Press release - The global financial safety net: In need of repair ?
Article for the September 2017 Economic Review
Financial integration holds opportunities for advanced and emerging market economies alike, by making investment and consumption smoothing easier, for instance. Nonetheless, it also exposes them to the vagaries of volatile capital flows and, occasionally, financial crises. The adoption of sound domestic policies, though important, may not be sufficient to resist such external shocks; hence the need for a “global financial safety net” (GFSN) that provides countries with financial support for crisis prevention and resolution and aids them in making the necessary adjustments. The aim of this article is twofold. First, it reviews the current state of the GFSN and its four main layers, i.e. countries’ stock of self-accumulated international reserves, bilateral swap lines between central banks, regional financing arrangements (RFAs), and the facilities of the IMF. Next, the article takes up recent discussions on reforms to the GFSN, aimed at improving, respectively, the functioning of the global reserve system, the coordination of bilateral central bank swaps, and IMF-RFA cooperation.
The GFSN has grown significantly over the past few decades and has become increasingly multi-layered, owing to a large build-up in the stock of international reserves and, since the global financial crisis, relatively larger roles for central bank swaps and RFAs. The different layers of the safety net each exhibit their own strengths and weaknesses, suggesting a degree of complementarity between them, rather than substitution. International reserves ensure their holder of quick and flexible access to liquidity, but their accumulation can be costly and may increase global systemic risks. Central bank swaps typically bear much lower costs, but they have been granted very selectively, primarily to serve the interests of their providers. RFAs tend to have wider ownership and more region-specific knowledge than the IMF, but they typically lack the latter’s surveillance and monitoring capacities. The IMF, in turn, seems best-placed to engage in global risk-sharing and encouraging good and multilaterally consistent policies, but still carries stigma, related to its past handling of crises, which is thought to have been a key driver of the development of the other layers of the GFSN.
The article’s discussion of current GFSN reform proposals suggests the following. First, changes to the way the IMF’s special drawing rights (SDRs) are allocated and exchanged could be helpful in supporting a move towards a more balanced global reserve system, but only if the amount of SDRs in circulation is substantially increased. In the meantime, the US dollar is likely to remain the world’s principal reserve currency. Second, while it may be useful to establish a loose, common framework for sharing information and harmonisation of bilateral swap terms between central banks, there are strong reservations about transferring decision-making powers on central bank swaps to the multilateral level, say to the IMF, as this conflicts with the independence and domestic mandates of central banks. Third, there are gains to be made, in terms of a more effective and efficient use of available resources, from stepping up IMF-RFA cooperation. Given RFAs’ heterogeneity and in line with their preferences and comparative advantages, the collaboration with the IMF could be structured along different models of engagement, ranging from information sharing, cooperation in the field of technical assistance and/or monitoring, to actual co-financing.
All in all, recent years have already seen considerable improvements in the way the GFSN is working. Although full integration of its different layers seems neither feasible nor desirable, in view of their complementarities, there is still ample room for enhanced cooperation between them.