CHAPTER 4 The International Monetary Fund’s Work on Financial Stability
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GLENN GOTTSELIG
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ANNE-MARIE GULDE-WOLF
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SEM; government; country; central bank; financial conglomerate; securities affiliate; IMF's article; remittance system; IMF surveillance; Securities; Financial conglomerates; Central bank autonomy; Digital currencies; Exchange restrictions; Global; Europe; Asia and Pacific; Middle East; Africa; Solvency; South America; Central America; Caribbean
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Abstract

The Legal Department and the Institute of the IMF held their ninth biennial seminar for legal advisors of IMF member countries’ central banks, and the papers published in this volume are based on presentations made by officials attending this seminar. The seminar covered a broad range of topics, including sovereign debt restructuring, money laundering and the financing of terrorism, financial system and banking supervision, conflicts of interest and market discipline in the financial sector, insolvency, and other issues related to central banking.

A strong and sound financial system provides countries with the foundation for robust economic activity and growth. Financial stability is equally important, particularly given what has been learned from events in the recent past in which the contagious effects of one country’s financial instability adversely affected others. Naturally, financial stability may be said to be found in the absence of systemic financial crises that threaten macroeconomic stability; however, financial difficulties of individual institutions may still arise from time to time, but, when contained, should not be viewed as posing an inescapable threat to an otherwise stable financial system.

As the international organization responsible for surveillance over member countries’ financial sectors and many aspects of the international financial system, the International Monetary Fund (IMF) has a special role to play in safeguarding macroeconomic stability through efforts aimed at reducing or preventing financial sector stress. Indeed, monitoring and promoting financial stability have become important parts of the IMF’s mandate. The IMF is currently the one international organization capable of carrying out financial sector surveillance universally—that is, for all countries—and comprehensively. This chapter will examine the work of the IMF as it relates to financial stability, as well as touch on some of the reasons for IMF involvement in ensuring financial stability. The discussion will also identify the tools used by the IMF in its surveillance of financial sectors, examining the key procedures and operations applied in monitoring financial sectors. Finally, the discussion will conclude by identifying issues that should be considered in the context of the future work of the IMF in this field.

Why Is the IMF Concerned About Financial Stability?

The core mandate of the IMF focuses on maintaining open economies, avoiding exchange restrictions, promoting balanced growth, and supporting monetary cooperation. These core objectives have not only remained unchanged over the years, but have acquired added significance given the challenges brought about by increasing globalization. Throughout the 1990s, and partly in response to the financial crises of that decade, the IMF strengthened its surveillance activities that related to assessing financial sector health and financial sector vulnerabilities.1

Financial instability has a number of negative consequences. For example, economies experiencing instability in their financial sectors are likely to suffer from an increase in volatility in financial markets. Through risk premiums, volatility will increase prices and wages, affecting the labor market as well as overall consumption patterns. In addition, depending on the nature and severity of the instability, economies that are interconnected with those experiencing instability are at risk of experiencing contagion effects. Finally, if the instability persists there will be negative effects on economic growth. Financial crises can be extremely costly in terms of lost growth; Table 1 provides some indication of the costs associated with financial crises in various countries throughout the past 25 years. Not even the United States has been immune to such costs.

Table 1.

The Cost of Crises

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Source: IMF staff estimates.

The IMF’s Executive Board has noted the key elements of effective surveillance to include timely, comprehensive, and accurate information; focused, high-quality analysis; openness to different perspectives to minimize the risk of “tunnel vision”;2 effective communication of assessments to the authorities and the public; and engendering the desired impact on members’ policy decisions.3 The Board has agreed that, building on the lessons learned from the Mexican and Asian crises of the 1990s, steps would be taken to shape IMF surveillance to better meet these criteria.4 Consequently, IMF efforts to strengthen surveillance and crisis prevention have covered a wide range of areas, although, as indicated by the IMF Executive Board, there remains scope for further progress in many of them. The focus of these efforts has been on developing more systematic financial sector surveillance—in particular, through the Financial Sector Assessment Program (FSAP), but also through Article IV consultations, the Global Financial Stability Report, and the World Economic Outlook. In addition, other important areas include improved data provision to the IMF and data dissemination to the public, as well as strengthened assessments of policy frameworks and institutions against internationally recognized standards and codes.

Tools of IMF Financial Sector Surveillance

The FSAP

The FSAP is a joint initiative of the IMF and World Bank undertaken to provide member countries with a comprehensive evaluation of their financial systems and aims to reduce the likelihood and severity of financial crises. The program began in 1999, partly in response to the Asian financial crisis and to calls by the international community for intensified cooperative efforts to strengthen the monitoring of financial systems. Work under the program, which is supported by experts from a range of national agencies and standard-setting bodies, seeks to identify the strengths and vulnerabilities of a country’s financial system; to determine how key sources of risk are being managed; to ascertain the sector’s developmental and technical assistance needs; and to help prioritize policy responses. The initial pilot program involved assessments of some 12 countries.5 In 2000, Executive Directors in both the IMF and World Bank acknowledged the quality of the work thus far and agreed that the program should be continued, with coverage being expanded to around 24 countries. By the end of 2004, roughly two-thirds of the membership, amounting to about 120 countries, participated in the program or agreed to participate in it in the near future.

In implementing the FSAP, IMF and World Bank staff are guided by the observations of the Executive Boards of both institutions. During the 2003 review of the FSAP, the IMF’s Executive Board agreed that the FSAP had proven successful in providing a comprehensive and strategic framework to identify financial sector vulnerabilities; strengthening the analysis of domestic macroeconomic and financial stability issues; identifying development needs and priorities; and providing the authorities with appropriate policy recommendations.6 However, the review noted that the cost of the FSAP had increased due in part to the bunching of assessments of a number of systemically important countries and to the increase in the average number of international standards and codes that are assessed in detail. Consequently, the Board noted that while the FSAP remained the key tool for strengthening the monitoring of financial systems, resource constraints demanded that additional tools be employed to maintain the depth and quality of financial sector surveillance in between comprehensive assessments.7

The 2003 review also discussed additional modifications to certain features of the FSAP. It was understood that the number of comprehensive assessments undertaken in each year would be reduced to between 17 and 19, permitting more of a qualitative focus on the effectiveness of the assessments, as opposed to a quantitative focus on conducting a certain number of assessments.8 The need for greater selectivity in the scope of assessments was also discussed—the depth and intensity of the assessment of individual financial sector standards should be tailored to country circumstances and take into account the priorities of country authorities. In particular, in industrial countries, where the potential scope of the program is large, a two-stage approach might be appropriate in which a prioritized set of standards could be covered in the first stage, while the remaining standards could be assessed in the context of subsequent FSAP reassessments and updates. While there have been periodic modifications to certain features of the FSAP, the importance of the program and its corresponding benefits have been affirmed by participating countries.

As one of the IMF’s key surveillance instruments, the FSAP is designed to alert national authorities to likely vulnerabilities in their financial sectors—whether originating from inside the country or from outside sources—and to assist them in the design of measures that would address these vulnerabilities. The emphasis of this exercise is on prevention and mitigation rather than on crisis resolution. A key tool of the exercise involves stress tests. Stress tests aim to assess vulnerabilities arising from macro-financial linkages by assessing the impact of exceptional but plausible shocks to key macroeconomic variables on the soundness of the financial system. The findings supplement the FSAP analyses that use a number of other tools to analyze financial sector systemic risks and vulnerabilities. Stress tests also serve as a useful tool for the supervisory authorities and financial stability policymakers in the country, because they highlight risk measurement and management both at the individual financial institution level and at the systemic level.9

The FSAP exercise also ascertains the overall robustness of the financial sector’s infrastructure. Sectoral developments, risks, and vulnerabilities are analyzed using a range of financial soundness indicators (FSIs).10 FSIs are a new branch of economic statistics crossing several measurement disciplines. FSI data have, first, a prudential aspect that draws on the supervisory and financial accounting concepts developed to monitor the condition of individual financial institutions and, second, a macro aspect that looks at information on the sector as a whole drawing on economic statistical measures. Thus, they include both aggregated information on financial institutions and indicators that are representative of markets in which financial institutions operate. The FSIs typically encompass balance sheet and income information and indicators that are representative of markets in which financial institutions operate. Broadly, the FSIs would fall within the following categories: capital adequacy, asset quality (lending and borrowing institutions), profitability and competitiveness, liquidity indicators, and indicators of sensitivity to market risk.11

The IMF promotes two sets of FSIs—a core and an encouraged set—which are set out in Table 2. Indicators of the core set (banking sector indicators) are expected to be more easily available and relevant to most countries, even those with relatively less developed financial systems. Based on data availability and financial structure they can be combined with selected additional indicators of the encouraged set (indicators relating to nonbank financial institutions and markets, the corporate sector, real estate markets, and households) that might be of particular relevance in the country concerned, depending on its level of financial development, institutional structure, and regional circumstances. The IMF’s Statistics Department is involved in a compilation exercise attempting to collect core FSIs on a consistent basis for about 70 countries, as well as at least some of the encouraged set, as appropriate. It is expected that following the conclusion of the pilot phase, collection of FSIs will become a part of regular statistical reporting to the IMF.

Table 2.

Core and Encouraged FSIs

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Source: IMF, Compilation Guide on Financial Soundness Indicators (July 30, 2004), http://www.imf.org/external/np/sta/fsi/eng/2004/guide/chap1.pdf.

Prior to the availability of fully consistent FSIs, countries and FSAP missions, as well as other IMF missions, are monitoring FSIs based on country-specific definitions. While this can limit intercountry comparability of some of the data, it does provide a set of indicators to be continuously monitored, and adverse changes indicate the need to take action.12 Monitoring FSIs therefore helps to strengthen surveillance and monitoring of financial sectors, in particular once FSAP assessments have established a base line. They are intended to complement macroeconomic indicators, which also help to identify risks to financial stability, and may also be used to monitor the impact of policy action. Other structural underpinnings of financial stability—systemic liquidity arrangements; the institutional and legal framework for crisis management and loan recovery; and transparency, accountability, and governance structures—may also be examined to ensure a comprehensive assessment of both stability and developmental needs. In the FSAP context, the analysis of FSIs is becoming increasingly integrated with the stress-testing exercise. For example, previous work done on FSAPs has shown how FSIs can help the interpretation of stress tests by providing an indication of deterioration in financial conditions associated with a change in FSIs of a given size. At the same time, stress tests can provide a basis for interpreting, or benchmarking, future movements in FSIs.

As part of the process, the FSAP provides assessments of observance of various internationally accepted financial sector standards, set within the broader institutional and macroprudential context. The standards that have been assessed in the context of the FSAP—with country-specific prioritization of which standards were most relevant for assessment in each case—have been the Code of Good Practices on Transparency in Monetary and Financial Policies, the Basel Core Principles for Effective Banking Supervision, the Core Principles for Systemically Important Payment Systems, the International Organization of Securities Commissions Objectives and Principles of Securities Regulation, and the International Association of Insurance Supervisors Insurance Core Principles. Table 3 provides a comparison of the various standards used in assessments of some of the initial FSAP participants.

Table 3.

Standards and Codes Assessed in the FSAP

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Source: IMF, Financial Sector Assessment Program—A Review: Lessons from the Pilot and Issues Going Forward, November 27, 2001, http://www.imf.org/external/np/fsap/2001/review.htm#tab_1.

After a request has been initiated by a member country, the FSAP process begins with the selection of the FSAP team. Along with IMF and World Bank staff and contractual experts, the team may comprise experts from a range of cooperating central banks, supervisory agencies, standard-setting bodies, and other international institutions. Before the mission takes place, the team prepares and forwards a set of questionnaires to the country authorities; the topics covered form the basis for many of the discussions between the team members and country authorities. While on mission in the country, the team members meet with the staff of the central bank, the finance ministry, regulatory agencies, and financial institutions. Preliminary results are synthesized into the aide-mémoire, which is then provided to the country authorities prior to the team’s departure.

The aide-mémoire is reviewed by other selected IMF and World Bank staff back in headquarters, and comments resulting from this review, as well as that of the county authorities, are incorporated into a final version. The aide-mémoire is a confidential working document and should not be authorized for publication.13 However, the findings contained therein form the basis for separate summary reports prepared by IMF and World Bank staff for their respective institutions’ Boards of Directors. The Financial System Stability Assessment (FSSA) is presented to the IMF’s Board, while the Financial Sector Assessment (FSA) is reviewed by the World Bank’s Board. The FSSA focuses on the linkages between the macroeconomy and the soundness and operations of the financial sector, including regulatory and governance frameworks, and other stability and market integrity issues of relevance to IMF surveillance. In addition to presenting an overall stability assessment, the FSSA also contains summary assessments of relevant financial sector standards—these summaries are also issued as Reports on Observance of Standards and Codes (ROSCs) for the financial sector.14 Furthermore, the team provides the country authorities with two additional reports—a Detailed Assessment of the Observance of Standards and Codes, which contains assessments of the observance of selected financial sector standards, codes, and good practices; and Selected Financial Issues, which is a detailed and technical analysis that is the basis of the aide-mémoire and the FSSA. These reports are exclusively for the authorities of the countries and not communicated to the Executive Boards of the IMF and the World Bank.15

Lessons from the FSAP

The FSAP has been a successful program, with more than half of the membership having been assessed. In addition, the assessments have cut across the wide range of the membership, including most of the Group of Seven (G-7) countries as well as many developing and emerging market countries.16 The FSAP reports have provided some general indications of the issues facing the financial sectors in similarly positioned countries. For example, in many of the developing countries the systems are dominated by banks, and the recommendations have often placed an emphasis on developing nonbank financial institutions in these countries. In addition, the evidence often reveals significant balance sheet vulnerabilities to macroeconomic shocks in these countries along with significant shortcomings in legal and regulatory frameworks. In emerging market economies there are generally fewer instances in which significant balance sheet vulnerabilities present themselves; however, there are sometimes concerns regarding the enforcement of the regulatory framework as well as deficiencies in nonbank supervision and regulation. This contrasts to the situation revealed in developed countries where, generally, the financial systems are sound and well-supervised, and where more concern would be focused on challenges arising from consolidation, globalization, and financial innovation.

Countries are increasingly undertaking their own efforts to strengthen financial sector surveillance. In a growing number of countries—often spurred by an FSAP report—central banks conduct their own financial stability analyses and publish financial stability reports.17 Notwithstanding such reports, FSAP reports often afford important complementary elements. Stability reports typically rely on indicators that are equivalent to FSIs; however, many do not assess compliance with international standards and codes. The ability of the IMF and World Bank to provide independent assessments is an important advantage to the FSAP. This advantage extends to other aspects of the FSAP as well. For instance, system-focused stress tests are a standard component of the FSAP, while financial stability reports carried out by central banks make limited use of this tool. The FSAP assessments also could be seen as having an advantage in covering issues that involve several institutions and agencies, such as systemic liquidity or a framework for crisis management.

As time goes on, the FSAP will continue to provide key lessons on the nature of financial sector issues, while playing an important role in informing country authorities of developments in their financial sectors and encouraging other countries to undertake their own financial stability reporting efforts.

Article IV Consultations

Periodic, mostly annual, Article IV country consultations have traditionally been the cornerstone of IMF surveillance, and, while new tools such as the FSAP have been introduced to allow for a comprehensive assessment of a member’s financial sector, the Article IV consultations remain a key aspect of the IMF’s overall surveillance efforts, providing systematic and ongoing financial sector surveillance covering the whole membership. Generally, IMF surveillance reflects a number of distinct purposes—including, briefly, provision of policy advice; assessment of coordination among key macroeconomic policies; information gathering and dissemination; review of technical assistance needs; and identification of vulnerabilities. The Article IV consultations address many aspects of these purposes, but to better grasp the specific, and evolving, nature of the Article IV consultation, an initial review of the IMF Articles of Agreement is instructive.

Article IV of the IMF’s Articles of Agreement addresses obligations regarding exchange arrangements. In outlining the general obligations of the members, Section 1 states, “Recognizing that … a principal objective [of the international monetary system] is the continuing development of the orderly underlying conditions that are necessary for financial and economic stability, each member undertakes to collaborate with the Fund and other members to assure orderly exchange arrangements and to promote a stable system of exchange rates.” Section 3(a) provides that the IMF “shall oversee the international monetary system in order to ensure its effective operation, and shall oversee the compliance of each member with its obligations under Section 1 of this Article.” In order to fulfill this function, Section 3(b) provides that the IMF “shall exercise firm surveillance over the exchange rate policies of members with respect to those policies.”

In a decision of the IMF Executive Board in 1977, the IMF set out the general principles for the conduct of surveillance.18 This decision establishes that surveillance over members’ exchange rate policies requires a comprehensive assessment of the members’ general economic situation and economic policy strategy. The surveillance procedures provide that these assessments shall be conducted against the ultimate objectives of financial stability, sustained sound economic growth, and reasonable levels of employment. The procedures also recognize the importance of adapting surveillance to “the needs of international adjustment as they develop.”

In the context of financial system stability, the surveillance efforts under Article IV were in the past focused chiefly on members’ exchange rate policies; however, the IMF has recognized that surveillance should no longer be limited to fiscal, monetary, and exchange rate policies, but, drawing on the general oversight responsibilities outlined in Section 3(a), should include other critical economic issues. In monitoring financial systems, Article IV consultation missions now focus on (1) conditions and developments in the banking and financial system and markets that may disrupt macro-economic conditions and policies; (2) macroeconomic conditions and developments that may impinge upon the financial system; and (3) aspects of the institutional, legislative, supervisory, and prudential regulation frameworks that could entail risks for the soundness of the financial system. Other aspects often covered during the missions include the activities of the offshore financial centers (OFCs) and anti–money laundering and combating the financing of terrorism efforts. It should be noted that the primary responsibility for financial sector surveillance in the context of Article IV consultations lies with the IMF area departments. However, area department staff will often require special support from financial sector experts in other IMF departments to ensure adequate coverage of financial sector issues in Article IV consultations.

For surveillance efforts to be effective, individual Article IV consultations need to retain a clear focus on the key issues in each country. This requires selectivity according to country-specific circum-stances.19 Article IV reports should clearly indicate the focus of the discussions. Selectivity should be guided by the following principles: (1) within the expanded scope of surveillance, the selection of topics to be covered in surveillance discussions with a member should be based on macroeconomic relevance; and (2) within these selected topics, the issues at the apex of the Fund’s hierarchy of concerns should be those related to external sustainability, vulnerability to balance of payments or currency crises, sustainable growth with price stability, and, for systemically important countries, conditions and policies affecting the global or regional economic outlook.

In principle Article IV consultations take place on an annual basis. Article IV consultations involve multiple steps and outputs including compilation of economic and financial data, production of analytical studies, dialogue with country authorities, communications with nonofficials, and written reports. As with the FSAP, IMF staff visit the member country to gather information and hold discussions with government and central bank officials and, often, private investors, labor representatives, members of parliament, and civil society organizations. Upon return, the mission submits a report to the IMF’s Executive Board for discussion. The Board’s views are subsequently summarized and transmitted to the country’s authorities.

An Article IV staff report would typically include a special section discussing financial sector issues, covering key vulnerabilities and structural weaknesses as well as the policies required to address them. The section would include a table on selected FSIs and other relevant indicators, as available, and a description of the key institutional features of the financial system, as relevant. Further, the section would include a discussion of (1) the relative importance of the main segments of the financial sector and domestic and international linkages among sectors; (2) the financial condition of the most important segments of the financial sector; (3) the key risks and structural concerns as a result of meetings with the supervisory authorities; and (4) key developmental issues relating to the strengthening of institutions, governance, and legal frameworks. Finally, the discussion would highlight areas that, because of lack of information or resource constraints, have not yet been adequately covered, and require further examination.

In countries for which a recent FSAP assessment, an FSAP reassessment, or FSAP update is available, a sufficient coverage of the financial sector will have been provided as a result of the FSAP. In such cases, financial sector surveillance in the Article IV consultation focuses on the FSSA report. In particular, FSAP findings are discussed with the authorities during the Article IV mission, the FSSA—a report summarizing the assessment—accompanies the Article IV staff report, and the main findings and policy recommendations contained in the FSSA are presented in the Article IV staff report. The FSSA also contains the summary ROSCs assessed in the FSAP. In cases where a previous FSAP assessment or update identified significant vulnerabilities or important structural weaknesses, the coverage of financial sector surveillance in the Article IV consultation should include an update of progress in implementing the recommendations of the FSSA. This update should focus on those recommendations that were assigned the highest priority in the FSSA, including those followed up with technical assistance.

The 2004 review of surveillance noted an improvement in the coverage of financial sector issues in recent years, but it also acknowledged that a further strengthening is required to elevate this coverage to the level established for other main areas.20 Coverage also varies substantially across countries, being generally quite broad for emerging market countries and providing substantial insights into macro-financial linkages, whereas it is more selective for industrial countries and rather uneven for developing countries.21 Such variance is partially due to the intensity of concerns about financial sector weaknesses. It also reflects the allocation of financial sector expertise—that is, the quality of coverage tends to be more robust in consultations with substantial participation from the staff of the Monetary and Financial Systems Department and the International Capital Markets Department. In the future, efforts will be made to continue improving the treatment of financial sector issues in surveillance. As indicated by the IMF Executive Board at the conclusion of the last FSAP review, these efforts cannot be expected to rely solely on full FSAP assessments, given resource constraints and the voluntary nature of this program, and other options will need to be considered.22

Multilateral Surveillance in the Context of the Global Financial Stability Report and the World Economic Outlook

In practice, surveillance is conducted through various vehicles within the IMF. In IMF terminology, it is customary to use the expressions bilateral and multilateral to characterize the two broad categories of surveillance activities. Bilateral surveillance, as discussed earlier, is typically conducted through the Article IV consultation process undertaken by all member countries, but it may also take place through program reviews associated with the IMF’s financial assistance, the FSAP, technical assistance, or other formal and informal processes directed at individual countries. Multilateral surveillance, perhaps more difficult to define, may be thought of as “global surveillance” or surveillance of global linkages.23 In practice, however, not all countries are equally relevant for this purpose. In the past, multilateral surveillance effectively meant surveillance of large industrial countries because, given their weight in the world economy, most of the global economic developments were driven by their policies. As other countries begin to influence the global economy, and with systemic financial vulnerability issues having assumed greater importance, the scope of multilateral surveillance has widened.24 As part of the institution’s multilateral surveillance, IMF missions visit member countries’ main financial centers, both in industrialized and emerging economies, to discuss developments in national and international financial markets with commercial and investment banks, securities firms, stock and futures exchanges, regulatory and monetary authorities, and credit rating agencies.

The main products of the IMF’s multilateral surveillance efforts, the Global Financial Stability Report and the World Economic Outlook, focus the international community’s attention on key issues in financial sectors.25 The Global Financial Stability Report replaced two earlier IMF publications: the annual International Capital Markets Report (published since 1980) and the quarterly Emerging Market Financing (published since 2000). It was created to provide a more frequent assessment of global financial markets and to assess global financial market developments with the view to identifying potential weaknesses. The report focuses on current conditions in global financial markets, highlighting issues of financial imbalances, and of a structural nature, that could pose a risk to financial market stability and sustained market access by emerging market borrowers. By drawing attention to these imbalances, the report seeks to play a role in preventing crises, and thereby contribute to global financial stability. As a biannual report, its focus is on relevant contemporary issues, rather than a comprehensive survey of all potential risks, and on elaborating the financial ramifications of economic imbalances highlighted by the World Economic Outlook.

The World Economic Outlook presents the IMF staff’s analysis and projections of economic developments at the global level. Throughout the 1970s, preparation and discussion of the World Economic Outlook was primarily an internal exercise at the IMF, remaining so until 1980, when the decision was made to publish the report.26 Throughout the 1980s the World Economic Outlook grew to become more than a forecasting exercise, focusing increasingly on elaborating policy options available to member governments. The analysis and projections contained in the publication have now become integral elements of the IMF’s surveillance of economic developments and policies in its member countries, as well as of developments in international financial markets. The analysis of countries, often broken into major country groups classified by region or stage of development, focuses on major economic policy issues as well as on the analysis of economic developments and prospects. It is usually prepared twice a year, with its release coinciding with the meetings of the International Monetary and Financial Committee, and is the IMF’s principal vehicle for multilateral surveillance. It is the foundation for integrating the analysis of developments in individual countries into a larger multilateral context.

There are a number of challenges currently facing the IMF’s multilateral surveillance initiatives. A number of reviews have suggested that the linkages between bilateral and multilateral surveillance efforts could be further integrated and thereby strengthened.27 A recent report noted that progress has been made in integrating the quantitative aspects of bilateral and multilateral analysis; more specifically, country databases feed into World Economic Outlook projections while country desks make use of World Economic Outlook forecasts.28 Nevertheless, the latest biennial review noted that there was still “substantial room to strengthen the analysis of regional and global spillovers” and staff reports for Article IV consultations contained very little discussion of the impact of global economic conditions and risks. In addition, there are times when IMF advice appears to have little influence on the policy decisions of major countries. Consequently, efforts may need to be increased to improve the level of influence of the policy discussion contained in the multilateral surveillance products, or these products may come to be viewed as better suited to providing exclusively objective policy analysis. Another challenge concerns the scope of multilateral surveillance, and whether the IMF should continue to focus its efforts on its traditional areas of expertise, or expand the scope to include other issues facing the world economy. This issue is in general repeatedly addressed in the periodic surveillance reviews, and at present, the IMF’s Executive Board has endorsed a measured approach in this area, recognizing the value of addressing issues related to the investment climate and institutional reforms in a country, while at the same time calling for greater selectivity in coverage of the nontraditional areas.29

Conclusion

Many forces are constantly at work in the international financial system causing uncertainties and instability. The IMF is among the key international organizations striving to lessen the uncertainties and smooth the instability. Among the most important contributions to these efforts are the various bilateral and multilateral surveillance initiatives that the IMF staff execute on a regular basis.

The nature of global financial relations and the attendant risks continue evolving. Greater international financial integration and, in particular, the rapid increases in global capital flows over the 1990s have created new risks for countries, in particular those with vulnerable financial sectors. The IMF undertakes periodic reviews of the effectiveness of its surveillance activities, and—recognizing the newly emerging financial sector risks—has responded by augmenting the Article IV consultation—the more traditional form of surveillance—with the FSAP and other efforts more specifically focused on uncovering financial sector risks. The creation of these new tools is a good indication that the IMF will—through its continuous efforts to detect imbalances and formulate recommendations to correct the imbalances—continue its efforts to reduce the likelihood of future financial crises, lessening the hardships faced by all those who rely on smoothly functioning financial systems.

Notes

1

Surveillance is the process of regular dialogue and policy advice that the IMF is mandated to provide to its members, covering macroeconomic and financial developments and policies in their countries. The IMF has been working to improve the surveillance process by deepening its coverage of financial system issues and, in particular, by promoting the Financial Sector Assessment Program (FSAP). These efforts are intended to better identify financial system strengths and weaknesses, and thereby lessen the frequency and diminish the intensity of potential financial system problems.

2

“Tunnel vision” refers to the danger that the analysis underlying the surveillance exercise may miss key vulnerabilities, be unduly influenced by a country’s good past performance, or, in countries with IMF arrangements, by the agreed program framework. See, e.g., IMF, “Biennial Review of the Implementation of the Fund’s Surveillance and of the 1977 Surveillance Decision: Surveillance in a Program Environment,” March 15, 2002, at 17, http://www.imf.org/external/np/pdr/surv/2002/031502.pdf, discussing opportunities for the Executive Board to provide guidance regarding surveillance in program countries that would highlight the need for a “fresh and independent look.”

3

IMF, “Enhancing the Effectiveness of Surveillance: Operational Responses, the Agenda Ahead, and Next Steps,” March 14, 2003, http://www.imf.org/external/np/pdr/surv/2003/031403.htm.

4

IMF, “Enhancing the Effectiveness of Surveillance: Operational Responses, the Agenda Ahead, and Next Steps,” Public Information Notice No. 03/50, April 10, 2003, http://www.imf.org/external/np/sec/pn/2003/pn0350.htm.

5

In the context of the present discussion, the term “country” includes territorial entities for which statistical data are maintained on a separate and independent basis, even though they are not states as understood by international law and practice. For example, the Eastern Caribbean Currency Union or ECCU, which is a currency union of six member countries and two territories, is counted as one FSAP assessment.

6

IMF, “The Acting Chair’s Summing Up—Financial Sector Assessment Program—Review, Lessons, and Issues Going Forward,” March 18, 2003, Selected Decisions and Selected Documents of the IMF, Twenty-Eighth Issue (Washington: IMF, 2003) [hereinafter Selected Decisions], at 179.

7

The Board agreed that the additional instruments would include reassessments, focused updates, work undertaken during Article IV consultation missions, and ongoing monitoring of financial sector developments and policy issues from headquarters. Id. at 181.

8

In the Executive Board’s 2005 review of the FSAP, it was agreed that the average frequency of FSAP updates would be roughly five years. The update would comprise, at minimum, an assessment of financial sector developments and progress in implementing earlier FSAP recommendations. IMF, “IMF Executive Board Reviews Experience with the Financial Sector Assessment Program,” Public Information Notice 05/47, April 6, 2005, at 3.

9

IMF and World Bank, Analytical Tools of the FSAP (Washington: IMF, 2003), http://www.imf.org/external/np/fsap/2003/022403a.pdf.

10

The IMF’s Executive Board originally endorsed a list of both core and encouraged macroprudential indicators (later renamed FSIs) in June 2001. See IMF, “Concluding Remarks by the Acting Chairman of the IMF Executive Board—Macroprudential Indicators,” June 25, 2001, http://www.imf.org/external/np/mae/fsi/2001/eng/062501.htm. In 2003, the IMF’s Executive Board reviewed progress on the FSIs and welcomed the work by country and international agency experts on the FSIs. IMF, “IMF Executive Board Discusses Financial Soundness Indicators,” Public Information Notice 03/71, June 13, 2003, http://www.imf.org/external/np/sec/pn/2003/pn0371.htm. See IMF, “Compilation Guide on Financial Soundness Indicators,” July 30, 2004, http://www.imf.org/external/np/sta/fsi/eng/2004/guide/index.htm.

11

See V. Sundararajan et al., Financial Soundness Indicators: Analytical Aspects and Country Practices, IMF Occasional Paper No. 212 (Washington: IMF, 2002), explaining these FSI categories in the context of their use in macroprudential analysis. See generally, G. Slack, Availability of Financial Soundness Indicators, IMF Working Paper 03/58 (Washington: IMF, 2003).

12

Intercountry comparability of FSIs is sometimes limited by country-specific definitions. An example is the definition of nonperforming loans where some countries count a credit as nonperforming after three months of nonpayment of principal and interest, whereas others would use a six-month threshold. Such differences do not matter when examining changes for one country over time.

13

IMF, “Summing Up by the Acting Chairman—Financial Sector Assessment Program—A Review—Lessons from the Pilot and Issues Going Forward,” Selected Decisions, at 184. The procedures designed to ensure the confidentiality of sensitive information obtained through the FSAP are set out in the Confidentiality Protocol, a document that was jointly agreed to by the IMF and World Bank in 2000. See IMF, Selected Decisions, at 185–92.

14

Like the FSAP report, the ROSC is prepared in response to a request from a member country; however, unlike the FSAP report, the ROSC can be prepared separately by either IMF or World Bank staff and need not be con-fined to financial sector issues. For an informative discussion of the relationship between FSAP reports and ROSCs, see F. Gianviti, “Legal Aspects of the Financial Sector Assessment Program,” in Current Developments in Monetary and Financial Law, Vol. 3 (Washington: IMF, 2005), at 222–25.

15

These reports can, however, be published if the country seeks the IMF Managing Director’s consent to do so. In practice, most countries choose to use these documents for internal purposes only and not to publish them.

16

Given the voluntary nature of the FSAP, some systemically important member countries have, however, not yet volunteered.

17

The first financial stability reports were published in the mid-1990s in the United Kingdom and several Nordic countries, but by 2004 the number of countries publishing such reports grew to 25. See IMF, “Financial Sector Assessment Program—Background Paper,” February 22, 2005, at 7, http://www.imf.org/external/np/fsap/2005/022205a.pdf.

18

IMF, “Surveillance over Exchange Rate Policies,” Decision No. 5392-(77/63), as amended, Selected Decisions, at 10.

19

See IMF, “Biennial Review of the Implementation of the Fund’s Surveillance and of the 1977 Surveillance Decision—Overview” (July 2004), at 5, http://www.imf.org/external/np/pdr/surv/2004/082404.pdf#modalities.

20

IMF, “Biennial Review of the Implementation of the Fund’s Surveillance and of the 1977 Surveillance Decision—Overview” (July 2004), http://www.imf.org/external/np/pdr/surv/2004/082404.pdf#modalities (IMF staff review of surveillance), and IMF, “The Chairman’s Summing Up—Biennial Review of the Implementation of the Fund’s Surveillance and of the 1977 Surveillance Decision,” July 23, 2004, Selected Decisions and Selected Documents of the IMF, Twenty-Ninth Issue (Washington: IMF, 2005) [hereinafter Selected Decisions, 29th Issue], at 52.

21

IMF, “Biennial Review of the Implementation of the Fund’s Surveillance and of the 1977 Surveillance Decision—Overview” (July 2004), http://www.imf.org/external/np/pdr/surv/2004/082404.pdf#modalities.

22

IMF, “IMF Reviews Experience with the Financial Sector Assessment Program and Reaches Conclusions on Issues Going Forward,” Public Information Notice No. 03/46, April 4, 2003, http://www.imf.org/external/np/sec/pn/2003/pn0346.htm. Other options include, for example, focused FSAP updates, participation by staff from the Monetary and Financial Systems and International Capital Markets Departments in Article IV missions (or separate missions by these staff), monitoring of financial sector developments from IMF headquarters, and training of area department staff by staff in the Monetary and Financial Systems Department.

23

Independent Evaluation Office, “The IMF’s Multilateral Surveillance: Draft Issues Paper for an Evaluation by the Independent Evaluation Office” (June 2005), http://www.imf.org/external/np/ieo/2005/ms/eng/061405.pdf.

24

In some cases, the term “multilateral surveillance” is used to emphasize the peer review aspect of surveillance designed to facilitate policy coordination. This was the sense in which the term was used, for example, in the context of the G-7 framework in the 1980s. Id. at 5. Regional surveillance is also an area in which the IMF has become much more effective in recent years, evidenced by surveillance activities relating to monetary unions and the production of various regional economic outlooks.

25

Other products of multilateral surveillance include internal World Economic and Monetary Developments exercises, confidential staff vulnerability exercises, and the IMF’s inputs into G-7 and G-20, Working Party 3 of the Organization For Economic Cooperation and Development, and the Financial Stability Forum.

26

The first published World Economic Outlook appeared in May 1980, and, by 1984, it was expanded to a semiannual publication schedule. James M. Boughton, Silent Revolution: The IMF 1979–1989 (Washington: IMF, 2001), at 227–30.

27

In the 2002 biennial review of surveillance, the Executive Board stated that “… there remains scope for better integration of multilateral surveillance with bilateral surveillance.” Selected Decisions, at 30. Similarly, in the 2004 review, the Board took the position that “… Fund surveillance is an ideal vehicle to analyze global and regional spillovers” and that there was “… substantial room to improve treatment of these issues through greater integration of bilateral, regional, and multilateral surveillance.” IMF, “The Chairman’s Summing Up—Biennial Review of the Implementation of the Fund’s Surveillance and of the 1977 Surveillance Decision,” July 23, 2004, Selected Decisions, 29th Issue, at 51. An independent report in 1999 described the transfer of knowledge across departments within the IMF, as viewed by internal observers, as insufficient. The report found that “in the surveillance context, this manifests itself in an inadequate cross-fertilization between multilateral and bilateral surveillance, and in insufficient use of what is learned in different countries.” External Evaluation of IMF Surveillance, Report by a Group of Experts (Washington: IMF, 1999), at 13.

28

Independent Evaluation Office, supra note 23, at 8.

29

IMF, “The Chairman’s Summing Up—Biennial Review of the Implementation of the Fund’s Surveillance and of the 1977 Surveillance Decision,” July 23, 2004, Selected Decisions, 29th Issue, at 50 and 53.

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Cover Current Developments in Monetary and Financial Law, Vol. 4
Current Developments in Monetary and Financial Law, Vol. 4
Author:
International Monetary Fund
ISBN:
9781589065079
Publication Date:
06 Nov 2008
Publisher:
International Monetary Fund
DOI:
https://doi.org/10.5089/9781589065079.072
Pages:
864