Structural adjustment
Bailouts or bail-ins? Responding to financial crises in emerging economies
What are the best policies for responding to potential financial crises?
Authors:
N. Roubini; B. Setser
Publisher:
Institute for International Economics, USA, 2004
Following the East Asian crisis there have been many calls for reforming international financial structure. However, this book argues that these sweeping institutional reforms are not necessary. Rather there is a need to use existing institutions more effectively. The book focuses on practical ideas for improving the official sector’s capacity to respond to emerging-market financial crises. Throughout it emphasises that:
- there are enormous differences between different crises
- different cases need to be addressed within a framework that provides consistency and predictability to borrowing countries as well as to those who invest in emerging-market debt.
When an emerging-market country is threatened with a financial crisis it faces the prospect of being forced to devalue it’s currency and default either on its government debt or on loans to the country’s banks. There are two main options that the official sector can take to respond:
- an IMF loan (a ‘bail out’)
- debt restructuring (a ‘bail in’).
The point of departure for the book is that since neither option is attractive or in itself a solution to the financial crisis, there is currently inconsistency and confusion regarding which of these policies, in what combination should be applied. The book aims to provide an improved framework for taking these policy decisions.
Individual chapters include:
- the new nature of emerging-market crises: the reasons why many emerging markets have experienced financial crises in the last decade
- analytical literature on crisis resolution: academic models of the choices the IMF and other official creditors face once a crisis strikes
- experience with bailouts and bail-ins: lessons that can be drawn from the actual experiences in the last decade with bail-outs and bail-ins
- official policy toward crisis resolution: has the official sector been able to send signals that were consistent with the policy decisions it took in subsequent crises
- responding to liquidity shortages: examines in detail the options for providing emergency financing for countries facing shortages of foreign exchange, as well as the challenges that arise when the private sector (rather than government) is the initial source of the country’s financial difficulties
- seniority of sovereign debts: can sovereign debt restructuring be made less disorderly and costly if they were to be ranked according to a precise system of priorities?
- legal reform: can legal reform reduce the economic disruption that accompanies sovereign debt restructuring without upsetting the balance between the rights of creditors and debtors needed to make the sovereign debt market work?
- concluding critique of the current policy framework and recommendations for reform, including:
- be willing to distinguish between countries, and make hard judgements early on
- link financing to appropriate policy adjustments
- match financial response to the crisis
- large-scale IMF lending can usefully complement a coercive debt restructuring
- preserve IMF’s de facto seniority
- don’t let cross-border bank credits off the hook too easily
- be willing to finance a domestic lender of last resort that helps backstop the local banking system
- recognise more explicitly the IMF’s role in a wide range of crises
- lay out a more realistic IMF access policy
- don’t rely on the IMF to save countries that are too strategically important to fail
