Tuesday, September 6, 2011

IMF: Equity based global institution or systemically important financial institution

   The IMF is an equity based financial institution with countries as share holders, who are represented on the IMF board by elected Executive Directors (except 5 heriditary 'peers'). It is important to understand the differences and similarities with private financial institutions, so as to adopt practices from the latter to increase efficency.  One of the most fundamental differences is that IMF shares are not tradable but assigned to member countries by means of a Quota formula. The quota formula determines the maximum share holding and vote share of individual countries, though a country can in principle, not take up its full entitlement if it does not have the funds or is not interested in the higher vote share.  A related difference is that all loans made by the IMF (its principle financial expendiduteres)  have to be approved by the executive board. These differences are (except the heriditary rights) appropriate for a global economic institution!
    In other respects there is nothing in the "articles of agreement of the IMF" preventing it from acting like a systemically important private financial institution, only self imposed restrictions/practices that can and should be changed. The IMF should use a mix of equity and market debt (borrowing from private global markets) to carry out its primary work of lending to countries in need of liquidity support.  A debt-equity ratio of 4:1 (say) would be quite consistent with a safe conservative financial institution, while allowing the IMFs lending resources to be five time its equity base.  As a macroprudential policy the approved debt;equity ratio could be allowed to vary around a mean value depending on the state of the Global economy.  Thus the debt:equity limit would be allowed to rise automatically during the upside and peak of the cycle and fall on the downside and trough of the cycle.  This would add a global automatic stabiliser to the World economy and also allow the IMF to respond more flexibly and quickly to liquidity crises arising from financial crises.
   There would be no need for special arrangements such as NAP/NAB that have been criticised as 'government bail outs' and give rise to a replay of governance and control issues that should be settled once and all through a modern, 21st century quota formula.  One welcome outcome would be to subject IMF lending, which is professedly for meeting liquidity problems, to some market discipline. This is particularly important for lending to countries who are likely to remain on the border line of solvency (below or above), even if stringint policy reforms are carried out (conditionality).  This reform would also allow the total resource requirements of the fund to be easily met by relatively small adjustments (up or down) in the total outstanding equity, as is routinely done in private institutions.
    Traditionally the IMF quota has also determined access to IMF loan funds.  Since the start of the global financial crisis the link between the IMF quota and the maximum allowed borrowing from it has been decisively broken. Many countries have recieved loans of 100s of per cent's their quota while some have recieved loans of 1000s of per cent's their quota.  Thus the link between the quota and access (borrowing limit) has been decisively broken.  The argument that as a matter of principle the quota formula must have variables determining access is not credibile given this recent history.  More important is the practical link between GDP and these new loan levels, which has clear implications for raising the weight of GDP in the formula. 

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