# b. “Lender of Last Resort” (Emergency Liquidity Support)

The second principal function of the IMS is as a lender of last resort, an issue on which the Bretton Woods convention focused heavily. Without a lender of last resort on the global scale, countries need to self-insure against potential losses from terms of trade shocks. Imperfections in international capital markets imply imperfect access to credit, thus borrowing to smooth consumption during such shocks is not always possible. “Sudden stops”<sup>94</sup> in access to foreign currency flows pose a risk. As a result, countries that do not possess an internationally-accepted currency feel a need to self-insure against these shocks by accumulating foreign exchange reserves. Note that there are other motivations for accumulating foreign reserves that will be discussed in more detail below.

As noted in the historical section of this paper, part of the _raison d’etre_ of the International Monetary Fund is to smooth out access to foreign currency when temporary shortages occur for member countries. Purpose (v) of the Articles of Agreement states: “To give confidence to members by making the general resources of the Fund temporarily available to them under adequate safeguards, thus providing them with opportunity to correct maladjustments in their balance of payments without resorting to measures destructive of national or international prosperity.” Those “resources” are gold, major international currencies and other member currencies that were subscribed over the years to the Fund. In this sense, “the Fund” is a fund for pooling international reserves.95 It performs this function as a lender of last resort to sovereign nations via their central banks. Commercial banks and other financial institutions within those member countries do not have direct access to the IMF’s resources. In that sense, the IMF does not perform the direct role of a lender of last resort in the way that central banks do at the national level. (Beyond this lender-of-last-resort-to-sovereigns function, the IMF also has explicit surveillance and policy coordination functions that will be discussed in more detail in the policy coordination section below.) In terms of the international lender of last resort function, there are several initiatives that are either at various stages of implementation or on the table for policy discussion. They can be separated into different categories: (i) enhanced direct funding for the IMF—“right sizing” the IMF for the much larger level of trade flows and international capital flows that have far outpaced the size of the IMF balance sheet; (ii) creating contingent financing mechanisms—either bilaterally via swap arrangements between central banks or new contingent funding arrangements for the IMF (along with accompanying contingent loan instruments); (iii) regional pooling of reserves and/or emergency lending arrangements (as opposed to international ones); and (iv) creating an international central bank with its own currency that could be used to perform lender of last resort functions.

The IMF’s resources for providing foreign currency financing to countries under stress have not kept pace with the size of the global economy, global trade or global financial flows. Quotas amount to SDR 217.4 billion (about US$335 billion) or about 0.5 percent of world GDP. Quotas are reviewed every five years to determine e if they should be increased. The quota is paid 25 percent in SDRs or major currencies and the remaining 75 percent in the country’s own currency. Another option that has been used to a limited extent is the sale of IMF’s vast store of gold—managed carefully so as not to disturb gold markets. The Fund has 90.5 million ounces of gold,<sup>96</sup> currently worth about $164 billion, which is the third largest holding of gold in the world.<sup>97</sup> A third direct approach would be the issuance of IMF bonds; given that regional development banks already issue bonds for leveraging their membership’s paid-in and contingent capital, there is a precedent. Some commentators (for example, Richard Cooper)

> 94 See Calvo (1998) and Calvo et al (2004).

> 95  Article 1 of the IMF Articles of Agreement refers to six purposes for the IMF’s establishment.

> 96 See “Gold in the IMF” Factsheet on the IMF’s website www.imf.org. The value stated above is end-August 2011 gold prices.  According to the

> 97 The United States and Germany have larger holdings (according to World Gold Council data).

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