International Financial Institutions in the Global Economy

International Financial Institutions

• Membership organizations made up of signatory nations.

• Focus on two broad areas:

– The international financial system's policy framework, function and stability

– Economic development

• Most capital is “callable”, i.e., not paid-in by member states

• Many of the funds used by the banks are borrowed in international capital markets

International Financial Institutions

• Have “hard” and “soft” loan windows for borrowers

• Technical assistance is a major part of activities

• Provides resources to the private and public sectors

The IFI's

• The International Monetary Fund

• The World Bank Group

• The Regional Multilateral Development Banks (or MDBs)

– Asian Development Bank

– African Development Bank

– Latin American Development Bank

– European Bank for Reconstruction and Development

• The Bank for International Settlements-1930

Original Concept Behind Creation of IFIs

• Economic growth, assisted by free trade, would create a middle class with property interests that would be hostile to political instability and Soviet Communism

• Note: Soviet Union refused to join, although it did participate in Bretton Woods negotiations

• China (i.e., Nationalist China or Taiwan) was a founding member

Some Assumptionsof Founders of the IFIs

• Private flows of long-term capital would be limited by governments

• Economic growth depended on capital investments and access to foreign exchange

• Major infrastructure projects and investments were typically made by governments

• Exchange rates would be fixed but flexible• Wealthy countries would remain in charge• Gold would remain a part of the system

Historical Overview of the IFIs

Bretton Woods Conference – 1944

– Forty-five nations, led by WWII allies, met at a resort in Bretton Woods, New Hampshire to plan the reconstruction of the world economy. Meeting sought to address:

• Memories of Great Depression of 1930’s

• Exchange rate stabilization

• Physical destruction of World War II

Historical Overview (cont.)

Bretton Woods – 1944

– Most Significant Outcome:

• International Monetary Fund

• International Bank for Reconstruction and Development (The World Bank)

• World Trade Organization discussed, not adopted but leading to GATT in 1947

Post-WWII Functions of IFIs

• World Bank and IMF began operations immediately after end of World War II

• Marshall Plan and other bilateral aid programs diminished World Bank's role in reconstruction right at the start, especially in Western Europe. USSR diminished WB's role elsewhere in Europe

• World Bank evolved into a development and aid bank for the non-industrialized nations

• IMF became a source of policy and resources for the the international financial system, dominated by the United States and its western allies

The International Monetary Fund

Based in Washington, D.C. Currently 185 member nations, each considered a voting share holder

Overseen by a Board of Governors made up of representatives (Ministerial level) of each member nation – with a really big Annual Meeting.

Executive Board of 24, working with a Managing Director (usually European) as Board Chairman, overseas operations. 3000 staff

Voting on major decisions based on share of “ownership” - as in Credit Union - Key Issue

The International Monetary Fund

• IMF focused on administering the Bretton Woods exchange rate system until early 1970s and to facilitate international transactions in support of trade

• The original concept of providing financial support for short-term balance of payments needs of member nations has evolved into ongoing financial support for longer-term development and financial stability issues.

• No project financing

The IMF – Original Purpose

IMF originally was designed to:

• Assist countries to attain and maintain currency convertibility in the current account

• Did not focus on capital controls – capital account convertibility not seen as likely given national sovereignty

• Supported stable exchange rates for its member countries with the dollar (and gold) as anchor.

• By the early 1970s, the Nixon Administration ended the dollar's link to gold and thereby marked the end of the post-war Bretton Woods monetary system. $35/ounce.

IMF Basics

Shares are allocated by “quotas,” or the amount of resources each member is expected to “deposit” with the IMF

One quarter of each members quota is required to be in hard currency

Resources available to all members, regardless of economic status

New administration in Washington under pressure to loosen voting requirements in IMF

IMF Basics – the SDR(cont.)

In 1960s IMF created a “reserve asset” as a “unit of account”, the SDR. The SDR was to supplement members quotas.

Not a reserve currency, and not intended as a world currency (but moving that way?).

Allocated to each member and may be used internally in exchange for reserve (i.e., hard) currency. May be used freely up to specified limit.

Based on a basket of currency, currently just under $1.57/SDR.

The SDR

Basket of key international currencies - US$,

Yen, Euro, UK pound Can be exchanged for freely convertible

currencies by members. Was made less critical by rise in capital flows

and flexible exchange rates. At the end of 2009, SDR Allocation to all

members increased by over 200 billion SDRs

The SDR

IMF Staff is thinking . . . . Issuing SDR-denominated bonds could create a

new class of reserve assets Pricing both world trade and international financial

assets could provide a buffer from exchange rate volatility.

All part of a reform of the international monetary system

France (now IMF) is thinking . . . .

International Monetary Fund Voting Shares* (vs Quota shares)

1 United States 16.48 5 France 42 Japan 6.2 7 Italy 33 6.07 8 Saudi Arabia 24 Germany 5.3 9 Canada 2.25 UK 4 10 Russia 2.6

China (inc Korea and Singapore)

*As percent of total shares, October 2011

IMF Functions

• Regulatory

– Ensure members adhere to Article VII provisions related to currency convertibility

• Consultative

– Annual Article IV consultations – economic reviews

– Surveillance over member policies

• Data collection

– International Financial Statistics

– Debt information (with World Bank and BIS)

IMF Functions

• Services

– Technical assistance programs – voluntary

– Data and accounting advice

• Financial – heart of the IMF's role today

– IMF provides resources to member states through numerous programs and “facilities”

– At market and concessional terms

– Usually involves some degree of conditionality

IMF Financial Functions

• Lending operations funded out of the pool of resources provided the IMF by its members

• Total “quotas” (sort of like deposits) equaled $328 billion in August 2010.

• Goal for ($767 billion )

• 2010 review shifted 6 % quota shares to dynamic economies

• Japan in 2009 agreed to offer a line of credit to IMF equal to $100 billion to supplement Fund's lending capacity. US agreed in June 2009 to up to $100 billion in additional funds.

IMF Financial FunctionsLending position as of (September 2010):

Loans committed (mid-2010): $200 billion, of which $146 billion have not been drawn

Loans outstanding: $76.4 billion to over 65 countries

of which: concessional loans: around $10 billion to 57countries

Biggest borrowers: Romania, Ukraine, Hungary

IMF Financial Functions

• Non-concessional “window” includes:

• “Stand-by arrangements” and other programs which offer funds at market based rates, usually in the form of a type of line of credit

• Conditions are stipulated, including specific policies and measures a country has agreed to implement to resolve its balance of payments problem

• Limited by member's quotas and reserve currency holdings.

• Time limit imposed for repayment

IMF Lending Rate

IMF Concessional Financing

• Current concessional facilities are available for low income countries:

• Poverty Reduction and Growth Facility (PRGF)

• Exogenous Shocks Facility (ESF)

• Heavily Indebted Poor Countries (HIPC)

• Multilateral Debt Relief Initiative (MDRI)

• Fund staff prepares a Poverty Reduction Strategy Paper along with any access to financing

IMF Concessional Financing (cont.)

• Currently 22 nations with a PRGF program

• Three with an ESF program

• Total outstanding drawn: just over $2 billion

IMF Conditionality

• Is a part of almost every credit extended

• Focuses on policy changes in fiscal and monetary areas

• Typically,

– Spending cuts

– Tax increases

– Interest rates adjustments

– Market oriented policies

IMF Conditionality (cont.)

• The target of most criticisms of IMF activities:

• IMF policy prescriptions on macroeconomic policies viewed as interference in the internal affairs of the member state seeking aid

• Considered insensitive to the domestic economic development needs, especially in low income states

• Calls for tighter monetary and fiscal policies seen to hurt growth and employment

IMF Conditionality Challenged

• The target of most criticisms of IMF activities:

• . . . .that the whole system is under the control of the United States and other industrialized economies

• . . . . that exchange rates valuations are biased toward hard currencies that hurt the interests of developing and NICs alike.

– Asia crisis 1997/98

– Argentina 2001

IMF Conditionality Challenged (cont.)

• What if IMF had no conditionality?

• There wouldn't be an IMF. . . . at least not as we know it.

• As lender of last resort

• As source of (free) technical advice

• Would no longer provide someone to blame – scapegoat for beleaguered governments around the world.

IMF Conditionality Challenged (cont.)

• World its role be greatly diminished given its moderate resources?

• Would loosening voting rules lead to relaxing lending standards?

• Would there be conflict with new economic powers?

• Difficult to avoid moral hazard issue if conditionality rules were relaxed and access to Fund resources enhanced.

• If IMF no longer acts as lender of last resort, what does?

The World Bank Group

1. The International Bank for Reconstruction and Development (IBRD)

2. The International Development Association (IDA)

3. The International Finance Corporation (IFC)

4. Multilateral Investment Guarantee Agency (MIGA)

5. The International Centre for Settlement of Investment Disputes (ICSID)

The World Bank Group

• New IBRD and IDA commitments or lending totaled $24.7 billion in 2008

• No change from 2007, but up 23.5 percent from 2004

• Sources of funds are donor nations, most from industrialized countries

• Number of projects about 300

• Projects selected on economic and political basis

1. The World Bank

• The IBRD, generally called “The World Bank” is focused on project lending in a range of developing countries.

• Projects are selected on economic and political basis

• Range from massive hydro electric dams to micro projects

• 670 projects outstanding in 2008

• Gave up on Structural Adjustment Lending

2. The International Development Association

• IDA provides long-term, interest free loans and grants to the 82 poorest countries.

• IDA eligible countries must have per capita incomes of less than $1,065 or do not qualify to borrow from the IBRD

• Focus is on sub-Saharan Africa

• China and Egypt graduated from IDA eligibility, now donor countries

• Cummulative commitments: $193 billion

Pressures on World Bank

• Over the years, pressure has been on Bank to meet basic human needs

• To avoid supporting projects with adverse environmental issues

– Three Gorges Dam in China in 1980s and 1990s

• To support private sector in the developing economies

• To encourage foreign investment into the recipient countries

3. The International Finance Corporation

• The IFC supports private investments in developing and “transition” countries.

• Provides long-term loans and other forms of capital for economic development projects but through the private sector.

• Projects are selected on economic and political basis

4. Multilateral Investment Guarantee Agency (MIGA)

• Provides political risk insurance and guarantees to promote foreign investment in developing countries

• Small agency compared to other parts of the group – net exposure of $3.6 billion, less than half in IDA countries

• Cumulative guarantees issued $19.5 billion, $2.1 billion in 2008

5. The International Centre for Settlement of Investment

Disputes (ICSID)• Provides facilities for arbitration of international

investment disputes between foreign investors and host countries

• Can be critical factor in attracting new foreign investment

Bank for International Settlements

• Central Banks' Central Bank – Has 55 member banks

• Founded in 1930 and based in Basel, Switzerland

• Collects data on international banking, including many aspects of international lending

• Works with other agencies, such as OECD and Bank/Fund

• Primary role is to help set international rules for bank accounting standards

Bank for International Settlements

• In 1988 set out the Basel Capital Accord in which the central banks from the G-10 countries agreed to apply common minimum capital standards to their banking industries

• Updated in 2006 – Working on Basle III

• Focused originally on credit risk, now more broadly market risk

• Provides for a percentage of capital that must be held in reserve to support lending activities

Financial Stability Board - 2009

• Now houses the Secretariate of the Financial Stability Board

• Created in April 2009 in response to the financial crisis.

• Members are G20 plus a few more – about 25 nations plus other authorities

• To monitor potential risks in the world economy

• All “systemically important” financial institutions, instruments and markets to be overseen – including hedge funds.

• To prevent another debt bubble, could recommend financial companies maintain provisions against credit losses and impose constraints on borrowing.

Conclusion

• Are IFIs still relevant in a dynamic and ever changing international financial system?

• Can they provide the financial and technical resources to really make a difference in the poorest countries?

• Robert Zoellick, President of World Bank, in 2009 called for 1% of stimulus package to be spent on a “vulnerability fund” for assisting developing nations: - how realistic is this and other spending proposals?

Conclusion

1. Vulnerability Fund would focus on three areas

1. Safety net for the poorest

2. Investments in infrastructure

3. Support small and medium-sized enterprises and microfinance institutions

Conclusion

Vulnerability Fund Questions

• What is the absorptive capacity of these nations?

• Economically and politically?

• Oversight? World Bank & UN?

• Role of private sector?

• Priorities of donor nations? France? China?

• Reaction of the donor nation populations?

• Would IMF reforms have an impact?

Conclusion

• More resources?

• Less oversight?

• Accountability?

• Amount to loosening credit standards?

• Can a “prequalification” process work for the IMF?