committee saw a need for further improvement, particularly on data timeliness. It was also important to complement core indicators by broadening the IMF’s Special Data Dissemination Standard to cover additional financial data. Consideration should also be given to increasing the Special Standard’s usefulness, its accessibility to the public and market participants, and publication of members’ record of compliance.
Directors and Interim Committee members also supported the steps the IMF had taken to promote greater transparency in economic policymaking. These included encouraging members to release Letters of Intent for their programs, which complemented the longstanding IMF policy of encouraging members to release the Policy Framework Papers that members prepare with IMF and World Bank staff assistance in connection with drawings under the Enhanced Structural Adjustment Facility.
It was noted at the Board’s April discussion that the IMF had steadily become more transparent with respect to its own policy advice, most recently through the issuance of a Press (now “Public”) Information Notice following the conclusion of a member’s Article IV consultation (see Box 3). Directors emphasized that clear, concise, and analytically sound staff reports—as well as frank and comprehensive assessments by the Board—were vital for the effectiveness of the PIN process, and they agreed to return to these issues, including ways to expedite PIN publication. In April 1998, the Interim Committee specifically encouraged more members to release PINs. The Committee also asked the IMF “to continue its efforts to increase dissemination of information on its policy recommendations and encouraged member countries to increase the transparency of their policies.”
IMF’s Central Role in Crisis Management
Directors recognized at their April meeting that it was unrealistic to expect that every crisis could he anticipated or prevented. In case of a crisis, the international community had to be prepared to respond quickly with policy advice, well-integrated technical assistance, and, if necessary, adequate financing. The World Bank and the Asian Development Bank had provided critical technical and financial support for the Asian countries’ adjustment efforts; bilateral support had also been important. The Board cited the need for the IMF to coordinate carefully assistance from different sources and ensure, in particular, that such assistance complemented the conditionality of IMF arrangements.
In April 1998, the Interim Committee endorsed the central role of the IMF, in particular its role in supporting the necessary reforms through conditionality. The Committee also welcomed the timely response to the Asian crisis by the international community, including the IMF, and stated that the IMF could not be expected to be able to finance every balance of payments deficit. Its catalytic role was essential for attracting other sources of financing in support of members’ adjustment efforts, as was its role, when needed, to coordinate support from other sources.
Involving the Private Sector in Preventing and Resolving Crises
Directors agreed that the world financial community must strengthen its capacity to respond to balance of payments crises in ways that ensure the appropriate involvement of all groups of creditors, including the private sector. Such involvement was required to share the burden equitably with the official sector and to limit moral hazard. Specifically, Directors believed that the means used to resolve one crisis should not encourage imprudent or unsustainable behavior by creditors or debtors, thereby increasing the potential magnitude and frequency of future crises.
In recent crises, many groups of private creditors had sustained large losses. Equities and long-term debt instruments had lost value, and investors in bankrupt enterprises had received no special treatment. A serious challenge had emerged, however, with respect to creditors with short-term claims, where concerns were raised about moral hazard. Such claims were normally highly liquid, which could make it easier for creditors to “bolt for the exit.” Members had tried to avoid defaults on such claims because of the potential impact on the stability of their financial systems and their countries’ access to international capital markets. Thus, efforts were made to roll over, extend, or restructure the maturing obligations to external creditors. This issue underscored the importance of preventive measures to discourage excessive reliance on short-term financing. Such measures included appropriate macroeconomic and debt-management policies; nondistortionary tax systems; effective prudential supervision of financial systems; the provision of timely and comprehensive data to financial markets, including on the debt of the corporate sector; and appropriate sequencing of steps to open the capital account.
Directors also cited the importance of strengthening countries’ capacity to withstand sudden shifts in market sentiment, in particular, by strengthening their financial systems. Nevertheless, it was recognized that such efforts were not foolproof: circumstances would likely arise in which prevention would not be fully effective and countries would experience balance of payments crises. In most such cases, Directors emphasized, the IMF’s approach should be to ensure that the appropriate adjustment programs included the continued involvement of private creditors (see the section on Policy on Sovereign Arrears to Private Creditors in Chapter VIII). At its April 1998 meeting, the Interim Committee endorsed this view, agreeing that ways had to be found to involve private creditors at an early stage. The Committee asked that the Board consider more actively ways to increase private sector involvement in crisis prevention and burden sharing, including devoting efforts to strengthen incentives for creditors and investors to better use information to analyze risks appropriately and avoid excessive risk taking. The Committee suggested the following mechanisms to meet this objective:
- closer contacts with private creditors to better explain IMF-supported arrangements and to develop modes of private sector financing that would help “bail in” private creditors in times of crisis;
- studying further the possibility of introducing provisions in bond contracts for bondholders to be represented, in case of nonpayment, in negotiations on bond contract restructuring;
- extending the IMF’s policy of providing financing to members in arrears to include sovereign bonds (“lending into arrears”) when appropriate;
- encouraging the adoption of strong bankruptcy laws to improve operation of both domestic and international capital markets; and
- advising members to exercise caution with respect to public guarantees to reduce the risk of a private debt problem turning into a sovereign debt problem.