“Financial Risk and Crisis Management after
the Global Financial Crisis” Series No.8 (5/2016)

The IMF as a Global Framework for Currency
and Financial Crisis Management1

Junko Koedai

Associate Professor, Faculty of Political Science and Economics,
Waseda University

This document is an English translation of the original Japanese, which appears in
the May 2016 edition of The Japan Economic Research Institute Monthly Report,
published by The Japan Economic Research Institute.
11. Introduction
The International Monetary Fund (IMF) plays a critical role as a crisis
manager from a global standpoint, as an international lender of last resort(ILOLR) for international financial systems during currency and financial
crises. Because the IMF plays such a critical role, it is subject to the
judgment of global society whenever a crisis occurs, and its problems comeinto clear view. What types of issues is the IMF’s crisis management
framework currently dealing with then?2
ILOLRs are not limited solely to the IMF. During the global financial crisisof 2008, the US Federal Reserve Board (FRB) came to play the role of aliquidity supplier. In addition, the European Central Bank (ECB) exerted
greater influence as a liquidity provider during the Euro crisis, and the useof European regional financial arrangements such as the European
Financial Stability Facility (EFSF) and the European Stability Mechanism(ESM) also increased. Liquidity supply frameworks set up in Asia include
the Chiang Mai Initiative (CMI) as well as its further multilateralization
among the ASEAN+3 nations. Therefore, in what ways does the IMF differ
from other ILOLRs, and in what ways is it related to them?
This research series has already discussed the roles of the FRB’s currency
swap agreements (#1, #7) and regional financial cooperation in Asia (#6).
This paper will discuss the characteristics of and issues involved in the IMF’s
crisis management framework and contrast it with the other ILOLRs.

2. The Role of an International Lender of Last Resort: Theoretical
Background3
In theory, no consensus has actually been reached as to whether aninternational lender of last resort (ILOLR) is even necessary. Depending on
the assumptions of any given model, one may conclude that an ILOLR
should have an unlimited supply of funds at its disposal or that it would bebetter to do away with ILORLs completely. Other models fall between these
two extreme perspectives.
2

This paper does not seek to provide a new analysis; instead it focuses on introducing anddissecting existing research and discussions. Also, although the paper primarily discusses the
IMF, those wishing for a more general view on the institutional design of international financial
system should refer to papers such as Fukuda (2005).
3
This section introduces the current discussion, with reference to Chapter 3 of Roubini and
Setser (2004).

The conclusion that an “unlimited” supply of funds (or an ample amountthat can fully cover any possible liquidity gap) is necessary complies withclassic theoretical models that take liquidity crises into consideration (e.g.,
Chang and Velasco, 19994). The term “liquidity crisis” here refers to suchsituations as the one that South Korea faced during the 1997 Asian currency
crisis. At the time, even though South Korea had relatively stable
fundamentals, speculative behavior on the part of investors—whereby theyattempted to convert won-denominated short-term investments into
dollar-denominated equivalents—dragged the nation into crisis.5 However,according to this model, if an ILOLR capable of supplying enough funds tocover the liquidity gap had existed, this type of speculative behavior would
never have occurred. In other words, if an ILOLR could rapidly provide
unlimited funding, it could help avert a liquidity crisis. Therefore, a total
bailout would be the ideal scenario, which would imply that ILOLRs should
be strengthened.
In contrast, the conclusion that ILOLRs should be done away with is often
built on the fundamental concept of lenders’ and borrowers’ risks. Classicalarguments point out that the insurance function of an ILOLR results inincreased moral hazard for both lenders and borrowers (in this case, theincentive to take excessive risk). Even if this problem of moral hazard does
not fully substantiate the extreme argument of abolishing ILOLRs, it does
contribute to arguments that preach caution with regard to strengthening
ILOLRs.
However, if ILOLRs were to be abolished, what sort of response could be
mounted in the event of a financial crisis? Nations could guard against crises
by increasing their reserves, but the act of holding these reserves would be,in itself, an opportunity cost. It is also conceivable to rely on private-sector
funds, but it is often the case that there are not enough private institutions
to supply sufficient liquidity on a global scale in the midst of crises.
Between the two extreme schools of thought regarding ILOLRs—abolitionand provision of unlimited funds—sit other theoretical models that, forexample, advocate the efficacy of partial bailouts in cases wherein crises are
4

The model used by Chang and Velasco (1999) takes the domestic lender of last resort function
from the model used by Diamond and Dybvig (1983) and applies it to an open economy.
Investors’ attempts to convert domestic currency-denominated short-term debt into a foreign
currency cause a liquidity crisis, which then turns into a currency crisis. This mechanism differsfrom that of Diamond and Dybvig (1983), according to which liquidity problems arise becauseof banks’ proclivity for short-term borrowing and long-term lending, which induces low
liquidity.
5
See Ogawa (2000), Ito (2007), and others for detailed accounts.

brought on not only by liquidity problems but also by weak fundamentals(e.g., Corsetti, Guimaraes and Roubini, 2006). Since this approach allows forcrisis prevention through public funding and political efforts, it is consistent
with the view that the ILOLR plays a critical role as a crisis manager.

3. The Characteristics of IMF Financing
In view of the perspectives discussed, what types of funding does the IMF
actually supply and is it actually engaging in crisis management? Specificterminologies such as quotas, special drawing rights (SDRs), conditionality,
and so on are often used in this context by the IMF. In this section, we will
introduce such terms and describe the characteristics of IMF financing.
Specifically, we will discuss funding formats, the scale of funding, andfunding conditions.6 We will then compare the IMF with other ILOLRs in
the next section.
Funding Format: Public Currency Swaps
IMF funding occurs entirely through currency-claim rights known as SDRs.
As SDRs themselves are not liquid assets, they must be converted into
specific currencies when making loans. Under the SDR mechanism,
IMF-specified and voluntary participant nations provide “freely usable
currencies” that can be exchanged for SDRs. Since only public entities canhold SDRs, such exchanges are conducted through government transactions
and not through the markets.
Although this IMF funding format is unique, it can be considered a type of
public currency swap framework—one that has 188 participating nations.
Because a significant subset of nations will not feel the effects of a crisis at
any given point, a stable supply of funds can be provided.
The structure of the currency basket that determines the SDR’s value isrevised once every five years to reflect the relative importance of eachcurrency in the global trade and financial systems. Table 1 shows the changeover time in the weights of each currency in the basket. Although the freely
usable currencies that are currently incorporated include the US dollar, theEuro, the Japanese yen, and the British pound, the Chinese renminbi is to be
added to the basket in October 2016 with the third-largest weighting behind
the US dollar and the Euro. This step is in line with the forecast that China’s
share of the global GDP is expected to grow in the future. For example, the6

See Okamura, ed. (2009) for a detailed discussion of the IMF’s setup in this regard.

IMF’s World Economic Outlook predicts that China’s GDP will outstrip theEurozone’s over the next five years (2016–2020) (Figure 1).
Table 1. Composition of the Currency Basket for SDR Valuation (%)
2001-2005

2006-20102011-2015

US

45

44

42

2016–2020(Scheduled
Weighting)
42

Eurozone

29

34

37

31

Japan

15

11

9

8

UK

11

11

11

8

China

0

0

0

11

Source: Expansion of material no. 8.5 from Okamura (ed., 2009) using data from the IMF website.
Figure 1. GDP of Nations with Currencies in the SDR Valuation as a Percentage of World GDP

Source: Drafted from IMF World Economic Outlook (WEO) data.

Funding Scale: Financing and Capital Increases
The scale of IMF funding is dependent on either capital increases (quota)
or financing from participant nations. A breakdown of the IMF’s usable
resources (see Figure 2) shows that during the 2008 global financial crisis,
these resources played a critical role through their temporary expansion via
financing. Quotas had been increased a number of times in the past, but
quotas as a share of global GDP constantly declined.

Figure 2. Breakdown of Usable Funding from the IMF (in Hundreds of Millions of USD)

Source: Drafted from IMF website data. Year-end values.

The IMF’s usable funding is less than 1% of global GDP (Figure 2). Somesuggest that the IMF should strengthen its funding base by issuing more
SDRs (e.g., Zhou, 2009). However, such funding is not limitless, as
converting SDRs into liquid assets inevitably results in fiscal limitations forthe nation providing the funding (Eichengreen, 2012).
Funding Conditions: Conditionality etc.
The IMF is the creditor with the highest seniority (priority of payment),
but it does not accept collateral. As such, its lending rate, called the SDR
interest rate, is determined on the basis of the weighted average of the freely
usable currencies’ short-term interest rates. Since short-term interest rates
under a floating-rate regime are largely determined by fiscal policies, theSDR interest rate and its movement over time (see Figure 3) reflect the fiscal
policies of the US, the EU, Japan, and the UK. Since these nations haverecently been maintaining non-traditional fiscal policies, the SDR interest
rate is reaching its lower limit of 0.05%. However, with China joining thecurrency basket this autumn and considering that the three-month rate on
China’s sovereign debt is above 2% (see Figure 4), the SDR interest rate
could once again trend upward.

Figure 3. SDR Interest Rate over Time (Annual, %)Source: Drafted from Data Stream. Monthly average values.
Figure 4. Benchmark Interest Rates for Three-Month Chinese Sovereign Debt (Annual, %)Source: Drafted from Bloomberg generic interest rate (bid/offer) data. Month-end values.

In exchange for not being able to dictate how its loans must be used, theIMF sets various targets, or conditionalities, for macroeconomic policy. IMF
conditionalities impose various constraints on borrower nations. First, if anation does not meet certain benchmarks called “prior actions,” it will notreceive IMF financing. In addition, if it does not fulfill “quantitative
performance criteria” (QPCs), then funding will usually be discontinued. It is
critical to impose the appropriate conditionality on a country and oblige it tocommit to policies that are effective in bringing a crisis under control. This
leads to a recovery in creditworthiness, thereby priming both private andother public funds. This is the key role of a crisis manager.
However, some distrust certainly exists with regard to IMF

conditionalities. In Asia, in particular, during the Asian currency crisis, the
IMF’s imposition of strict fiscal austerity measures on fiscally healthy
countries (such as South Korea and Thailand) and the excessive impositionof structural conditionality (on Indonesia and others) that would not benecessarily critical to bringing the crisis under control led to an increased
distrust of the IMF. In the years since the crisis, a deeply-rooted warinesshas remained with respect to receiving IMF assistance, which is considered
to be a stigma.7
To lessen this stigma, the IMF moderated its conditionalities. For example,
it removed structural benchmarks from its QPCs (when funding is divided
into installments, the next installment would usually not be provided unlessthese benchmarks were met) and only set applicable benchmarks that could
be calculated from macro variables and other such data. It also establishedliquidity supply facilities (see the separate column on this) with noconditionality for countries with strong fundamentals.
Although these steps did moderate the IMF’s conditionalities, theorganization was more circumspect in its proactive use of prior actions withrespect to countries with medium-term structural problems. For example, in
the assistance it gave Greece during the Eurozone crisis, it attached fourprior actions as conditions for approval of the extended fund facility.

4. Comparison with Other ILOLRs
How is the IMF similar to and different from other ILOLRs? This section
compares the IMF with ILOLRs such as the Chiang Mai Initiative (CMI), the
US Federal Reserve Board (FRB), and the European Stability Mechanism(ESM).8
Chiang Mai Initiative
Although the CMI, like the IMF, is a type of public currency swap
framework, it only serves the ASEAN+3 area. Multilateral currency swaps(multilateralization) among the region’s countries became possible in 2010,
and at present, the available pool amounts to $240 billion. The IMF was afactor leading to the CMI’s establishment. This was because of the strong
IMF stigma following the Asian currency crisis (see previous section), which
7

8

See Ito (2012) for a discussion on this stigma in Asia.

This paper does not discuss regional financial arrangements set up in other regions (e.g., theArab Monetary Fund, Latin American Reserve Fund, and North American Framework
Arrangement).

engendered regionalization regarding the international financial system inAsia. Still, if withdrawals from this pool exceed a certain level (called the
IMF delinked portion), it is necessary to engage in the IMF program. Thus, it
is one of the few ILOLRs with a definite link to the IMF.
So far, the CMI has never been implemented. Even in the global financial
crisis of 2008, South Korea, which was facing liquidity problems, is said tohave avoided using the CMI because of its link to the IMF program (Kawai,2009). The IMF delinked portion was subsequently raised from 20% to 30%
in 2014.
Federal Reserve Board
The FRB’s currency swap agreements are part of a crisis management
framework that is independent of the IMF. Executing a central bankcurrency swap agreement is ostensibly influenced by political factors, but
having such an agreement provides a very readily available mechanism tothe parties involved. Since lending conditions are predetermined, thissystem is highly regarded for its ability to provide same-day funding in theevent of a crisis. Also, these lending conditions do not include conditionalityof the type imposed by the IMF on macroeconomic policies.
Also, since the funding is provided by a central bank, which has
currency-issuing authority, the supply can be unlimited. However, it isunlikely that a central bank would actually supply unlimited liquidity withno restrictions. In particular, the FRB could withhold funding because ofpolitical considerations or if it were concerned that easing would result indomestic inflation. When insufficient dollar liquidity became a problem
during the 2008 global financial crisis, the FRB played a key role insupplying dollars; however, at that time, easing measures were a desirable
form of monetary policy for the US.
European Stability Mechanism9
The European Stability Mechanism (ESM) is a regional financial
arrangement set up to stabilize the Eurozone’s financial system. Unlike the
CMI, the ESM does not have any formal links with IMF programs. Still, as in
the troika system of the IMF, the European Commission (EC), and theEuropean Central Bank (ECB), the ESM cooperates with the IMF wheneverpossible.
9

Formerly the European Financial Stability Facility (EFSF), which coexisted with the ESM
from October 2012 to June 2013.

Unlike a public currency swap framework, the ESM funds itself by issuingbonds in the market. Since these bonds are guaranteed by Germany andother EU nations with high credit ratings, it is possible to procure long-term
financing with low-cost funds. As a result, the funding cost, known as thebase rate, can be negative. By contrast, IMF loans cannot carry a negativeinterest rate because the SDR interest rate, on which such loans are based,
has a 0.5% floor, and IMF loans tend to be relatively short term.10
After the ESM’s establishment in October 2012, Greece, Cyprus, and Spain
became ESM program nations. Among these three, Greece and Cyprus had
also received IMF loans, but 80–90% of the funding they received was fromthe ESM and other European institutions (see Table 2).
When a country receives IMF financing, the IMF and the borrower sign amemorandum of understanding. However, in the troika system of the IMF,
the EC, and the ECB, the IMF’s performance criteria and the EC’squantitative targets are set in accordance with each other. Additionally,
although the IMF focuses on short-term macroeconomic policy, the EC covers
comprehensive medium-term structural reform (IMF, 2012). Therefore, inthis type of cooperative structure, the issue is whether ILOLR peers cancooperate to provide an appropriate support package in a timely fashion.
If a country has not received IMF financing, the IMF’s policy statements
are not legally binding; therefore, the IMF’s cooperation with the ESM is not
an inevitable consequence. Spain did not receive support from the IMF
during the Euro crisis, apparently because the country was concerned thatreceiving IMF support would increase the spreads on its sovereign debt andhurt its banks’ balance sheets. It therefore accepted support from the ESM,
which limits how such funding can be used, and injected the funds into its
banking sector. A joint agreement between Spain’s central bank and the EC
determined the financial institutions that would receive the proceeds of the
ESM financing. Although this agreement was ostensibly coordinated with
the IMF, this particular case did not lead to the IMF having formal power ofenforceability over policy implementation in Spain.

5. Conclusion: Issues in the IMF’s Crisis Management Framework
This paper has considered the role of ILOLRs, described their theoreticalcontext, and discussed the characteristics of the IMF and compared it with
10

However, financing from the extended fund facility and financing for low-income countries
have longer maturities of 10 years.

other ILOLRs. So what issues have these discussions illuminated?
Eventually, it will become difficult for the IMF to provide “unlimited”
funding because it cannot avoid fiscal limitations. The IMF has set up a more
flexible lending framework in response to this issue. Specifically, theestablishment of the Flexible Credit Line (FCL) in 2009 made it possible for
the IMF to provide funding to countries with strong economic fundamentals
without imposing access limits or conditionalities. So why has the FCL notbeen more actively used? Possible explanations for this include the lack ofinterest on the part of member countries and the rigorous loan qualification
criteria (Reichmann and Resende, 2014). In theory, the very existence of aliquidity supply function can prevent a liquidity crisis; therefore, it is notnecessarily accurate that the function is ineffective just because it is not used.
However, the lending framework likely needs some further revisions. For
example, it may be worthwhile for the IMF to enhance the FCL’s
rapid-response capability by pre-approving all financing criteria or to set up
a new framework in which loans could be provided to a number of countries
simultaneously.
Even if the IMF is unable to provide unlimited funding, it can still fulfill a
critical role as a “crisis manager” (Fisher, 1999). However, because thestigma of the IMF remains strong and other ILOLRs are increasing theirpresence, the IMF faces the challenge of providing a global perspective thattranscends national and regional interests and of contributing to theimplementation of appropriate policies. Further, enhancement ofmultilateral dialogue could also be effective, but dealing appropriately withthe constantly changing global economy is a challenge. Also, even if the IMF
is able to provide the right advice, it will not have any control regarding thepolicy execution of a country in crisis if that country has not requested IMF
funding. In any event, therefore, the IMF’s policy surveillance activity has
major limitations (Mussa, 1997).

[Column]
IMF Credit Lines
In theory, an ILOLR can prevent a liquidity crisis if it is able to cover liquidity
gaps through the rapid supply of sufficient funding (see Section 2). In line with thistheory, the IMF has, in fact, established and enhanced credit lines for countries withstrong fundamentals and good track records. The IMF currently provides two typesof credit lines: the Flexible Credit Line (FCL) and the Precautionary and Liquidity
Line (PLL).
The FCL is a renewable credit line for countries with strong fundamentals andgood track records. Countries eligible for the FCL do not have any conditionality ora maximum access limits (as determined by their quota share), and they can receive
all the funds upfront in a lump sum. On the other hand, countries that do not meet
FCL criteria but have relatively stable fundamentals are eligible for the PLL. For
these countries, the access limit is set at 1000% of the borrower’s quota on a
cumulative basis.
The FCL first came into existence in March 2009. At the time of the 2008 global
financial crisis, the IMF had only one available liquidity provision facility, which
had a 500% access limit.* At that time, countries that were facing liquidity problems
did not utilize the IMF; instead they relied on the FRB for liquidity supply.
However, even after the establishment of the FCL/PLL, few countries haveapplied for credit lines from the IMF. As of the time of writing this paper (May2016), the only countries that have applied for the FCL are Mexico, Colombia, andPoland, whereas Morocco is the only one that has applied for the PLL.
*For more on credit lines before the 2008 global financial crisis, see Ogawa (2000).

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Financial Crisis and the IMF], Okura Zaimu Kyokai.
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System Economics: From the Perspective of Social Shared Capital], Universityof Tokyo Press.
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[9]IMF. 2011. Review of Conditionality
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[Profile: Junko Koeda]
Associate Professor, Faculty of Political Science and Economics, Waseda University(Applied Macroeconomics, Applied Finance, International Finance)
Graduated from the Faculty of Economics, University of Tokyo. Earned her Ph.D. from
UCLA. Worked as an economist at the International Monetary Fund’s headquarters inWashington, DC, and as a project assistant professor at the University of Tokyo’s
Graduate School of Economics and Faculty of Economics before assuming her current
position in 2014.
i

Major Works“A Debt Overhang Model for Low-Income Countries,” IMF Staff Papers, Vol. 55 (4),2008.
“Endogenous monetary policy shifts and the term structure: Evidence from Japanese
government bond yields,” Journal of the Japanese and International Economies, Vol. 29(C), 2013.
“Exiting from QE,” with Fumio Hayashi, NBER Working Papers 19938, National
Bureau of Economic Research, Inc., 2014.