TOPIC 2

INTERNATIONAL FINANCIAL INSTITUTIONS AND POLICY

Part 1: International Financial Institutions

International financial institutions (IFIs) are organizations that facilitate international

monetary and financial cooperation, as well as provide financial assistance and expertise to
member countries. They play a critical role in promoting economic stability, development,
and financial integration on a global scale.
International Financial institutions such as World Bank, International Monetary Funds,
African Development Bank, Asian Development, etc., are created for so many reasons
including regional developments and investments. Since the world is a global village,
domestic economies depend on these institutions for development /loan support among other
reasons. They include:
International Monetary Fund (IMF):
 Mission: The IMF aims to ensure the stability of the international monetary system—
the system of exchange rates and international payments that enables countries to
transact with each other.
 Functions:
i. Surveillance: Monitoring global economic trends and providing policy advice
to member countries.
ii. Financial Assistance: Providing loans and financial assistance to member
countries facing balance of payments problems.
iii. Technical Assistance and Training: Offering expertise and training to member
countries to strengthen their economic institutions and policies.
World Bank Group:

 Mission: The World Bank aims to reduce poverty and support sustainable
development by providing loans, grants, and expertise to developing countries.
 Components:
i. International Bank for Reconstruction and Development (IBRD): Provides
loans and credits to middle-income and creditworthy low-income countries.
ii. International Development Association (IDA): Provides interest-free loans and
grants to the world's poorest countries.
iii. Other Entities: Includes the International Finance Corporation (IFC), the
Multilateral Investment Guarantee Agency (MIGA), and the International
Centre for Settlement of Investment Disputes (ICSID), focusing on private
sector development and investment.

African Development Bank:

 Mission: Promote economic and social development in African countries by

providing financial and technical assistance for various development projects and
 programs. It aims to improve the lives of people in Africa by fostering sustainable
economic growth, reducing poverty, and enhancing living standards.
 Functions:
i. Financial Support and Project Financing: Providing loans, grants, and
technical assistance to support a wide range of development projects and
programs in various sectors, aiming to drive economic growth and enhance the
well-being of people in African countries.
ii. Capacity Building and Knowledge Sharing: Enhancing the skills and
capabilities of African countries through training, expertise, and knowledge
sharing, and providing policy advice to improve the business environment and
overall policy formulation.
iii. Promoting Regional Integration and Private Sector Development: Encouraging
collaboration and integration among African nations, focusing on regional
economic development, trade, and cooperation. Additionally, supporting
private sector growth through project financing, advisory services, and
initiatives that stimulate investments and business growth.

Part 2: The International Payments Mechanism

The International Payments Mechanism refers to the system and processes that facilitate the
transfer of funds and financial transactions between individuals, businesses, and financial
institutions across different countries. These mechanisms are crucial for conducting
international trade, investment, and financial activities, allowing the movement of money
across borders in a secure and efficient manner.
There are several key components and systems that make up the International Payments
Mechanism:

SWIFT (Society for Worldwide Interbank Financial Telecommunication):

SWIFT is a global messaging network that facilitates secure and standardized communication
between financial institutions worldwide. It plays a crucial role in international funds
transfers and messaging related to payment instructions, confirmations, and other financial
transactions.
SEPA (Single Euro Payments Area):
SEPA is an initiative that aims to create a single integrated payment market within the
European Union (EU). It standardizes and simplifies payment processing for euro
transactions, enabling efficient cross-border payments within the SEPA region.
CHIPS (Clearing House Interbank Payments System):
CHIPS is a major payment system in the United States used for large-value, time-critical, and
high-priority payments. It provides a platform for the settlement of both domestic and
international payments in U.S. dollars.
TARGET2 (Trans-European Automated Real-time Gross Settlement Express Transfer
System):
TARGET2 is the real-time gross settlement system used for handling large-value euro-
denominated transactions in the European Union. It ensures fast and secure settlement of
payments in euro across borders.
Cross-Border Payment Processors:
Various international payment processors and intermediaries facilitate cross-border payments,
including PayPal, TransferWise (now Wise), Payoneer, and others. These platforms offer
services for transferring funds between individuals, businesses, and accounts in different
countries.
Correspondent Banking:
Correspondent banking involves relationships between banks in different countries that
facilitate transactions and payments on behalf of their customers. Correspondent banks often
have established agreements to process payments and clear funds in different currencies.

Foreign Exchange (Forex) Markets:

The Forex market is where currencies are traded, allowing participants to buy, sell, and
speculate on different currencies. It's a critical component of the international payments
mechanism as it sets exchange rates and enables currency conversions for cross-border
transactions.
International Payment Regulations and Compliance:
Compliance with regulatory requirements, such as anti-money laundering (AML) and know-
your-customer (KYC) rules, is a crucial part of the international payments mechanism to
ensure the legality and security of transactions.
Efficient and secure international payment mechanisms are essential for global trade, finance,
and economic development. They help facilitate smooth transactions, improve liquidity,
reduce settlement risk, and foster economic growth on an international scale.

Part 3: Programming models & Stabilization Policies and Packages.

Programming Models
Programming models are used to analyze economic relationships and simulate the behavior
of economic variables. Example include economic models and computational simulation
models.

Economic Models:

Economic models use mathematical and computational techniques to simulate and analyze
economic phenomena. These models help understand the interactions within the international
payments mechanism, such as trade balances, exchange rate dynamics, and capital flows.

Macroeconomic models aim to represent the entire economy. One popular model is the
Keynesian Cross model, which simplifies the economy into consumption and income:

Keynesian Consumption Function:

C=a +b × Y

where:

 C is consumption,
 Y is income (or output),
 a is autonomous consumption,
 b is the marginal propensity to consume
Computational Simulation:

Computational models, often based on economic theories and statistical data, are used to
simulate the behavior of economic variables within the international payments mechanism.
These simulations aid in policy analysis and decision-making.

Econometric models use statistical techniques to estimate relationships between economic

variables. One common model is the simple linear regression model:

Equation for Simple Linear Regression:

Yi=β0 + β1Xi + εi

where:

 Yi is the dependent variable (e.g., exchange rate),

 Xi is the independent variable (e.g., trade balance),

 β0 and β1 are parameters to be estimated,

  εi is the error term.

Stabilization Policies and Packages

Stabilization policies and packages are strategies implemented by governments and central
banks to stabilize and support the economy during periods of economic instability,
downturns, or crises. The main objective of these policies is to restore economic equilibrium,
promote growth, manage inflation, and reduce unemployment. These policies often
encompass both monetary and fiscal measures, along with structural reforms. Let's delve
deeper into these components and how they contribute to stabilization efforts.

Monetary Policy:

Monetary policy involves actions taken by a central bank to control the money supply,
interest rates, and credit availability. It primarily aims to influence consumer spending,
borrowing, and investment. Key tools of monetary policy include:

 Interest Rate Adjustments: Central banks modify interest rates (e.g., the federal funds
rate) to influence borrowing costs. Lowering interest rates stimulates borrowing and
spending, promoting economic activity.
 Open Market Operations: Central banks buy or sell government securities to manage
liquidity in the financial system, affecting short-term interest rates.
 Reserve Requirements: Adjusting the reserve requirements for commercial banks can
influence their lending capacity and money supply in the economy.

2. Fiscal Policy:

Fiscal policy involves government decisions regarding taxation and government spending to
influence economic activity. Key components of fiscal policy include:

 Government Spending: Increasing government spending, especially on infrastructure

projects and social programs, can boost demand and stimulate economic growth.
 Taxation: Adjusting tax rates can impact disposable income, consumption, and
investment. Tax cuts can encourage spending and investment, while tax hikes can
help in controlling inflation.
 Transfer Payments: Direct financial assistance to individuals or businesses during
economic downturns can bolster consumption and support businesses, aiding in
stabilization.
Stabilization Packages:

Stabilization packages involve a combination of monetary and fiscal measures, often

accompanied by structural reforms, to stabilize the economy. These packages are designed to
address specific challenges and promote sustainable economic growth. Components of
stabilization packages may include:

 Macroprudential Measures: Policies aimed at ensuring financial stability and

preventing excessive risk-taking in the financial system.
 Structural Reforms: Initiatives to improve the efficiency and competitiveness of
markets, labor force, and regulatory frameworks.
 Debt Restructuring: Addressing unsustainable levels of public or private debt through
restructuring and refinancing.
 Support for Affected Sectors: Targeted support for sectors hit hardest by economic
challenges, such as subsidies or financial assistance to struggling industries.

4. International Cooperation and Assistance:

In a globalized world, collaboration with international organizations and other countries is

crucial. Coordinated efforts can provide financial assistance, knowledge sharing, and policy
coordination to stabilize the global economy during crises.

Stabilization policies and packages are adapted based on the unique circumstances of each
economic situation. Their effectiveness depends on timely implementation, appropriateness to
the context, and coordination among various stakeholders to restore economic stability and
support long-term sustainable growth.