The document discusses the adequacy and reform of the Global Financial Safety Net (GFSN) and the IMF's lending toolkit. It notes that while the size of the GFSN has increased, it has become more fragmented without effective coordination between its components. The coverage of the GFSN is also uneven, leaving some systemic countries underinsured. The IMF has explored ways to strengthen the GFSN, including by reforming its lending toolkit to provide more reliable assistance. Bilateral swap lines have also expanded, but questions remain around who should bear the costs of maintaining adequate foreign currency reserves to support financial systems.

1. Reforming the Global Financial Safety
Net and the Fund’s Lending Toolkit
Thorvald Grung Moe
Research Associate
Levy Economics Institute, Bard College
24.02.2017

2. The GFSN (Global Financial Safety Net)
• International reserves
• Central bank swap arrangements
• Regional financing arrangements
• IMF resources
• Market-based instruments
• Objectives
o Insurance against crisis
o Supply finance when a crisis hit
o Incentivize sound macro policies
IMF: Adequacy of the global financial safety net (March 2016)
While there is general consensus that there is something wrong with the
GFSN, no one agrees on what is actually wrong or what needs to be done

3. IMFC Communiqué 2016
• We agree that a strong and coherent GFSN—with an adequately
resourced IMF at its center—is important for the effective functioning of
the IMS (International Monetary System), safeguarding stability, and
helping reap the benefits of further financial integration (April, 2016)
• We call on the IMF to continue to explore ways to further strengthen the
GFSN, including through more effective cooperation with regional
financing arrangements (April 2016)
• We call on the IMF to explore ways to strengthen its approach to helping
members manage volatility and uncertainty—including through financial
assistance, also on a precautionary basis (April 2016)
• We look forward to finalizing the ongoing review of the IMF’s lending
toolkit to further enhance its effectiveness (October 2016)

4. GFSN part of a broader IMS agenda at the IMF
• Capital flows - review of experiences with the institutional view
• Adequacy of the GFSN – consideration for toolkit reform
• Review of the FCL and PLL instruments
• Cooperation with Regional Financing Arrangements
• The role of the SDR: Further considerations
• Strengthening the International Monetary and Financial System
• Adequacy of Global Financial Safety Net Architecture
• Guidance note on reserve adequacy
2017:
2016:

5. IMF activities in 2016 for a more resilient IMS
(from The Managing Director’s Global Policy Agenda, October 2016)
• Maintained access to bilateral borrowing
• Identified gaps in the Fund lending toolkit
• Planning for a test run of Fund-CMIM collaboration
• Explored role of state-contingent financial instruments in preventing
and resolving sovereign debt crises
• Implemented the new SDR basket
• Explored broader use of the SDR
• particularly whether the SDR could address gaps in the international
monetary system and complement the GFSN

6. IMS & GFSN – an ongoing discussion since the GFC
Zhou Xiasochuan: Reform of the IMS (2009)
• The acceptance of credit-based national
currencies as major international reserve
currencies, as is the case in the current
system, is a rare special case in history.
• The crisis again calls for creative reform of
the existing international monetary system
towards an international reserve currency
with a stable value, rule-based issuance
and manageable supply

7. “Global liquidity is poorly understood, as we
noted in the Palais-Royal Initiative”(Ed Truman, 2011)
• The international monetary system has been gradually overwhelmed
by gigantic masses of moveable private international liquidity
• The explosive growth of this (cross-border) lending now saddled the
world with a debt problem that fundamentally threatens the
international financial system
• A certain consensus was reached in the G30 on an approach in which
central banks would agree on a range of growth for international
lending that would be acceptable
• In Basle, however, central banks did not move beyond some
strengthening of prudential controls
H. J. Witteveen (1983): Developing a new international monetary system

8. What will the Fed do in the next GFC?
• … the United States is bound to
be the final lender of dollars to
the rest of the world, and that is a
meaningful prospect so long as
the dollar is the world’s key
reserve currency.
• Although conceivably forgotten,
that is part of the flip side to the
“exorbitant privilege” of issuing
the world reserve currency
Paul Tucker (2014)
• But I should caution that the
responsibility of the Fed is not
unbounded. My teacher Charles
Kindleberger argued that stability of
the international financial system
could best be supported by the
leadership of a financial hegemon or
a global central bank.
• But I should be clear that the U.S.
Federal Reserve System is not that
bank. Our mandate, like that of
virtually all central banks, focuses on
domestic objectives.
Stanley Fischer (2014)

9. IMF resources on a downward trend since 1980
From Bank of England (2016): Stitching together the global financial safety net

10. SIZE AND COMPOSITTION OF GFSN

11. The GFSN is larger, but more fragmented and
with uneven coverage…
•Growing relative importance of BSAs and RFAs
•The coverage of the safety net is uneven, with
sizeable financing gaps in many economies,
especially systemic and gatekeeper emerging
markets (EMs), and
•it remains too costly, unreliable, and conducive to
moral hazard

12. Size of GFSN has expanded significantly
• Reserves grew from about US$ 2
trillion in 2000 to about US$ 12
trillion in 2013; two thirds held
by EMs
• However, “innocent bystanders”
can quickly become vulnerable
during systemic crisis

13. A more fragmented GFSN
• Decentralization of the safety
net combined with lack of
coordination between the
various elements has led to an
increasingly fragmented
safety net
IMF (2016): Adequacy of the GFSN

14. Coverage of the safety net is uneven
Systemic and gatekeeper EMs are insufficiently covered

15. Diagnosis of the GFSN
Most elements do well on speed and predictability, but
less so on reliability, and poorly on cost and policies

16. Is the Global Financial Safety Net adequate?
• Our main message is that, with
the current temporary IMF
resources in place, the GFSN
appears capable of dealing with
most severe, but plausible, crisis
scenarios which could pose a
threat to the international
financial system
• The GFSN can deal with an EME
sudden stop and a AE liquidity
shortage
BoE (2016)
• Resources under the GFSN
would not be sufficient at an
aggregate level under a
widespread shock
• 3 percent probability + severity
corresponding to the 85th percentile
• The GFSN would, however, be just
sufficient to cover the aggregate
financing gap under very strong
assumptions of full access to all
GFSN elements
• ESM, BSA + all IMF resources
IMF (2016)

17. IMF (March, 2016) - CONCLUSIONS
• There is scope for improving the safety net
• The Fund could deliver better on cost and reliability, and to some
extent speed
• Expanding and improving the fragmented system has not been fully
successful
• The safety net could be strengthened through reforms of the Fund
• Improving the Fund may require revisiting its toolkit
• E.g. provide immediate liquidity support and reliable cover for the full
duration of shocks to a wide range of countries to limit contagion

18. BILATERAL SWAP ARRANGEMENTS

19. Central bank cooperation during the great
recession (F. Papadia, 2013)

20. Two chronic weaknesses of the IMF
• Problem of unresponsiveness
• Bureaucratic and multilateral
processes
• Problem of resource
insufficiency
• IMF cannot create money
=>
US will act independently when
the IMF is either too slow or too
small to protect vital US interests

21. Alan Grayson: "Which Foreigners Got the
Fed's $500,000,000,000?"
Bernanke: "I Don't Know."

22. Will Fed lending to non-US banks provoke the
Right? (J. L. Broz, 2012)
• Crisis lending from the Federal Reserve
correlates strongly with exposure of US
banks to foreign countries
• Fed’s emergency lending primarily to countries
that in which US money-center banks held large
claims on banks and corporations
• Voting against this bill strongly correlated
with share of campaign contributions from
big money-center banks
• But more importantly, almost all Republicans
and many (97) right-wing Democrats voted yes
• => The Fed is no longer in favor with the Right
Ron Paul:
I am surprised and
deeply disturbed
to learn the staggering
amount of money
That went to foreign
banks
The Federal Reserve
Transparency Act of 2012

23. Ed Truman's three key global swap proposal
1. IMF declares a need for global liquidity
2. Participating central banks would meet and agree or not with the
IMF that there was a global need for liquidity that could and should
be met by activating the network
3. Individual central bank (or pair of central banks) decides to
respond to the decisions of the IMF and the central banks as a
group with request for a specific swap operation
• Importantly, no central bank would be required to activate the third
key, and central banks would retain the capacity to enter into swap
agreements outside of the three-key framework

24. Or … Global Liquidity Insurance?
• The premium would depend on the
level of insurance but also on the
quality of the country’s policies
• Premium would be invested in portfolio
of government bonds of US, Euro zone
and Japan
• Fed, ECB and BoJ would backstop the
pool’s line of credit in the event of a
global crisis
• This system would institutionalize ex
ante swap agreements

25. PBOC swap line
network expanding
• RMB lines around US$ 500
billion
• AE BSA lines could be US$ 1.2
trillion
• Global BSA together around US$
2.4 trillion

26. COOPERATION WITH RFAs
(Regional Financing Arrangements)

27. Improving link between IMF and the RFAs*
• Inter-institutional relations
• Representation
• Division of labor in crisis lending
• Unconditional tranches
• How to arranging a joint rescue
• Cooperation in surveillance and analysis
Without meaningful IMF governance reform, a
comprehensive GFSN remain an illusion
* U. Volz (2016): Toward the Development of a Global Financial Safety Net or a Segmentation of the Global Financial Architecture?

28. A New Monitoring Instrument?
• Could unlock access to different elements of the GFSN
• Would be useful for members that do not wish to tap Fund resources
• The IMF
• Have comprehensive information
• Could vouch for sound policies
• Would give assurance of further resources – should there be a need
• Open access – for all member countries, but
• Strict (UCT) quality standard
• Quantitative targets and structural reforms would remain central

29. REFORMING THE FUND’S TOOLKIT

30. Recent IMF toolkit reforms
• Contingent Financing Facility (CFF) eliminated
• Flexible Credit Line (FCL) created – for countries with very strong
policy frameworks
• Precautionary Credit Line (PCL) created – for countries with sound
policies
• Rapid Financing Instruments (RFI) – for emergency assistance
---------
• Low uptake; STIGMA
• “An IMF program carries a signal of insolvency” (Reinhart & Trebesch)

31. A New Liquidity Instrument?
• 2013 agreement among six reserve currency-issuing central banks
• Considerable interest for similar facility from other countries
• Systemic and gatekeeper countries
• Frequent small and short lived liquidity events
• E.g. Taper talk (May 2013), China stock market correction (June 2015), RMB
devaluation (Aug 2015)
• New lending tool need to be more predictable and reliable
• Prequalification and no ex post conditionality
• Would provide support for relative moderate but frequent liquidity
shocks

32. Challenges
• Moral hazard – could weaken traditional conditionality
• Qualification criteria – vis-à-vis FCL and PLL
• IMF as rating agency
• Article of Agreements – “temporary use for BOP problems”
• Short-term facility
• Resource constraints
• Standing facilities

33. Cross-border lending and the GFSN
Has the system become too elastic?

34. Lender of Last Resort in Dollars for the
Domestic Financial Systems
• The expansion of international balance sheets will increase the
potential demand for (dollar) liquidity support in case of shocks.
• This trend should be accepted as a normal consequence of open
capital markets and international banking, together with the
predominance of a very limited number of currencies in international
finance
• In the longer run, policy choices on global liquidity will determine the
shape of global capital markets
• Faced with increased volatility, there is some trade off between ex
ante arrangements for liquidity provision and capital flows
management measures (J-P Landau, 2013)

35. Japanese banks expanding overseas but
facing new challenges (IMF GFSR, Oct. 2016)
• Japanese banks may face increased risks from external funding, if
severe and persistent money market disruptions occur
• Since the global financial crisis, overseas expansion by Japanese banks
has helped offset the pullback of European banks from international
banking
• If broad dollar funding markets … were to become disrupted, Japan's
large foreign currency reserves and access to central bank swap lines
could be a critical backstop
• Conditions in dollar money markets and their implications for external
funding conditions of Japanese banks need to be monitored closely

36. Riksbanken (2012): (Proposal to…)
Strengthening of the foreign currency reserve
• One important reason why the Riksbank may need to
grant emergency liquidity assistance in foreign
currencies is the Swedish banks' use of funding in
foreign currencies
• The Riksbank therefore needs to hold foreign currencies
to be able to replace such funding in the event of a crisis

37. Sveriges Riksbank will act as LLR in FX if needed
• The major Swedish banks have since the 1970s increasingly funded their
lending through wholesale funding, and during the 2000s wholesale funding
in foreign currencies has grown particularly rapidly.
• Sveriges Riksbank is tasked with safeguarding financial stability and the
functioning of the financial markets.
• The capacity to provide liquidity assistance is one of the Riksbank’s
fundamental tasks in its role of safeguarding a stable and efficient financial
system
• There is an improbable, but not impossible scenario where Sveriges Riksbank
need to supply the banking system in Sweden with liquidity in foreign
currencies on a large scale (Riksbanken, 2012)

38. Banks’ assets to GDP
• The Swedish banking system is
large, concentrated,
interconnected and increasingly
exposed to the housing sector
• Swedish banks use a large share
of wholesale funding, a large
proportion of which is in foreign
currency

40. Is it dangerous (for Swedish banks) to borrow
in dollars? (Deputy Governor Lars Nyberg, 2011)
• Looking back, we can say that the liquidity problems (during the GFC)
were solved quite well, but …
o What would happen if the Riksbank had been unable to borrow
dollars from the Federal Reserve as easily as we could during the
crisis?
o How large a foreign currency reserve do we need to have to ensure
that the Swedish banks will not face a shortage of liquidity in a crisis
situation?
o And who is to pay the costs of this preparedness?

41. Will dollars be available? And who should pay for
them? (Deputy Governor Lars Nyberg, 2011)
• Why doesn't the Riksbank, quite simply, reach an agreement with the
Federal Reserve so that they can always supply us with dollars should we
need them?
• I don't think we should have any illusions about this matter, regardless of
how strong our current cooperation is with the Federal Reserve. When
there is a crisis, we must be prepared to deal with matters ourselves.
• Another way of minimizing the risk is for the Riksbank is to maintain a
foreign currency reserve that the banks can have access to in a crisis, as it
does at present
• The question is, what does it cost to maintain a foreign currency reserve like
this? And who should reasonably pay this “insurance premium”?

42. IMF (2016): A further tightening of FX liquidity
requirements should be evaluated
An extended LCR for the three-month horizon in U.S. dollar and euro
 Consider LCR in in Danish and Norwegian kronor for Nordea
-----
Swedish banks could need sizable FX liquidity support since a large
part of their liquid assets are held in securities that may not be widely
traded in a crisis - such as covered bonds
Thus, Sweden’s existing reserves of 11 percent of GDP should be
maintained

43. Possible prudential measures to mitigate
systemic liquidity risk among Swedish banks
• Stricter LCRs, especially in foreign currencies
• Separate LCR for hedged dollar borrowing
• Limits on open (net) positions in foreign currencies
• For both banks and non-bank financial institutions
• Reserve requirements on short-term currency liabilities from
abroad
• Upgrade the ability to assess the risk and liquidity exposures
of the financial system and the economy as a whole
Quoted from Maintaining Financial Stability in an Open Economy:
Sweden in the Global Crisis and Beyond (SNS Förlag, 2012)

44. Iceland: Capital flow management measures
How to preserve monetary and financial stability in the rougher seas of freer capital movements
• Foreign exchange markets
exhibit excess volatility
• Exchange rates diverge from
fundamentals for protracted
periods
• Uncovered interest rate parity
does not hold, except at long
horizons, and then often
through sharp and disorderly
corrections
• Restrict unhedged FX borrowing by
domestic agents
• Impose prudential limits on banks
FX balance sheet
• LCR and NSFR in FX
• This will limit their FX balance sheet
• Consider a tool that affect capital
flows when the interest differential
becomes sizeable
Már Guðmundsson: Capital flows, systemic risk and policy responses, April 2016

45. End note: The end of a hegemon?
• Part of the world’s economic problem
today is that the United States has
resigned as leader of the world
economy, and there is no candidate
willing and acceptable to take its
place
• We have not only the end to the
domination role which I detected in
1960 (sic!), but also faint sighs of the
end of United States leadership
(Charles P Kindleberger, 1981)