trade-o¤s faced by countries that may borrow from both the market (commercial lenders) and IFIs.

In what follows, we develop a relatively simple model of emergency ...nancing<sup>9</sup> that allows us to obtain a set of analytical results. This contrasts with much of the recent literature, which tends to rely on numerical simulations. To keep things straightforward, our model abstracts from several important real-world features such as liquidity and creditor coordination issues as well as reforms and conditionality. Our aim is to understand the fundamental di¤erences between IFIs and private lenders, focusing on the underlying incentives for a country to borrow and to repay each type of creditor. We show that IFIs are preferred because their bylaws allow them to commit to (i) lend limited amounts at close to the risk-free rate under most circumstances, and (ii) refrain from lending until any unpaid arrears are cleared. This avoids the possibility of debt dilution, sets IFI lending aside from private lenders, and explains why, in many instances, the presence of IFIs adds value. However, we also ...nd that preferred lending may be constrained by a country’s willingness to honor the commitments made, with the constraint depending on the probability and the severity of future shocks, on repayment costs and on the country’s access to private lenders, which, in turn, depends on similar parameters.

In a similar vein to the common statement in corporate ...nance that if all ...nancing is debt then none is (it turns into equity), we may quip that if all lending is preferred then no lending is. Preferred lending cannot be unlimited, otherwise it may not be considered as preferred. From a normative standpoint, our analysis suggests that if the capital or resources of preferred lenders are restricted, they may wish to concentrate their activities in countries where there is a signi...cant bene...t to having access to such emergency lending when needed but where that need may be relatively infrequent. If emergency ...nancial assistance is required frequently, or is extremely rare, market solutions may be just as good and private lenders may even dominate IFIs. In addition, we ...nd that there are situations in which a country is better o¤ if it cannot borrow from the market, providing a justi...cation for restrictions on commercial lending under certain speci...c conditions.

In the next section, we review the literature on di¤erent aspects of PCT. In section 3, we introduce the basic model and study the case in which the country borrows from an IFI. In section 4, following the standard sovereign debt literature, we assume that the country relies on private lenders. In section 5, we allow for the simultaneous presence of multilateral and private lenders. Section 6 discusses how a capital constrained IFI should optimally allocate its resources, while section 7 looks at some of the key assumptions of the model and discusses the robustness of the results. Finally, section 8 provides a set of policy implications and concludes.

# 2 On preferred creditor treatment, a brief review

Our paper borrows from several strands of literature on IFIs and PCT. First, a number of papers have discussed potential explanations for why IFIs may enjoy PCT, although none contains a model illustrating how it can be supported as an equilibrium outcome. Among these, Buiter and Fries (2002) suggest countries may confer PCT to IFIs in return for competitive lending rates. Levy Yeyati (2009) argues that PCT is related to an insurance motive–namely the expectation that IFIs will extend credit during a crisis. Humphrey (2015) stresses IFIs mutual ownership structure. Risk Control (2017) collects statistics related to these three potential “drivers”of PCT (favorable rates, countercyclical lending, cooperative nature of the institutions) and ...nds evidence that IFIs do indeed extend funds at lower rates than the market, that they are countercyclical, and that they lend in bad times. The paper also compares the degree of “mutuality” of each institution and discusses how that may a¤ect preferential treatment.

Second, within the large empirical literature on sovereign defaults, a subset of papers consider defaults (and the building up of arrears) on IFIs. Schlegl et al (2015, 2019) claim a hierarchy in seniority with the IMF and MDBs at the top. Their analysis is based on World Bank data and covers 127 countries from 1980 to 2006. Considering arrears, bonds appear below MDBs in the pecking order, and then come bilateral lenders, banks and trade credit. The analysis also shows that not all multilateral lenders are treated equally;

> multilateral lenders such as the IFC (the private sector arm of the World Bank Group) do not generally claim preferred status.

> 9 Focusing on emergency lending (and abstracting from lending for consumption-smoothing motives in normal times) provides a clean way to illustrate how a preferred lender could exist as an equilibrium outcome.

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