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The moral hazard of IMF lending: making a fuss about a minor problem?

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The International Monetary Fund (IMF) is under serious attack. Some critics blame IMF lending for having contributed to the spreading of financial crises in emerging markets. Consequently, they call for putting an end to IMF lending. This radical proposal rests on the contention that official financial support has discouraged IMF borrowers to pursue appropriate economic policies, and private creditors to pursue prudent lending strategies. Major IMF rescue operations, notably the Mexican bailout in 1995, drew particular attention to moral hazard on the part of international banks. It is striking indeed that banks do not seem to have suffered large losses in Mexico and Asia, although banks were heavily engaged there. "Too-big-to-fail" considerations may have motivated recent IMF rescue operations. However, IMF lending to all developing countries has remained small in relative terms. IMF credit outstanding in 1997 accounted for about 1 percent of international banking and developing countries' GNP, respectively. Longer-term developments in IMF lending do not support the view that incentive problems have become more serious over time. There is no empirical justification to blame the IMF for having encouraged inflationary policies and inflexible exchange rate regimes in developing countries by offering financial assistance in the case of emergencies. Furthermore, the IMF is unlikely to have shaped banking behavior in a significant way. The cross-country distribution of bank lending is not correlated with the cross-country distribution of IMF lending. The structure of private capital flows to developing countries has shifted towards equity financing and away from loan financing, although bailouts tend to benefit banks rather than equity investors. Putting an end to IMF lending would do more harm than good. Eradicating minor moral hazard problems would come at the cost of more serious contagion if financial crises were no longer contained by official emergency lending. Contrary to the past, moral hazard could become a relevant problem in the future, if the IMF were empowered to act as a true international lender of last resort. The new international financial architecture should involve private creditors directly in financial rescue operations, in order to prevent private creditors from taking excessive risk. Moreover, an IMF commanding over substantially increased financial resources must obey the rules of a lender of last resort. Developing countries would have to meet basic financial standards, in order to qualify for liquidity support. Emergency financing should be provided at a rate of interest above the market rate and, as far as possible, on collateral.

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Peter Nunnenkamp

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