IMF Scraps Loophole Allowing Bigger Loans to Stop Contagion

  • Fund scraps exemption created in 2010 for loan to Greece
  • Republicans sought change as part of IMF governance reforms

The International Monetary Fund scrapped an exception to its lending rules that allowed bigger-than-usual loans when a country’s default threatened severe financial harm across borders, a loophole created to fund Greece in 2010 amid the euro-area debt crisis.

The IMF’s executive board voted Wednesday to drop the so-called systemic exemption, fund spokesman Gerry Rice said in an e-mailed statement. The goal of the change and other reforms that the IMF will detail in coming days is to “better calibrate IMF lending decisions to members’ debt vulnerabilities, while avoiding unnecessary costs for the members, their creditors, and the overall system,” he said.

To get a loan above the IMF’s lending limit, countries must prove that their debt is highly probable to be sustainable over the medium term. In 2010, the fund’s executive board allowed that condition to be bypassed when there’s a high risk the country’s default would set off global financial spillovers.

The change in 2010 enabled the IMF to offer Greece a loan of 30 billion euros over three years, the largest in history relative to a country’s shares in the institution. At the time, IMF staff feared that spillovers from Greece could threaten other euro-area countries with weak finances and banks holding Greek debt.

‘Too Risky’

“The systemic clause was probably too risky,” said Andrea Montanino, a former IMF executive director who heads the Atlantic Council’s global economics program in Washington. “You don’t have any insurance.”

Now that the exemption has been removed, the IMF will probably be more aggressive in pushing countries with unsustainable borrowing loads to restructure their debt, he said.

The Greek loan amount was five times the amount allowed under conventional limits, which are tied to the size of a nation’s shares in the fund. The deal allowed Greece to stave off a debt restructuring, though it eventually restructured debt held by private creditors in 2012.

Debt remains an issue for Greece, which agreed in August to an 86-billion-euro bailout led by the euro area. The IMF, whose current Greek loan program expires in March, has said it won’t provide a fresh loan to the country until European governments provide debt relief and the Greeks show more progress on economic reforms.

Republican Opposition

The exemption was unpopular among U.S. Republican lawmakers, who felt the IMF shouldn’t bend its lending rules. Last month, the U.S. Treasury agreed to push to repeal the loophole, in exchange for Republican support for changes to the fund’s governance -- originally proposed in 2010 -- that increase its capital and give emerging markets more sway over votes.

In a 2014 report, IMF staff said the systemic exemption isn’t a “coherent long-term solution.” The exception only benefits countries that are large or interconnected, according to the report.

Staff instead proposed that a country’s creditors be asked for “a relatively short extension of maturities” in exchange for IMF support. Creditors would be asked for a “reprofiling” that “would typically not involve a reduction in either principal or coupon,” staff wrote.

In case of contagion concerns, IMF staff recommended lending by other creditors such as development banks or a common backstop, such as the one that was created in Europe during the debt turmoil. In some circumstances, it may be best to delay a decision on debt restructuring, the report said.

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