Lender of last resort: The IMF as International Lender of Last Resort

Lender of last resort

Lender of last resort: The Financial System Safety Net

Lender of last resort: Two Views of the LOLR

Lender of last resort: The EMU System

The International Monetary Fund’s (IMF’s) role in helpingMexico during the Tequila crisis in 1995 has been widely blamed for contributing to the Asian crisis in 1997 by causing expectations among lenders that loans to sovereign countries are safe. The IMF does not protect banks directly but through its assistance to countries like Mexico in balance of payments crises or when the threat of crisis is substantial, itmayprovide indirect protection for banks that have lent to the government in a crisis country.

The proper role of the IMF in sovereign crises has been the subject of debate after the Mexican and Asian crises. Prominent economists like Meltzer (1998) have suggested that the IMF should limit its role in crises to serve as a LOLR in the classical sense. In other words, the IMF should provide loans to bridge a crisis only in the case of pure liquidity crisis. In such a crisis a country’s fundamental ability to repay loans is not impaired. Instead, the crisis could arise because a country has run out of foreign exchange reserves, and liquidity is not forthcoming in international financial markets as a result of a lack of information about a country’s prospects. In this situation, based on its superior access to information about countries’ prospects, the IMF could step in.

Focusing the IMF’s role in country crises as an LOLR when there are liquidity crises could require financial resources beyond the capability of the IMF. Many observers argue, however, that the IMF’s involvement, even on a small scale, will increase the willingness of private lenders to extend loans to countries in crisis, since the IMF is considered particularly well informed about economic conditions in member countries.