Current Legal Issues Affecting Central Banks, Volume III.
Chapter

1D. Arrears and Burden Sharing at the IMF

Author(s):
Robert Effros
Published Date:
August 1995
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Author(s)
REINHARD H. MUNZBERG

This paper elaborates some aspects of the International Monetary Fund’s response to arrears. The emergence of arrears in the mid-1980s has had an impact on the Fund’s decisions on financial issues, in particular on the system of charges and remuneration.

IMF’s System of Charges and Remuneration

In 1981, the International Monetary Fund adopted a set of rules pursuant to which it determines at the beginning of each year a rate of charge on the use of its general resources. That rate of charge is intended to cover the cost of operating the Fund. However, the charge was also considered necessary to strengthen the Fund’s reserves. Therefore, in addition to taking into account the Fund’s income and expense, the rate of charge is determined so as to generate each year a so-called target amount of net income. That net income target was originally defined as 3 percent of the Fund’s reserves at the beginning of the financial year and was later increased to 5 percent. The equivalent of the target amount would be placed to reserves. This system of setting the rate of charge is still in effect today. However, the Fund has linked it more closely to developments in the SDR interest rate, which determines the Fund’s main operating cost—the remuneration payments to creditors. The rate of charge is now set as a proportion of the SDR interest rate, but the proportion takes into account the elements described above.

In the mid-1980s, arrears to the Fund increased progressively with respect to charges as well as with respect to repurchases. The Fund reacted in several steps to this emergence of arrears. In addition to increasing the net income target to 5 percent, the Fund, in 1985, adopted a system of special charges that would recover the cost caused by overdue repurchases as well as by overdue charges. These special charges had two different legal bases.

The legal basis for special charges on overdue repurchases to the Fund is Article V, Section 8(c) and (d). The Fund may levy increased rates of charge on overdue repurchases, which, in contrast to all other charges, need not be uniform. A second legal basis was found in the concept of implied powers. It was considered essential for the operation of the Fund to recover costs arising from overdue charges through a special charge.

This system of special charges was maintained for several years. The experience, however, was mixed. In 1991, during discussions of the quota increase, the Third Amendment, and the Fund’s cooperative strategy in the area of arrears, it was decided to modify the system of special charges and to suspend them in some cases. Countries in protracted arrears that were resuming cooperation with the Fund in the areas of policies and payments (particularly countries that were embarking on a meaningful and sustainable adjustment process in the context of a rights accumulation program and that promised to stay current with the Fund in the future) were given the benefit of the suspension of special charges as long as they stayed current with the Fund.

Thereafter, the Fund decided to modify further the system of special charges. The original objective to recover costs as long as repurchases and charges were overdue was changed. While maintaining a system of special charges, the Executive Board limited its application to the early period after an obligation becomes overdue. The system no longer covers protracted arrears; special charges are imposed on overdue obligations during the first six months. The main emphasis is to prevent arrears from becoming protracted and to discourage the incurrence of arrears.

System of Burden Sharing

The next measure to protect the Fund’s financial position against arrears was taken in 1986. At that time the focus of the discussion had shifted to the allocation of the cost of overdue obligations.

On the accounting side, the Fund had decided in 1985, following accepted accounting standards, to adopt a system of “deferred income.” When an obligation is overdue for more than six months, the Fund no longer recognizes income as accrued but recognizes income when over-due obligations are actually discharged. This measure affected the system for determining the rate of charge and the generation of net income. The deferral of income inevitably leads to a lower income; therefore, the corresponding amount is to be recovered from other members than those in arrears. Consequently, under the system in effect at that time, the new accounting practice led to an increase in the rate of charge. Against this background, the Fund considered means to alleviate the burden of debtors and to provide for a broader sharing of cost. The discussion culminated in the adoption of a system known as “burden sharing.”

Before arriving at a decision, the Fund contemplated a number of options with respect to recovery of cost and its sharing. These options included charging an administrative fee on all members based on quotas. However, that idea was abandoned. The Fund has a self-contained system of generating income. It has a system of charges and remuneration; it does not rely on contributions, whether voluntary or mandatory budget contributions. Therefore, the Fund is free to take decisions on how to cover costs. Moreover, to add administrative fees to the Fund’s financial system would have required an amendment to the Articles, and the Executive Board preferred not to embark on such a discussion at that time.

The system ultimately adopted is based on the Fund’s power to determine the rate of charge and to determine the rate of remuneration. It is within the Fund’s power to determine the exact level of the rate of charge and the exact level of the rate of remuneration within the limits prescribed by the Articles. Therefore, it was decided to make adjustments to the rate of charge and the rate of remuneration so that these adjustments borne by users of Fund resources and creditors of the Fund would offset the cost generated by overdues—the cost equivalent to the deferred income. Adjustments would be made on a quarterly basis in an amount corresponding to actual deferred income, and these adjustments would be shared, in principle, on an equal basis by both the rate of charge and the rate of remuneration. Second, the burden sharing system envisages that adjustments would be temporary and refundable as soon as, and when, the charges that gave rise to an adjustment are settled. Therefore, a contingent liability was established to be discharged from income of the year when charges are settled.

This system was originally adopted for two years and was renewed on an annual basis. However, there has been increasing scrutiny of the system. The Executive Board has discussed and intends to continue discussing whether other systems could be established that would provide for a wider sharing of the burden. As explained, the feasibility of charging a fee was explored and abandoned. Other proposals were made in the context of the discussion of quota increases under the Ninth General Review of Quotas. For instance, it was proposed that members make contributions under an agreed system but on a voluntary basis. These additional payments would assist the Fund in carrying the burden of arrears. That proposal was not pursued further at the time, but it constituted part of the ongoing discussion of how to cover the cost of the Fund.

Special Contingent Account

The next issue in the sequence of events addressed by the Fund, originally in 1987–88, was the appropriate protection against the consequences of overdue repurchases. Under the Fund’s Articles, a general protection is provided from the Fund’s reserves. A provision on reserves—special and general reserves—is included in the Articles (Article XII, Section 6). To date, the Fund has accumulated a considerable amount of reserves.

However, it was considered appropriate to strengthen further the protection against any losses that might occur. It was explored whether the Fund should establish provisions against probable losses, and more specifically whether provisioning would be a relevant concept for the Fund. Under the Fund’s financial system, assistance from the Fund is provided in exchange for the currency of the member, and the member has to maintain the value of the holdings of its currency. Consequently, the Fund could not have a loss in terms of value of the holdings of a member’s currency. However, if a member withdraws from the Fund, maintenance of value ceases to apply. Therefore, after withdrawal from membership, a loss could occur if the member fails to settle its accounts with the Fund or fails to compensate the Fund for any losses that occurred in a settlement.

The Executive Board decided to establish a system of protection against losses that could occur after withdrawal through the generation of additional precautionary balances to be placed in a “special contingent account.” That special contingent account was adopted on the same legal basis as the system established for offsetting deferred income; that is, the Fund decided to make further adjustments to its rate of charge and to its rate of remuneration in order to generate each year an amount to be added to the special contingent account. First, these resources would be held in a special contingent account and become part of the Fund’s liquidity; second, they would protect against any losses that might occur. This protection would be in addition to the protection provided by the Fund’s reserves. However, the mechanism provided for equitable sharing of the amount to be generated and for refundability. Except for any amounts against which losses have been charged, contributions will be returned to contributors when there are no overdues or at such other earlier time as the Fund could decide (for example, when the Fund determines that in light of decreasing overdues the protection is no longer needed).

Second Special Contingent Account

Finally, during discussions of the quota increases under the Ninth General Review of Quotas, the cooperative strategy, and the Third Amendment, the Fund created a second special contingent account.

The Fund has a policy not to give further access to its resources to members in arrears. Nevertheless, after clearance of arrears, the member could get access to the Fund’s resources. However, for members that had accumulated a considerable amount of arrears, that had been in arrears for some time, and that had not cooperated with the Fund regarding adjustment policies, the Fund considered it essential that these members establish a record over a certain period during which the Fund would monitor performance, so that the Fund could be more confident that the member would continue to perform successfully under a new adjustment program. The Fund thought to assist such members through so-called “rights accumulation programs.”

Since a member cannot have access to resources while it is in arrears, a “rights accumulation program” does not contain any commitment of resources. However, a program would be negotiated with the member that covers a certain period of time (normally up to three years) and that contains performance criteria and reviews, and the member would accumulate “rights” subject to performance as monitored by the Fund. At the successful completion of the program, the Fund would provide resources to the member under a successor arrangement in an amount not exceeding the accumulated rights and only if all the other conditions for the new program were met.

In the context of the adoption of this “rights approach,” the Fund decided to protect the resources that would be provided under the successor arrangement (the resources provided to a member after it had completed a rights accumulation program) through adjustments to rate of charge and rate of remuneration and to place those amounts to a second special contingent account. Contrary to the first special contingent account, the resources for the second special contingent account are intended to be generated by debtors and creditors in a one-to-three proportion. These resources are to be returned to contributors when all repurchases of purchases made by members for the encashment of rights have been made or at such earlier time as the Fund may decide.

Conclusion

The foregoing is a brief summary of the measures adopted by the Fund with the objective of strengthening its financial position in light of arrears. The Executive Board continues discussions on the simplification of the system, and in particular on the equitable sharing of cost between the different groups of the membership.

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