Risk Management after the Financial Crisis

Euro billsThe IMF has had a preferred creditor status throughout the history of its lending. This implies that borrowing countries are expected to give priority to meeting their obligations to the IMF over other creditors. This column reviews the onset of this preferred status, its purpose, and the way it changed after the recent Eurozone crisis. By lending €30 billion to Greece in 2010, the IMF introduced the option to permanently waive the requirement that a borrowing country is on the path to stability. This option increases the chance of moral hazard and undermines the strong framework for the preferred creditor status.

By Susan Schadler

Throughout the history of IMF lending, the institution has had preferred creditor status – that is, distressed countries borrowing from the IMF are expected to give priority to meeting their obligations to the IMF over those to other creditors. This status is a defining characteristic of the IMF’s role in financial crises – it provides a high degree of confidence that IMF resources are safe when other creditors face substantial uncertainty about full repayment.

VoxEU.orgThe case for the IMF’s preferred status is not often questioned. There is something of a mantra within the Fund and among many Fund watchers that the status is appropriate to protect the resources of an institution that is the closest thing to an international lender of last resort. The preferred status permits the IMF to help distressed countries formulate policies necessary for restoring economic stability and a manageable level of debt, and to have credibility-enhancing ‘skin in the game’ while putting its own financial resources at minimal risk. Moreover, the IMF lends at very low interest rates when risk premia are typically very high – the preferred status is, in a sense, compensation. It is argued that without it, the Fund would have to be more cautious to whom it lends and could, therefore, be reluctant to play a full role in the most severe debt crises.

Maybe someday, there will be justice....

2008-01-03 16:53:10 by GeorgeBailey

The State Street Corporation, which manages $2 trillion for pension funds and other institutions, ousted a senior executive on Thursday and said it would set aside $618 million to cover legal claims stemming from investments tied to mortgage securities.
State Street made the announcement after it was sued by five clients asserting that they had lost tens of millions of dollars that they were told would be largely invested in risk-free debt like Treasuries. One fund lost 28 percent of its value during the credit crisis in the summer after placing big bets on subprime mortgages, according to the lawsuits

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