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the crash architecture scorecard

Institute for International Economics, Washington, DC

(This is Appendix A to Eichengreen's article "Toward a New International Financial Architecture, A Practical Post-Asia Agenda," February 1999.)

[Published with permission of the Institute for International Economics, copyright © 1999. All Rights Reserved.]

Architectural reform is a crowded field, making it hard to tell the players without a scorecard. This appendix therefore provides a roster of the competing plans. For those most closely resembling that laid out above, it provides an evaluation as well as a description.
National Proposals

The UK Proposal
The UK government proposes creating a new permanent Standing Committee for Global Financial Regulation bringing together the IMF, the World Bank, the Basle Committee, and other regulatory groups (Brown 1998). Its main task would be to establish and implement international standards for financial regulation and supervision. The United Kingdom would push for the mandatory adherence to codes of conduct for fiscal policy, monetary policy, corporate governance, and social policy to be drawn up by the World Bank and the Fund.

The French Proposal
The French government proposes transforming the Interim Committee into a council that would serve as the ultimate decision-making body for the IMF (Government of France 1998). That council, made up of national finance ministers, would meet regularly in order to vote on matters concerning the IMF's major strategic decisions, including financial commitments [1]. The French government recommends that the IMF work for the adoption of a "Disclosure Charter" for private financial institutions. It urges regulators to adopt rules to rein in the financial activities of offshore centers. It suggests that countries should more slowly and prudently liberalize their capital accounts and recommends, without providing details, the creation of a "financial safeguard clause" for governments to invoke, "in consultation" with the IMF, to protect themselves against destabilizing capital flows.

The US Proposal
The United States recommends the creation of a contingency-finance mechanism "anchored in the International Monetary Fund" to extend credit lines to countries not yet experiencing a full-fledged crisis but whose stability is potentially threatened. This would provide countries with strong policy fundamentals relatively short-term money at high interest rates.

The Canadian Proposal
Canada's six-point plan emphasizes "vigilance on the part of G-7 central banks," the pursuit of strong policies by emerging-market economies, attention to the needs of the poorest countries, steps to strengthen national financial systems and international oversight, development of a specific strategy for prudent liberalization of the capital account, and mechanisms for involving private investors in the resolution of crises, specifically the negotiation of standing credit lines and modification of the terms of bond contracts. It points to the need to consider standstill mechanisms and suggests that countries legislate an "Emergency Standstill Clause" affecting all cross-border financial contracts. The clause would be invoked only if the withdrawal of short-term finance were threatening financial stability (Canada, Department of Finance 1998). Activating it would require the agreement of the IMF Executive Board.
Private Proposals

Soros's Credit Insurance Agency
George Soros has suggested the creation of a public corporation to insure investors against debt faults (Soros 1997, 1998). Countries would pay a fee when floating loans in order to underwrite the cost of insurance. Each country's debts would be limited to a ceiling set by the IMF on the basis of its assessment of the country's macroeconomic and financial condition. Loans in excess of the ceiling would not be insured, and the IMF would not aid countries having difficulty servicing uninsured loans.

Kaufman's International Regulator and Rating Agency
Henry Kaufman (1998a, b) would create a new international institution with supervisory and regulatory responsibilities over financial markets and institutions. It would supervise the investment and position-taking activities not just of traditional financial intermediaries but of nonbank financial market participants (hedge funds, etc.). It would be empowered to harmonize minimum capital requirements, establish uniform accounting and disclosure standards, and monitor the performance of the financial institutions and markets of its members. Its board would be composed of investment professionals drawn from "all major industrial countries." It would provide public ratings of the credit quality of the market participants under its authority. The IMF would similarly provide ratings of the economic and financial strength of its members and make those credit ratings public.

Raffer's International Bankruptcy Court
Raffer's scheme for an international bankruptcy court is representative of a number of academic proposals along similar lines (Raffer 1990). Raffer would create an international court of arbitration, to be headquartered in a neutral country that is neither an active international leader nor borrower and give it the power to impose a standstill in the event of a crisis and impose settlement terms when debtors and creditors are unable to agree on voluntary restructuring terms.

Meltzer's "True International Lender of Last Resort"
Meltzer (1998) would limit IMF lending to short-term loans at high interest rates to countries following fundamentally sound economic policies and able to put up sound collateral. Central banks could borrow from the Fund only upon presenting internationally traded assets, and the Fund would be barred from making loans without receiving marketable collateral. In come forums he has suggested that the IMF might be closed and that the BIS, as the central bank for central banks, could instead serve in this function.

Calomiris' Rules for IMF Lending
Calomiris (1998b) would replace the Fund and the US Exchange Stabilization Fund with a reformed IMF that would offer a limited discount window lending facility. Loans would be at a penalty interest rate and for short periods only. The facility would be available exclusively to IMF members, and membership would require countries to (1) make their banks hold substantial amounts of capital and issue subordinate debt, (2) extend deposit insurance for other bank debt claims, (3) impose a liquidity requirement on their banks requiring them to hold 20 percent of their assets in cash or a close substitute, (4) require banks to hold a further 20 percent of their assets in liquid securities, (5) allow free entry by domestic and foreign institutions into the domestic banking market, (6) limit other government assistance to banks, (7) require banks to offer accounts denominated in both domestic and foreign currencies, (8) require banks to hold additional reserves if the exchange rate is pegged, and (9) require the government to follow certain debt management practices (e.g., limiting the share of short-term debt in total government obligations). IMF members would collateralize their discount window borrowing with government securities. Collateral would be in the amount of 125 percent of the hard currency borrowed, and 25 percent of the total would have to take the form of securities issued by foreign governments.

Garten's Global Central Bank
Jeffrey Garten (1998) would create a global central bank authorized to engage in open-market operations by purchasing the government securities of its members. Its operations would be financed by credit lines from national central banks or a modest tax on international merchandise transactions and/or certain global financial transactions. It would possess oversight powers over banks and other financial institutions and establish uniform standards for lending. It would be accountable to a committee of governors drawn form the G-7 and eight rotating emerging-market members.

Litan's Put Options in Bank Credits
Robert Litan would have countries receiving IMF assistance enact legislation imposing an automatic reduction of the principal of interbank deposits extended to banks in their countries (Litan et al. 1998). To discourage creditors from withdrawing their funds, haircuts would be imposed if creditors withdraw or fail to roll over their claims while an IMF program is in place. Countries that failed to enact this kind of creditor loss-sharing arrangement could be made ineligible for IMF assistance or required to pay a substantially higher penalty rate. Ideally, the IMF would make enactment of such legislation a condition for the disbursal of its assistance.

Edward's Specialized Agencies
Sebastian Edward's would replace the IMF with a trio of specialized agencies, each with limited responsibilities (1998c). His Global Information Agency would concentrate on providing timely and uncensored information on countries' financial condition. It would publish public ratings of their financial systems and issue red alerts when countries were not providing it with adequate information. His Contingent Global Financial Facility would provide contingent credit lines for countries following fundamentally sound policies but with temporary liquidity problems that were certified by the Global Information Agency as complying with its standards. His Global Restructuring Agency would have the power to impose a stay of payments (for a "cooling-off period) and would provide official financing, subject to conditionality, for countries that were engaged in good-faith negotiations with their creditors and making a realistic effort to restructure their economies.

Bergsten's Target Zones
C. Fred Bergsten has criticized the G-7's neglect of the role of exchange rate issues in the crisis, arguing the swings in the dollar-yen and dollar-euro rates were critical in destabilizing emerging-market currency pegs. He therefore advocates target zones for exchange rates to prevent this problem from recurring. [2] Under his plan, G-7 governments would announce limits on the extent of permissible swings between their currencies, starting with plus-or-minus 15 percent around agreed currency midpoints. Long-term disequilibria due to ongoing inflation differentials would be avoided by regularly adjusting the ranges by very small amounts. In the absence of such disequilibria, central banks would defend the bands as necessary by intervening in foreign-exchange markets and, if necessary, adjusting monetary policies. Emerging-market economies would then find it attractive, Bergsten suggests, to similarly establish bands for their currencies, perhaps around a trade-weighted basket of G-7 currencies.
International Proposals

IMF Proposals
The IMF, via speeches by its managing director and elsewhere, has sketched five imperatives to be included on an agenda for reforming the international financial system (e.g., Camdessus 1998c). First, enhance transparency by encouraging governments to provide additional information about their financial affairs, requiring nonfinancial firms to comply with sound accounting and auditing standards, requiring financial institutions to adopt sound risk-management practices and acceptable disclosure standards, and having the IMF agree to release more information of its own. Second, develop standards and codes of good conduct for economies and financial markets. Third, liberalize the capital account, but in an orderly fashion that recognizes the importance of putting in place the necessary preconditions. Fourth, strengthen and reform the financial sector. Fifth and finally, find a way of dealing with the "complicated" problem of bailing in the private sector. To date, IMF officials have provided few concrete details on how these goals might be achieved.

G-7 Proposals
In October 1998, G-7 finance ministers and central bankers issued an extraordinary out-of-cycle declaration on strengthening the international financial system (G-7 1998). While repeating elements of other international declarations, that is, the need for international standards for minimally acceptable financial practices and for increasing transparency, it also provided some specific if limited proposals for increasing the involvement of the private sector in crisis resolution.

G-7 ministers pointed to the need for heightened supervision of financial institutions in creditor as well as debtor countries (to be achieved by negotiating disclosure standards for nonbank financial intermediaries as well as banks and by having the IMF monitor its members' compliance and issuing a Transparency Report); to the need for greater transparency on the part of governments (which should strengthen the SDDS, release timely and accurate information on their international reserves, and comply with the IMF's Code on Fiscal Transparency and negotiate a companion code on Monetary and Financial Policy); and to the need for more transparency on the part of the IMF (which should release information "except where this might compromise confidentiality" and which should commission additional external evaluation exercises). To bail in the private sector, they embraced the idea of adding collective-action clauses in loan contracts (and for the G-7 countries themselves to consider their use in their own sovereign and quasi-sovereign bond issues), for the IMF to lend into arrears as appropriate, and for emerging economies to negotiate private contingent credit lines with commercial banks in the creditor countries.

This declaration said little, however, about how the negotiation of international standards should be organized other than involving the IASC and the Basle Committee in finalizing accounting standards. It said nothing about discouraging excessive bank-to-bank lending or about the need for Chilean-style capital-import taxes to prevent excessive short-term capital inflows. It said nothing about exchange rate policy or IMF advice and conditionality toward it, aside from the need to consider "the elements necessary for the maintenance of sustainable exchange rate regimes in emerging economies." Other than offering to "consider" incorporating collective-representation clauses into bond covenants, it offered no commitments to solve the prenuptial-agreement problem that prevents emerging markets from unilaterally moving in this direction.

G-22 Proposals
The G-22 issued three reports in October 1998. Because these reports are currently the international community's definitive statement on reforming the international architecture, and there is considerable overlap with proposals advanced in this book, it is worth considering them in detail.

--The Working Group on Transparency and Accountability
This group recommended establishing national standards for the disclosure of private-sector financial affairs and that regulators require banks and firms to adhere to recognized accounting standards. It recommended that countries that do not yet do so presently should report to the BIS data on their cross-border borrowing and lending, that governments should compile and disseminate data on the foreign-exchange position of the public financial and corporate sector, and that a working group should be established to explore the feasibility of gathering and publishing data on the international exposures of noncommercial-bank institutional investors. It urged the IMF to move toward greater transparency and asked national authorities to support the publication of Letters of Intent, background papers to Article IV reports, and Public Information Notices. It recommended that the IMF prepare a "Transparency Report" for each country in conjunction with its regular Article IV consultations.

The benefits of greater transparency are now widely accepted and are embraced in this book as well. However, the G-22 report (1998a) is more sanguine about governments' ability to gather information about private-sector behavior. It appears to assume, for example, that governments will be able to gather accurate information on the financial affairs of nonbank firms, that is, their foreign financial exposures, an assumption I do not share. It proposes that the Transparency Report should focus on compliance with disclosure standards and does not mention standards for financial supervision and regulation, corporate governance, and insolvency procedures, which are critical if the promulgation and monitoring of international standards are to make a difference for financial stability.

More generally, this working group says little about how international standards are to be set and enforced. It does not share my emphasis on the need to rely on private-sector resources in developing the relevant standards and to allow the private sector to take the lead wherever possible in monitoring compliance. Nor does it emphasize the need for international action to provide effective incentives for compliance. It does not suggest, as I do, that the IMF should condition its assistance to program countries on their taking specific steps to comply, that it make the interest rate charged on its loans a function of that compliance, or that it make eligibility for any preapproved credit lines a function of compliance status. [3]

--The Working Group on Strengthening Financial Systems
This group endorses the Basle Core Principles for Effective Banking Supervision and points to the need for similar principles in the areas of internal controls, liquidity management, corporate governance, and insolvency procedures (G-22 1998b). In contrast to my conclusions, however, it does not emphasize the role of the private sector in developing internationally recognized principles, instead supporting the related efforts of the Basle Committee and the OECD. [4] Nor does it embrace the idea that the IMF should monitor compliance with these principles and issue a report evaluating its members' compliance status, reporting that its members are divided on the issue of published compliance ratings. In contrast to my approach, the working group displays more faith in the ability of capital, reserve, and subordinated-debt requirements to deter excessive risk taking in emerging markets and in the capacity of regulators to effectively surveil the funding and investment decisions of banks and to restraint socially counterproductive behavior.[5] Above all, it says nothing about the need for Chilean-style controls to reinforce prudential supervision and regulation in developing countries or of the need for greater exchange rate flexibility to encourage banks and corporations to hedge their foreign exposures.

--The Working Group on International Financial Crises
This group recommends that lenders and borrowers explore the development of innovative loan contract provisions such as prenegotiated put options to enhance payments flexibility (G-22 1998c). It points to the desirability of incorporating collective-representation, majority action, and sharing clauses into loan contracts. To this end, it recommends that governments engage in "educational efforts" in the major financial centers and that the governments of creditor countries "examine" the use of foreign offerings. In contrast to my conclusion, it does not emphasize the need for the IMF to encourage its members to incorporate such provisions into their loan contracts and to key its lending rates and disbursements to their governments' willingness to do so. It does not stress the need for regulators in the leading creditor countries to make such provisions a condition for the admissions of international bonds to trading on their markets. It is uncritical about the scope for introducing new provisions into cross-border bank credits. It does not acknowledge that the only effective way to contain the risks of bank-to-bank lending when the banks in the borrowing country are too big and important to fail is by using inflow taxes to prevent excessive reliance on short-term foreign bank credits in the first place. It fails to acknowledge the need for greater exchange rate flexibility to encourage banks and firms to hedge their foreign exposures and as a deterrent to excessive capital inflows.

To facilitate orderly workouts of sovereign debts, the working group suggests that the international community should signal its willingness to provide the crisis country with conditional financial support, where appropriate, through IMF lending into arrears. However, it does not acknowledge the need for standing committees to facilitate restructuring negotiations.


Notes

1. An allied proposal, due to Philippe Maystadt, former chairman of the Interim Committee, would allow that committee to create subcommittees to address specific issues of concern.

2. See Bergsten (1998a) and, for an earlier incarnation that spells out the proposal in more detail, Bergsten and Henning (1996). Similar ideas have also been advanced by Paul Volcker (1995). The German government has also tabled a proposal for "the controlled flexibility of exchange rates" as its contribution to the architecture debate.

3. Although some of these possibilities are raised by the working group concerned with strengthening financial systems.

4. It does not acknowledge the need for the official sector to "initiate a dialogue" with the relevant private organizations and professional groups, but mainly with an eye toward determining how the private sector can more effectively utilize information that emerges from standard setting and prudential regulation rather than in how it can take the lead in the process of standard setting itself.

5. The section of the report on "Methods to Ring-Fence the Socialization of Risk and to Limit Forbearance" reiterates that providers of risk capital and subordinated debt should not be bailed out without addressing the political difficulties this presents.

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