Global Financial Safety Nets

How can countries cooperate to mitigate contagion and limit the spread of crises?

November 7, 2011

A country in financial distress and unable to service its external obligations poses potential problems for the stability of the international financial system, which the IMF was created to protect. In fact, the global financial safety net refers to a set of crisis prevention and resolution instruments, encompassing self-insurance (reserves); bilateral arrangements (e.g., swap lines between central banks during periods of stress); regional arrangements such as those in Asia, Europe and Latin America; and multilateral arrangements with the IMF at their center.

Recent developments in the global economy have highlighted the need to further strengthen global financial safety nets. As part of the cooperative response to the global financial crisis, the IMF’s lending capacity was tripled, and a general allocation of SDRs was made in the amount of $250 billion. There was also a major overhaul of how the IMF lends money by offering higher amounts and tailoring loan terms to countries’ varying strengths and circumstances.

More recently, the IMF has approved further reforms to strengthen its capacity to assist member countries in preventing crises. The reforms are: (i) the Flexible Credit Line (FCL) has been refined with a view to increasing its effectiveness and predictability; and (ii) a new Precautionary Credit Line (PCL) has been established to broaden the availability of crisis prevention instruments to countries that have sound fundamentals and policies but do not yet meet the qualification standard of the FCL. These reforms represent major enhancements to the crisis-prevention instruments, making them more broadly available to members. They respond to heightened perceptions of volatility and contagion which induce countries to demand enhanced insurance instruments. The FCL can be deployed simultaneously to multiple qualifying countries impacted by the same shock.

Discussions on how to enhance the global financial safety net, including the Fund’s capacity to deal with contagion in systemic crises, are also ongoing: the IMF is exploring options under a Global Stabilization Mechanism (GSM) that would enable the IMF to provide liquidity proactively to mitigate contagion in systemic crises in conjunction with bilateral and regional liquidity support arrangements. Work is also underway to potentially introduce a new Precautionary and Liquidity Line (PLL)—to provide increased and more flexible short-term liquidity to countries with strong policies and fundamentals facing systemic shocks. The agenda ahead also includes efforts to develop greater synergies with regional financing arrangements (RFAs) both in terms of surveillance activities and co-financing.