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G20-IMF-FSB Update - April 2, 2010

By Adam S. Hersh

April 2, 2010

Show Us the Money - Part II

In April 2009, G-20 leaders committed to provide the IMF with US$750b in new lending resources, and endorsed IMF gold sales to provide an increase of US$6b to support financing for poor countries. How has the IMF been putting these new resources to use? Last week, we reported on committed resources delivered and individual countries receiving new IMF funding since the G-20 turned its focus on the global economic crisis in November 2008. This week we take a look at the overall situation of IMF lending in the economic crisis. New lending is quite small relative to the the resources committed to the IMF by the G-20, and total IMF credit is also quite small when compared to past crises.

IMF Credit Outstanding, 1984-2010

Since April 2009 (through February 2010), the IMF agreed to a total of SDR 73.9b in new lending (~US$115b*), of which SDR 2b (~US$3.1b) was provided specifically to low income countries through the Poverty Reduction and Growth Trust (PGRT). The agreements to lend set limits and terms on resources available to member countries, although the total amount is disbursed in tranches over time according to country needs and satisfactory performance. In this time, total new lending disbursed from the IMF amounted to SDR 21.1b (~US$32.7b), bringing the total outstanding credit from the IMF for all member countries to SDR 45.2b (~US$65.9), as seen in the graph above. (*Note: SDRs converted to US dollars at an average US$1.55/SDR exchange rate).

While new lending in the current crisis expanded the quantity of credit supplied by the IMF by 84 percent, this represents a mere pittance of the US$750b in resources supplied by the G-20 for the IMF to combat the global economic crisis. The quantity of new IMF lending appears especially small when compared to past global crises, as seen in the graph above. From 1996, the year before the Asian crisis, total IMF credit increased SDR 24.7b to SDR 66.7b in 1998. At that time, the world economy was only half of the size that it is today: world GDP of US$36t then versus US$70t in 2009. In absolute terms, the IMF lending response to the current crisis falls short of past actions. But when viewed relative to the size world economic output, IMF lending in the current crisis does not even approach a scale proportionate to IMF lending during the Asian crisis.

Why hasn't the IMF lent more of the US$750b made available from the G-20? First, the US$750b figure is an impressive headline sum intended to signal an authoritative world response to the global economic crisis that would reassure private capital owners and encourage them not to pull back from financial markets. That all the leading countries were convinced to chip in further signaled there would be a unified, cooperative response to the economic crisis. The full US$750b sum was never meant to be leant out. The precautionary nature of (some of) this money can be seen in three new Flexible Credit Linelending arrangements extended to Mexico, Colombia, and Poland in 2009 totaling SDR 52.2b. Zero of this credit has been drawn by the borrowing governments, rather the money is there to calm private finance and dissuade them from pulling out of these respective economies.

Second, the crisis-stricken countries are not the ones borrowing from the IMF. The US, UK, and European countries all have debts issued primarily in their own, internationally widely-held currencies, and thus are not subject to the same kinds of balance of payments constraints that bind on most other countries that cannot borrow abroad in their home currency. With financial obligations denominated in their home currencies, monetary authorities could respond by issuing new liabilities without the need for external assistance. In fact, the crisis and subsequent "flight to quality" financial assets has helped keep interest rates (and the cost of these monetary policy responses) low.

In contrast with past crises, such as the Asian crisis of 1997-98, or Argentina's, Turkey's, and Brazil's crises of the early 2000's, countries borrowed heavily from the IMF to ease their deteriorating balance of payments. This can be seen in the graph above as IMF credit outstanding spiked up from 1996 to 2004. Aside from Iceland, which directly experienced a financial collapse, countries now borrowing from the IMF predominantly are seeking resources to counter the secondary "knock-on" effects of crises in developed economy countries: higher costs of or unavailable credit from private financial markets, and the loss of external demand due to diminished economic activity and wealth in other countries.

The G-20 made specific efforts to recognize the effects of crisis on low income countries that would suffer doubly from diminished access to financing from international capital markets and from loss of external demand for tourism and primary commodity exports. In addition to earmarking US$6b from the IMF gold sales, the IMF also pledged to double concessional lending and credit access limits to low income countries (pdf) under the Debt Sustainability Framework. So far, through February 2010, new lending to low income countries through the Poverty Reduction and Growth Trust (PGRT) amounted to SDR 1.4b (US$2.2b)--a 23 percent increase (in SDR terms) of lending to low income countries since the April 2009 G-20 meeting. In a speech to the Parliament of Ghana, the IMF reported new lending of US$5b to sub-Saharan Africa in 2009. IMF lending records indicate new loan agreements to sub-Saharan Africa totaled SDR 2.57b in 2009, or ~US$4b (however the amount of credit outstanding from these loans amounted to SDR 1.6b, or ~US$2.5b, in February 2010).

Third, it may be that countries are simply not demanding IMF resources. In the time since the Asian crisis, many countries pursued strategies of accumulating substantial precautionary foreign exchange reserves. Although holding excessive precautionary reserves poses costs on economic development (the resources could be put to more productive, growth-enhancing uses), the stocks of foreign reserves likely gives some developing countries sufficient resources to manage on their own exogenous economic shocks. Still, this is not true for all countries, and the low uptake of IMF resources, particularly by low-income countries is puzzling and a large question remains as to what extent there are "discouraged borrower" countries--those unwilling to seek IMF borrowing because of expectations that they will not be able to access resources.

FSB Reports on Compensation Policies

This week the FSB released its first thematic peer review on compensation policies (pdf) in member countries. FSB participation commits member countries to undergo periodic peer reviews and to adopt common standards on best practices for compensation incentives in financial firms: the FSB'sPrinciples for Sound Compensation Practices (pdf). The FSB sees this review as a "point-in-time assessment of a process in motion," which is another way of saying that there is much work still to be done for member countries and firms to be in compliance with compensation principles and standards by the year-end 2010 deadline (which will be further assessed by the FSB in 2011QII).

The review of compensation policies across FSB member countries is complicated by the fact that effective implementation of standards may be achieved through a variety of (combinations of) regulatory guidance and supervisory oversight. At this first pass, the FSB focused not on the degree of compliance with compensation principles and standards, but the extent to which regulatory/supervisory efforts to comply are underway in each jurisdiction. That said, there is a clear division between countries that at least appear to be putting changes in place, and those that are still predominantly preparing or considering various initiatives. Falling in the latter category are Argentina, Brazil, India, Indonesia, Russia, South Africa, and Turkey, or in other words, the developing country members of the FSB. Although the US, UK, and European countries receive higher marks for having further developed supervisory and regulatory proposals, however a number of the developed countries already had policies in place resembling the FSB principles and standards even though in practice these policies were ineffective. For example, standards that corporate boards should establish committees to set and oversee compensation policies or that compensation should be symmetric with risk outcomes were already routine in many jurisdictions, though were not effectively implemented or enforced. New policy outcomes--the substantive content of compensation rules--are contingent upon distinct and uncertain political processes. In the US and UK, not only are the substance and scope of compensation policies up for debate in legislative bodies, but also inter-bureaucratic power struggles are being waged within the prudential regulatory infrastructure.

While the FSB pats itself on the back in this report for member countries' progress in implementing compensation principles and standards, an independent review commissioned by the FSB from management consulting firm Oliver Wyman of how 20 systemically important multinational financial firms have implemented the FSB's compensation principles and standards (pdf) reaches some less sanguine conclusions. This independent review finds the FSB's compensation principles and standards lacking in key areas and in need of important extension and revision. First, the Oliver Wyman report cautions that regulation and supervision must be vigilant against firms that will test the will and scrutiny of regulators to enforce compensation policies. Second, though principles link compensation to perceived risk, this approach depends upon economic models of risk (that failed, leading to the current crisis)--a challenge that is downplayed or misperceived by the financial industry and could lead to further financial instability. Third, shareholders are persistently absent in monitoring and enforcing firms' internal compensation practices. Fourth, though the FSB principles aim to unite compensation practices with firm risk management practices (i.e. maintenance of the capital base), the linkage established in FSB principles is underdeveloped. This last issue posed a distinct problem in the present crisis as firms routinely paid out bonuses even when capital reserves had dwindled dangerously low and below regulatory standards.

What do Supervisory Colleges do Anyway?

Supervisory colleges formed under the FSB are intended as a venue for national supervisors to share information and to coordinate monitoring efforts over "large and complex" (a.k.a. systemically dangerous) financial institutions. The G-20's action plan from November 2008 called for creating supervisory colleges for all important multinational financial institutions, and now there are30 colleges covering 24 multinational financial firms and 6 insurance companies. Though the supervisory colleges have existed for some time and were emphasized as a solution under the Financial Stability Forum in response to the Asian financial crisis, the FSB still remains uncertain about the effectiveness of these institutions for regulators to manage risks in multinational financial institutions.

The FSB had charged the Basel Committee developing a set of good practice principles for supervisory colleges, released last week. Most of the principles enumerated pertain to establishing structures and processes that engage and forge mutual trust among the involved national supervisors. Cooperation and trust are important foundations for the supervisory colleges, as these are essential for regulators to overcome the "prisoners' dilemma" faced by national regulators of multinational financial institutions. Even where national regulators share common interests (ensuring the stability of individual institutions and the overall financial system), cooperation may not be forthcoming. Regulatory capture, the jurisdictional distribution of costs (risks) and benefits from a financial institution's behaviors, and so on can provide powerful incentives for regulators to "defect" from cooperation with other regulators in the college to improve benefits for their home country institutions. The situation creates fertile opportunities for financial institutions to exploit regulatory arbitrage. These difficulties in institutionalizing regulatory cooperation may in part help explain why the supervisory colleges have to date been ineffective.

Crisis episodes raise the incentives for mutual cooperation within the supervisory colleges, and the Basel Committee provides guidelines for how colleges can best operate in crisis management. But as the time since crisis increases, the incentives for cooperation will ebb and fade (the incentives are still there, but may not be enough to overcome the self-interested incentives). What is missing from the guidelines for supervisory colleges are structures that forge enduring cooperation even in times of (seeming) financial stability. If national regulators could sustain cooperation through non-crisis periods, they could be empowered to take coordinated international actions to deter supervised financial institutions from accumulating financial fragilities that create risks of future crises.

Norway Minister: G-20 Lacks Legitimacy

Writing in The New Straits Times, Norway's foreign minister Jonas Gahr Store charged the G-20 as "sorely lacking" in legitimacy:

It is not an elected body, it is a self-appointed group, established without the consent of other nations.

Store called for an institutions of international cooperation anchored in multilateral approval and international law. In place of the current G-20 configuration, he suggests a system of representation through geographical constituencies to expand the voice and representation of marginalized countries. With the immediacy of the financial crisis ebbing, Store argues the G-20 will find it hard to press ahead with critical longer-term truly global issues like climate change, public health, and development.

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