You are on page 1of 53

Monetary and financial system crises in the context of globalization and their impact on Republic of Moldova

Intoduction CHAPTER 1. Conceptual issues in the context of globalization on financial crisis 1.1 The concept of economic financial crisis in the economic schools vision 1.2 The causes and the impact of international financial crises in the context of globalization financial crises practices 2.1 The impact of international financial crisis on international financial market developments 2.2 The impaс of recent tinternational financial crisis on economic and social issues in the world economy 2.3 The scenarios of international financial crisis management CHAPTER 3. Moldova's development in the context of current international financial crisis 3.1The place and the role of RM in the context of globalization processes 3.2The 65 3.3 Management recommendations on effective methods of international financial crisis in Moldova Conclusions References Appendices ANA COSTIUC


9 17

1.3 The role of international financial institutions in managing international CHAPTER 2. Current international financial crisis and management











CHAPTER 1. Conceptual issues in the context of globalization on financial crisis

§1.1 The concept of economic financial crisis in the economic schools vision

There is a vast array of literature on financial crises based on historical case studies as well as current economic conditions written by economist, financial theorist and by policy analysts. Within this literature there is a number of “conclusions”, some of them are quite contradictory and thereby inconclusive. Every financial crisis is unique in its nature, forms, causes and consequences. However a generalized theory can be used to explain the financial crisis. Depending on the time, location, financial crises are very diverse in terms of timing, the source of monetary expansion and the object of speculation. For instances, Kindleberger argues that “financial crises are associated with the peaks of business cycle.” Before going to a deep analysis of financial crisis we would like to recall the business cycle by which we can broadly analyze the financial crisis. Irving Fisher

(1937) describes in his famous theory “Debt deflation Theory of great Depression”

about the business cycle. Schumpeter classifies the business cycle into four important partsBoom- Recession- Depression- Recovery. Starting from the mean, a boom is a rise which lasts until the peak is reached; a business entity tries to stay as long as possible in the peak point. A recession starts when business begins to fall from peak to the back again. When a business goes down more from the mean then it is said depression. Again business starts to move upward then it is called recovery period.



In a sense, any cycle of whatever duration can be described as going through these four phases - otherwise the fluctuations cannot really be described as "cycles". In the 19th century, business cycles were not thought of as cycle at all but rather as spells of "crises" interrupting the smooth development of the economy. In later years, economists and non- economists alike began believing in the regularity of such crises, analyzing how they were spaced apart and associated with changing economic structures. Let`s define on the definition of financial crisis. Goldsmith` s2 defined financial crisis - A sharp, brief, ultra cyclical deterioration of all or most of a group of financial indicators- short term interest rates, asset (stock, real estate, land) prices, commercial insolvencies and failures of financial institutions.” Michael Bordo3 , a monetarist, defines financial crisis in terms of ten key elements or links: a change in expectations, fear of insolvency of some financial institution, attempts to convert real or illiquid assets into money and so on. Zavalaiii (2001) divided the financial crisis into two major parts which are Currency crisis and Banking crisis. He defined Banking crisis Banking crises occur when a financial system become illiquid or insolvent. This type of crisis refers to bank runs, closures, mergers, takeovers, or large-scale assistant by the government to a group of banks or banking systems, should the crisis turn out to be systematic. A recent approach to define financial crisis is in the view point of asymmetric information problem. Mishkin defined financial crisis as follows “A financial crisis is a disruption to financial markets in which adverse selection and moral hazard problems become much worse, so that financial markets are unable to efficiently channel funds to those who have the most productive investment opportunities”. Thus a financial crisis is a sharp deterioration of a group of financial and economic indicators like economic growth, imbalance between money supply and demand, declining asset prices, potentially also accompanied by failures of financial institutions like bank, insurance and mutual funds and also non financial institutions. Since bankruptcies increases, unemployment surges and it leads to slower economic growth. Asymmetric information problems increase between lender and borrower and it makes failure the market. Different theories have been developed regarding financial crises how it occurs and how to recover the financial crisis. We analyzed four different approaches to describe financial crisis and tried to find the gap among these theories.

2 3

E. Philip Davis “ Debt financial fragility and systematic risk” ( Clarendon Press, 1995) Jorge Gallardo- Zavala “ Understanding Financial Crisis: A non technical Approach” ( Universidad Del Pacifco, 2001)


1.1 a Monetarist Approach for financial crisis Banking panics have been identified as a sign of financial crisis by monetarist. This theory focuses on only banking panics and banking crises. For example, Friedman and Schwartz (1963) noted that of six major contraction in the US over 1867-1960, four were associated with major banking or monetary disturbances. This is because public loss of confidence in Bank`s abilities to convert deposits into currency. When an important institution fails in the market, public confidence on bank became less and that helps to develop the crisis. Moreover, they view the banking panics was a major sources of contraction in the money supply which led to a severe contraction in the aggregate economic activity of the economy. Monetarists do not consider the declining the asset price, failures of business as a cause of financial crisis because it does not create banking panic and also does not hamper in money supply. In another approach macroeconomic causes like inflation have been identified as a financial crisis. According to Schwartz (1987), financial instability tends to arise from inflation. Inflation is highly related with the interest rate as well as money supply and an increase in inflation leads to an increase in interest rate. This makes trouble for the bank specially if the bank is engaged in fixed rate investment project or if bank lends in a fixed rate, even this instable price level may lead to insolvencies of the bank. In another study by Lindgen, Garcia, and Saal (1996)4 found that in weak banking systems, external shocks that affects terms of trade influence bank`s viability. In this study, some of the indicators used by the authors to determine bank unsoundness and its implications are: the money multiplier, claims on the private sector to GDP, interest rates, impact on the real sector, fiscal implication and exchange rate valuatio Monetarists do not see a necessary connection between business cycle and crisis and they do not rule out asset price bubble. They ignore the loss of wealth associated with capital market crashes, non financial bankruptcies, and failures of individual banks are financial crashes. Rather, in monetarist view “` financial crisis` is to be said a reserved for a shift to money that leads to widespread run on Banks. More specifically, Banking crises occur when financial systems become illiquid. This types of financial crisis refers to bank runs, closures, mergers, takeovers, or large scale assistant by the government to a group of banks or to the banking systems, should the crisis turn out to be systemic 1.1b Uncertainty and financial crisis

Understanding Financial crises- a non technical approach- Jorge Gallardo-zavala


The dictionary meaning of “Uncertain” is “not certain” or “doubtful”. Statistics shows there is a misunderstanding between the word “risk” and “uncertainty”. The dictionary meaning of “Risk” is “Possibility of Loss or Injury”. It is very important to understand the difference between risk and uncertainty. Uncertainty nothing says about loss or risk of injury but uncertainty is a source of risk. Risk is usually can be quantified but uncertainty can not be quantified. Moreover, uncertainty can be added in order to minimize the risk. Knight (1921) suggested the economic uncertainty as opposed to risk. Meltzer (1982) pointed out its importance in understanding financial crisis. The study of “economic uncertainty” can be divided into two main schools- (1) Mainstream (Keynesian) school and (2) the subjectivitist (Austrian School). In general, the mainstream defines uncertainty in the same manner as probabilists, that is uncertainty can be measured by assessing the probabilities, the associated risks, and the benefits of all possible outcomes. But Austrian school of Economics denied this definition saying “future is not knowable either precisely or probabilistically (inferring from past data) rather uncertainty applies to events whose implications resist purely objective analysis, such as wars, major changes in policy regime, financial crises etc. There is much need of uncertainty in the economy. According to Austrian economics school “uncertainty is the market main source of stability and Innovation… evolution and the creative process- also have a high need of uncertainty in order togenerate innovation.” In terms of opportunity for profit, uncertainty rooted in change was suggested by Knight to be a main source of competitive markets. If all probabilities were known and risk diversified, there would be no extra profit and entrepreneur will not be motivated anymore to make new business. Profits are earned by innovating and seeking opportunities where there is uneven information and uncertainty. This process of innovation which termed as “creative destruction of innovation” by Economist Joshep Schumpeter is taking place in the financial market. The innovation will be a creative destruction if the present business entity can cope with this new innovation, if risks are correctly priced and if can make profit. But it will not be, if financial intermediary fails to understand the properties of financial innovations by under pricing the risks. According to Davis “Adverse surprise, given uncertainty and imperfect information may trigger shifts in confidence and hence runs which affect markets more tan appears warranted nu their intrinsic significance, because they lead to rethinking of decision process as well as to decisions themselves. This helps explain the wide variety of proximate causes of financial crisis”


While uncertainty is important for innovation, on the other hand if uncertainty runs in a high level in the market, it may lead to a loss of confidence. Loss of confidence may lead runs and panics on financial institution or collapse of liquidity in securities market and lead to financial crisis. 1.1cAsymmetric information problem and financial crisis A number of researches have been done on asymmetric information problem and its relation with financial crisis. Simply, asymmetric information problem means the unavailability of information among the entities in the financial market. In the financial market, the two most important entities are borrowers and lenders and asymmetric information problem might exist in the financial contract between lender and borrower. Borrower has better information than lender about the borrower`s return on project, risk associated with that project while lender misses those information. In that case lender has to raise the interest rate which excludes some high quality borrower or lender may choose credit rationing rather than raise interest rates, in order to avoid adverse selection (Stiglitz and Weiss 1981). Asymmetric information creates the problem in financial structure in two ways- before the transaction entered into (Adverse Selection) and after the transaction entered into (Moral Hazard). Mishkin defined the adverse selection as follows “ Adverse selection occurs when the potential borrowers who are the most likely to produce an undersirable outcomes- the bad credit risks- are the ones most likely to be selected.” (1991. Page 3 ).The lender can not determine the credit risk accurately and therefore indifferent in lending money or alternatively charging an average interest rate from every borrowers. This action prevents some good borrowers taking loan and will encourage the risky borrower to take loan more which creates the market more sensitive and fragile. Moral hazard is the end result of asymmetric information which emerges after the transaction occurs. The lender runs the risk that the borrower will engage in activities that are undesirable in from the lender points of view because they make it more likely that the loan will be paid back. Moral hazard occurs because the borrowers have the incentives to invest in project in high risk in which the borrower does well if project succeeds but the lender bears most of the loss if the project fails. Moreover, borrowers may misallocate the funds in his personal use, to shirk and just not work hard or to undertake the investment in unprofitable projects. The conflict of interest between borrower and lender sing from moral hazard at many lenders will not be 6

willing to make loan which makes an imbalance between savings and investment in the real world. Mishkin (1991) identified five most important reasons for financial crisis- (1) increases in interest rate (2) stock market declines (3) increase uncertainty (4) bank panics and (5) an unanticipated declines in aggregate price level. He pointed that these five reasons of financial crisis are the result of asymmetric information problem. Increase in uncertainty, or an increase in interest rates and the stock market crash increased the severity of adverse selection problems in the credit market, while the decline in net worth of stemming from stock market crash increased in moral hazard which help lead to a crisis eventually. This theory of financial crisis explains the causes of financial crisis but does not explain how it develops and what are those signs of financial crisis? Moreover, asymmetric information problem is not the only cause of financial crisis. The role of government or the failure of government policy is not considered in this theory. 1.1d Financial Fragility Hypothesis The opposite theory of financial crisis of monetarist approach is “Financial fragility hypothesis” a concept developed by Minsky to theorize the financial crisis. Minsky (1977, 1982) elaborated Fisher`s approach and introduced the concept of `fragility` to attempt to clarify the problem of over indebtedness during an upswing. This Fragility depends on; first, the mix of hedge, speculative and ponji finance; second, the liquidity of portfolios; third, the extent to which ongoing investment is debt financed. Hedge finance states that investor’s cash inflows cover interest and principal payments for borrowers who obtains a debt to buy an asset. These are the safest investors. Speculative phase is the combination of safety and risky investment. In this phase, cash inflows cover only interest payments, but may not cover to amortize the principal. If the interest rate goes up and value of collateral goes down the speculator will be more risky and even might not cover the interest payment also. Ponji phase is the most risky phase in the crisis. in this phase, cash flows cover neither interest rate nor principal. Moreover Ponji borrowers depend only on the rising price of asset. Let’s analyze how this mechanism operates. In this theory Minsky divides the crisis into five main phases like business cycleDisplacement, Euphoria, Peak and Panic. According to Minsky, events up to a crisis start with a “displacement” some exogenous, outside shock like outbreak or end of a war or any significant invention to the macroeconomic system. Displacement will increase more profit opportunities at 7

least in one sector of the economy. As a result, business enterprise and individual invest more and more on that sector and because of that investment increases and so as production which will lead the economy in ` Euphoric` stage. In this stage bank will expand its credit expecting more profit from that particular sector and thinking this sector as a safe sector. As investment increases more and more it will lead to price increase which will create more profit opportunities which is termed as `peak`. As stated earlier, Ponji borrowers invest expecting an increase of price of particular asset. An artificial price increase is happened in this stage. Investors earn their maximum profit in this phase. Small price variation in the peak level because of government policy change or any other change like interest rate rise will lead to Fisher`s `distress selling` which follows the “crisis”. In this stage bankruptcies surge, economic activity slows, and unemployment increases 1.1 Rationality of choosing Minsky`s financial fragility hypothesis No financial crises theory explains a crisis in a perfect way. Monetarists emphasize only on banking panic and do not rule out asset price bubble, although they do not see a necessary connection with the business cycle. Monetarist theory does not consider loss of wealth, non financial bankruptcies, and failures of individual bank are the causes of financial crises but reality reveals different information. Uncertainty is a source of innovation at the same time a source of financial crisis. This theory promotes the competition in the market in a high level to get the innovation in the market but can not analyze in what level of competition leads to crisis and what should be the role o institution to limit the competition. Asymmetric information problem is one of the most crucial problems for making financial crisis which exists in the financial system but there is no proper incentive to reduce this problem. all of these theories does not identify the foundation of the crisis and can’t explain broadly how it develops. Among the financial crisis theories that we analyzed here, “Financial Fragility Theory” which is known as `Minsky`s financial crisis theory is the most useful to analyze the financial crisis. This theory broadly analyzes how a crisis happens explicitly and specially dividing the phase of the crisis cycle. To attain the goal of this thesis, we think this theory is useful as it is widely accepted to the economist as well as financial theorist.


§ 1.2 The causes and the impact of international financial crises in the context of globalization
Although his place in a dictionary (Webster)5 6 early decade of the last century, globalization requires conceptual '90s, the work of many foreign academics.


Globalization is one of the most common terms used in particular in the last few decades. The idea of globalization one can find many programs on radio and television across the globe, a lot of web-sites of various companies, politicians in speeches, in meetings of national and international organizations, let alone hundreds or even thousands The pages are presented all sorts of views on the causes and effects of this phenomenon in particular. Various aspects and connections of this concept has been expanded and continues to develop in an extremely fast. The idea of globalization is present in all areas of life: science, art, culture, morality, the technique in sitemele financial, transport and communication facilities, in technology, military affairs, the environment, S. of. Each makes its own act of charge if used in everyday language, this notion had some courtesy such as the global economy, global market global financial system, global crisis and other supporting raliendu this is the phenomenon or the they fight. What is particularly interesting and still unexplained once, is that after so many years from the emergence and development of this concept so widespread in all areas of life, not yet found a simple, clear and complex once all that is widely recognized. In the opinion of specialists in linguistics, verb globalize; was first certified by the Merriam Webster Dictionary in 1944. Some historians, linguists, but believes that this word can be found in some writings dating from the late fourteenth century, or even before. After some economists view globalization theorists was ;invented; in the '80s, but recognize that the conceptual point of view, it existed long before. Personally, my opinion after that globalization rally began with the Renaissance era, there has been a real explosion of science and technology, when there were a lot of inventions and developed banking system. This was the period in which they were created and expanded a lot of links between countries in Europe, Asia and America. After World War I, globalization has seen an even broader expansion. In a broader sense and including a wider range of activities and fields of application was observed after the second world war and subsequent settlement after the Cold War competition between the two systems, capitalist and socialist. With the advent and expansion of the use of computers and satellites artificali then, the explosion of this phenomenon could not be controlled. He took the true meaning of world natural proportions. In an objective can be considered as we are witnessing a new revolution and global users. Of all fields of application, and most often discussed by the phenomenon of economic globalization which in turn has a broad spectrum of manufacturing acivitatea event in the entire financial system and especially investment in international trade labor migration, tourism and other sectors. If some 50 years ago a form of globalization appear so-called Americanization, now she has a totally different look and a totally different meaning. Originally it referred specifically to foreign investment in stocks, in bonds in international trade


stimulated by reducing tariffs. Initially mainly export American cars in Europe instead importing clothing and all sorts of exotic products from different countries. Globalization is a considerable amount of effects, positive and negative. As positive elements, the highlights: amplification and trade liberalization, investment and financial flows, expansion of democratic values, individual identity protection, environmental protection, but also ;freedom movement; security. Must agree with the analyst Hans Blommestein, that for the first time in history, today, a global technology transforms the world financial market, the business, political and psychological, making them unrecognizable. From the perspective of free market, globalization will bring unprecedented prosperity, as more and more nations will participate in the global economy and technological and financial flows from developed countries to less developed countries will lead to an equalization of wealth and development of the whole world. John Gray emphasizes that globalization, which he sees as a supported interconnect technology between the political, economic, cultural world has, in the latter area, the effect of hybridization of cultures, preservation, renovation and development of cultural identities. Phenomenon of globalization is marked by an integration of the economies of various countries, that changes the entire quality of the various scaffold structures of national economies. Referring specifically to economic development in different countries based on the continuous development of science and technology and supported by socio-political concepts of democracy, globalization is a natural way a truly revolutionary trajectory. But globalization also has negative effects, such as lowering safety to all indicators, chronic local and regional phenomena of globalization, the globalization of major organized crime (trafficking in weapons, drugs, people), the radicalization of ethnic and religious fanaticism, terrorism. In economic terms, globalization leads, for example, economic chaos and environmental havoc in many parts of the world. Basically, through globalization, there is a deterioration of income distribution, financial and economic crises are multiplying, with large effects on social and political. .Moreover, globalization makes economic and social structures that do not adjust quickly to the extreme strain, can cause major conflicts. In fact, in the opinion of those who are against the globalization phenomenon and should be seen and understood in terms of how ;try; to ensure so-called consumer gain. By submitting a demand for abroad (in countries such as China, Malaysia, Philippines, India, Mexico ), To remove an enormously large number of jobs in local businesses. A lot of workers, technicians, engineers and other trades and professions lose their jobs. The loss of these jobs is assessed by experts in the field of labor organization is not temporary but permanent.


Currently due to the economic crisis is discussed on a number of unemployed, which exceeds U.S. 12 million people. Elimination of labor entails loss of certain monthly income or temporary limitation of these revenues (by providing unemployment benefits) for those who are removed from an activity that carried. Thus was purchased them drastically reduced income and therefore buying opportunities of consumer goods and services procurement. On the other hand removed from the work process to get out of the ranks of middle class population among the poor îngroşând. We must not forget that the middle class who formed the company, is the company that provides revenue because it represents the majority population. The percentage reduction of this social class, and entails many financial problems for the country. The whole world is currently experiencing the effects of a strong economic crisis. Opinion of many economists in different countries is that the crisis began in the United States and the effects of globalization are felt in all developed countries, developing and third world countries. United States initially entered formally into recession two years ago and none of the leaders of government departments did not want to formally recognize this state of affairs. In many applications of the media, the answers were very evasive or false, that sustaining the American economy is robust financial system and inflation was under total control and as such everyone be quiet. If these elected representatives, senators and congressmen would have warned people of the United States and other countries about the risks of this economic mess, he might have taken early measures which reduced the overall impact. Causes of that economic crisis has far exceeded that of the years 1929-1933, are multiple and have accumulated huge budget spending due to undue the large-scale financial fraud and controlled us, granting huge loans without kind of coverage, a weakening dollar in the various economic transactions, extending Outsourcing process to obtain large profits for private companies and stock holders of these companies and much more. Media seeking for months as a radar situation presents continuous stock exchange volatility stocks and falling gradually from the values of some special. high (hundreds of dollars) to the ridiculous amount of fractions. Enormous expenditure incurred in recent years affected and continues to affect the U.S. budget in general and each state in particular. From the positive values that the U.S. budget was eight years ago, it was a huge budget deficit and prospects in the current situation of continuous. growth. Finance professionals also claims that a deficiency has been known throughout history America. Which will eventually amount of the deficit, as will cover this huge deficit and that will be the effects on the national situation in general and living standards of every family in particular are as big question marks. Obama argued in his election campaign and after that all possibilities exist to reduce this deficit over 533 billion U.S. dollars over the next five years. Even if this statement was only meant to encourage the U.S. population, revived the spirit of distrust ever higher, putting in doubt the 12

current economic outlook. Estimates of increasing budget deficit by the end of 2009, refers to several trillion dollars, which will generate a deficit of around 1 trillion dollars annually for the next decade. Such a situation provides not only current generations but also those to come in a huge economic risk. Some current needs for excessive expenses are covered by hundreds of billions of U.S. dollars loan from the various countries including China. Others rely on taxes that will require population while reducing or liquidating national programs (for the repair of infrastructure in each state and nationally, repair bridges some risk in using, repairing and equipping schools with necessary equipment laboratories), eliminating a number of increasingly large staff of activities for public services (teachers, librarians, policemen, firemen, postman, S. All these effects are immediate and long term, do not stop at U.S. borders. They have spread around the world. Europe, Asia, Middle East, Latin America also faced with various aspects of the current economic crisis. Are now all sorts of efforts to find and address this global economic crisis. Economists are asked experts from different countries opiniilr called to say, and give some solutions as soon as possible effects. Currently, we are observing one of the most severe and deep world financial and economic crises in history caused by globalization processes. The most important economies (like those of the United States, China, India, Japan, Germany and Britain) are in deep recession and we also observe a severe financial crisis, e.g., mistrust between the financial institutions. This caused a reaction in which almost all governments engaged in substantial deficit spending to inject liquidity into financial markets and to fight the economic downswing. All this happened within half a year to nine months, and economic researchers are now confronted with explaining how this could have happened. The public and politicians ask the economics profession, what the causes of this deep crisis were and what can be done to overcome it. The financial crisis which had its origins in the United States and the induced worldwide economic crisis pose two important questions: (1) What caused the crisis? (2) What should be done to minimize the risk of repetition if not of identical events than of at least something similar? A more parsimonious way of turning around these two questions is the following: If in retrospect the causes of this crisis are so obvious, why did so many smart researchers (and especially economists) fail to appreciate the gravity of the situation beforehand? One could imagine that with sufficient preparation, these problems (financial and economic) would have been addressed well before the seriousness of the current crises had become apparent. It is reported1) that former US Treasury Secretary Henry Paulson6 tabled a plan for re-organizing and


consolidating the supervision and the regulation of the US financial system. One might similarly imagine that, sooner or later, federal agencies would have extended insurance to money market, mutual funds, and investment banks, but they remain unregulated so far. Early action would have brought on the regulatory umbrella. But such major changes in regulatory policy take time – even now (June 2009) it is not clear what type of regulatory framework will be implemented ultimately. At the most basic level, the sub prime crisis resulted from the tendency of financial normalisation and innovation to run ahead of financial regulation, as Eichengreen . For a long time, deregulation was the order of the day not only outside but also within financial markets, as illustrated, for example, by eliminating the Glass-Steagall Act’s restrictions on mixing investment and commercial banking7. However, considering what had happened, the problem was that other (regulatory) policies were not adapted to the new environment. Conglomerization and globalization takes time. In the short-run, investment banks were allowed to lever-up their bets, they “stood” completely beyond the purview of the regulators. As independent entities funded themselves on a short-term basis, they were vulnerable to liquidity “crunches” and disruptions to their funding. A crisis sufficient to threaten the financial system ultimately precipitated the inevitable consolidation8. A second major element of the crisis was a consumer spending boom from 2002 to 2007 and the resulting domestic and international imbalances. The Bush administration cut taxes, causing a massive deficit for the government9. The Federal Reserve cut interest rates in response to the 2001 recession. In addition to this action, the new financial innovations made credit even cheaper and more widely available. This, of course, is just one, but nevertheless a major element in the “crisis” story, contributing in its own way to the collapse of the market for sub prime mortgages. Such loans were packaged, “securitized” and pushed by the subsidiaries of Lehman Brothers and other major financial institutions. The result was increased US consumer spending and the decline of measured household savings into negative territory. The third element was financial internationalization. Much as with the separation of investment from commercial banking, the Great Depression led to the imposition of tight and persistent restrictions on international capital flows. From the 1970s on, these restrictions have gradually been relaxed, which was another indication that policy makers had forgotten the Great Depression. Deregulation continued and accelerated during the 1990s.6) Facilitating US Eichengreen B. (2008), Thirteen Questions About the Subprime Crisis, mimeo, University of California, Berkeley (January), 8 Eichengreen B. (2008a), Origins and Responses to the Crisis, mimeo, University of California, Berkeley. 9 Ibid.


dependence on foreign finance and feeding in this way the country’s credit boom helped to set the stage for what followed from 2007 on. What additionally helped to set the stage for the crisis were the rise of China and the decline of investment in Asia following the 1997 - 1998 currency crisis. With China saving on average nearly 50% of its GNP, this “money” more or less had to go abroad10. A great part of it went into US Treasury securities and the obligations of the Federal Home Loan Banks (FHLB), Fannie Mae and Freddy Mac. These capital inflows “propped” up the dollar11. It reduced the cost of borrowing for Americans on some estimates by as much as 100 basis points, encouraging them to live far beyond their financial means. This behaviour created an opportunistic market for Freddy, Fannie and for other financial institutions, creating substitutes for those agency’s own securities. To sum up: In the United States the financial crisis was facilitated by policies of domestic and international liberalization accompanied by however well-intended financial innovations, such as complex derivative securities, “conduits” and “structured investment vehicles”, which were not regulated at all. Other innovations in risk management worked in the same direction. According to Eichengreen (2008a, 2008b)12, commercial banks, investment banks and hedge funds were encouraged by the dynamic development of the financial market to use more leverage and their counterparties were inspired to provide it by the development of mathematical models and methods to quantify and hedge risks. These new models, which were rigorous and promised to provide “exact” information emboldened market participants to believe that the additional leverage was safe since participants now used scientific techniques and were convinced that they could manage it. A major problem was, however, that these “new” models were estimated using data from recent periods of low volatility over, typically, relatively short intervals, given that the financial instruments, whose returns being modelled, had existed only for a few years. Events, which should have been modelled or simulated, like a sharp drop in housing prices, were outside the sample period and, hence, were not captured by these models. Institutional investors convinced themselves on the basis of these models that their financial practices were relatively safe. They persuaded the public regulatory agencies to allow financial institutions to use these models when deciding how much capital to hold to provision against risk.11) This short analysis is by no means a complete or comprehensive explanation for the financial crisis.Other authors, such as Eichengreen (2008, 2008a), Acemoglu (2009), Adams (2009), or Congleton (2009), emphasize other factors (not testing the economic models out ofCaballero, R., E. Farhi, and P.-O. Gourinchas (2008), An Equilibrium Model of ‘Global Imbalances’ and Low Interest Rates, American Economic Review 98 (3), p.358-393.
10 11 12


sample, relying on trust or mistrust, and placing too much confidence in the market's adjustment capacity, for example). The specialists consider that the starting of the financial crisis in October 2008, in USA and other countries represents the most serious commotion of the international finances from the Great Depression from 1929-1933. Effects of the present crisis are spreading, beyond the financial sphere, to the level of the world economy, affecting the economical growth and the labor market and generating a series of other linked up effects with conjuncture implications or with long and medium terms implications, regarding the structure of the financial world system and its interface with the real economy. The drivers of the financial and economic crisis are complex and multifaceted. The main causes of the crisis are linked to systemic fragilities and imbalances that contributed to the inadequate functioning of the global economy. Major underlying factors in the current situation included inconsistent and insufficiently coordinated macroeconomic policies and inadequate structural reforms, which led to unsustainable global macroeconomic outcomes. The present financial crisis which crosses the world economy points out the interlacing of some common causes, traditional of the economical-financial crisis phenomena, generally, with other untraditional, specific. Among the main traditional causes of the economical-financial crisis we mention: the boom period of the credit growing in very big proportions; the strong growth of the prices for the actives, mainly on the real-estate market; the lending in uncontrolled proportions of the economical agents less or at all solvable (it is about the sub-prime mortgagers). Regarding the particular untraditional causes of the financial crisis started in October 2008, we mention, first of all, the proportion and the profundity of the sub-prime crisis. The subprime mortgage crisis, which led to a wider crisis in credit markets, was partly caused by an “excess” supply of liquidity in global capital markets and the failures of the central banks in the United States and some other advanced industrial countries to act to restrain liquidity and dampen the speculative increases in housing and other asset prices. While lax financial regulation may have contributed to the particular form taken by the crisis, the magnitude of this excess liquidity, and other associated factors, made further difficulties likely. These factors were made acute by major failures in financial regulation, supervision and monitoring of the financial sector, and inadequate surveillance and early warning. These regulatory failures, compounded by over-reliance on market self-regulation, overall lack of transparency, financial integrity and irresponsible behavior, have led to excessive risk- taking, unsustainably high asset prices, irresponsible leveraging and high levels of consumption fuelled by easy credit and inflated asset prices. Financial regulators, policymakers and institutions failed to appreciate the full measure of risks in the financial system or address the extent of the growing 16

economic vulnerabilities and their cross-border linkages. Insufficient emphasis on equitable human development has contributed to significant inequalities among countries and peoples. Other weaknesses of a systemic nature also contributed to the unfolding crisis, which has demonstrated the need for more effective government involvement to ensure an appropriate balance between the market and public interest. The level of international economic interdependence may also have contributed to an increase in vulnerability of the global economic system to external shocks that produce larger negative impacts on global aggregate demand. Globalization creates opportunities and brings extraordinary progress in some areas. Such as globalization or not happen overnight, most likely not resolve the current global economic crisis will not immediately find the solution. Will be needed for months if not years to find optimal solutions, the unanimous acceptance of their application and manifestation of global results. During this time the whole world is seriously concerned and intrigued by what has happened and continues to take place in the United States and the global effect of this economic crisis. It is a time when the psychological factor of insecurity and mistrust of each man and seized it creates a state of total confusion. Nobody knows how and what you have to act to save modest financial reserves that the agonist in a working life, to survive until the black cloud will disappear of this global disaster. Great private investors and major banks are extremely wary and reluctant to act. Placing us on an optimistic position believe that a shorter or more distant, global economi will find the necessary stability to propel it to new heights in the current century. How and when this will happen, only time will tell who will be able to confirm. What is particularly important until then is to provide a general equilibrium, economic, social and especially political challenge of sparks to prevent disastrous effects of various countries at national or even for all mankind.

1.3 The role of international institution in managing international financial crises
International financial institutions have a key role to play in softening the impact of the crisis in developing countries. They are crucial in providing financing to cash-strapped public and private sectors in developing countries and supporting growth-oriented fiscal policy. They have also a key role in providing assistance in strengthening social safety nets and the quality of public spending. 17

The financial crisis has brought international financial organizations and institutions into the spotlight. These include the International Monetary Fund, the Financial Stability Board (an enlarged Financial Stability Forum), the Group of Twenty (G-20), the World Bank, the Group of 8 (G-8), and other organizations that play a role in coordinating policy among nations, provide early warning of impending crises, or assist countries as a lender of last resort. The precise architecture of any international financial structure and whether it is to have powers of oversight, regulatory, or supervisory authority is yet to be determined. However, the interconnectedness of global financial and economic markets has highlighted the need for stronger institutions to coordinate regulatory policy across nations, provide early warning of dangers caused by systemic, cyclical, or macro prudential risks13 and induce corrective actions by national governments. In response to the financial crises Policy proposals for changes in the international financial architecture have included a major role for the IMF. As a lender of last resort, coordinator of financial assistance packages for countries, monitor of macroeconomic conditions worldwide and within countries, and provider of technical assistance, the IMF has played an important role during financial crises whether international or confined to one member country. The financial crisis has shown that the world could use a better early warning system that can detect and do something about stresses and systemic problems developing in world financial markets. It also may need some system of what is being called a macro-prudential framework for assessing risks and promoting sound policies. This would not only include the regulation and supervision of financial instruments and institutions but also would incorporate cyclical and other macroeconomic considerations as well as vulnerabilities from increased banking concentration and inter-linkages between different parts of the financial system14 In short, some institution could be charged with monitoring synergistic conditions that arise because of interactions among individual financial institutions or their macroeconomic setting. However, the IMF’s current system of macroeconomic monitoring tends to focus on the risks to currency stability, employment, inflation, government budgets, and other macroeconomic variables. The IMF, jointly with the Financial Stability Board, has recently See CRS Report R40417, Macro prudential Oversight: Monitoring the Financial System, by Darryl E. Getter 14 Lipsky, John. “Global Prospects and Policies,” Speech by John Lipsky, First Deputy Managing Director, International Monetary Fund, at the Securities Industries and Financial Markets Association, New York, October 28, 2008. World Bank. “The Unfolding Crisis, Implications for Financial Systems and Their Oversight,” October 28, 2008. p. 8.


stepped up its work on financial markets, macro-financial linkages, and spillovers across countries with the aim of strengthening early warning systems. The IMF has not, however, traditionally pressed countries to counter specific risks such as how macroeconomic variables, potential synergisms and blurring of boundaries among regulated entities, and new investment vehicles affect prudential risk for insurance, banking, and brokerage houses. The Bank for International Settlements makes recommendations to countries on measures to be undertaken (such as Basel II) to ensure banking stability and capital adequacy, but the financial crisis has shown that the focus on capital adequacy has been insufficient to ensure stability when a financial crisis becomes systemic and involves brokerage houses and insurance companies as well as banks. The financial crisis has created an opportunity for the IMF to reinvigorate itself and possibly play a constructive role in resolving, or at the least mitigating, the effects of the global downturn. It has been operating on two fronts: (1) through immediate crisis management, primarily balance of payments support to emerging-market and less-developed countries, and (2) contributing to longterm systemic reform of the international financial system15 The IMF also has a wealth of information and expertise available to help in resolving financial crises and has been providing policy advice to member countries around the world. IMF rules stipulate that countries are allowed to borrow up to three times their quota250 over a three-year period, although this requirement has been breached on several occasions in which the IMF has lent at much higher multiples of quota. In response to the current financial crisis, the IMF has activated its Emergency Financing Mechanism to speed the normal process for loans to crisis-afflicted countries. The emergency mechanism enables rapid approval (usually within 48- 72 hours) of IMF lending once an agreement has been reached between the IMF and the national government. As of April 2009, the IMF, under its Stand-By Arrangement facility, has provided or is in the process of providing financial support packages for Iceland ($2.1 billion), Ukraine ($16.4 billion), Hungary ($25.1 billion), Pakistan ($7.6 billion), Belarus ($2.46 billion), Serbia ($530.3 million), Armenia ($540 million), El Salvador ($800 million), Latvia ($2.4 billion), and Seychelles ($26.6 million). The IMF also created a Flexible Credit Line for countries with strong fundamentals, policies, and track records of policy implementation. Once approved, these loans can be disbursed when the need arises rather than being conditioned on compliance with policy


See CRS Report RS22976, The Global Financial Crisis: The Role of the International Monetary Fund (IMF), by Martin A. Weiss. 19

targets as in traditional IMF-supported programs. The IMF board has approved Mexico for $47 billion under this facility. Poland has requested a credit line of $20.5 billion. The IMF also may use its Exogenous Shocks Facility (ESF) to provide assistance to certain member countries. The ESF provides policy support and financial assistance to lowincome countries facing exogenous shocks, events that are completely out of the national government’s control. These could include commodity price changes (including oil and food), natural disasters, and conflicts and crises in neighboring countries that disrupt trade. The ESF was modified in 2008 to further increase the speed and flexibility of the IMF’s response. Through the ESF, a country can immediately access up to 25% of its quota for each exogenous shock and an additional 75% of quota in phased disbursements over one to two years. The increasing severity of the crisis has led world leaders to conclude that the IMF needs additional resources. At the 2009 February G-7 finance ministers summit, the government of Japan lent the IMF $100 billion dollars. At the April 2009 London G-20 summit leaders of the world’s major economies agreed to increase resources of the IMF and international development banks by $1.1 trillion including $750 billion more for the International Monetary Fund, $250 billion to boost global trade, and $100 billion for multilateral development banks. For the additional IMF resources, $250 billion was to be made available immediately through bilateral arrangements between the IMF and individual countries, while an additional $250 billion would become available as additional countries pledged their participation. The increased resources include the $100 billion loan from Japan, and the members of the European Union had agreed to provide an additional $100 billion. Subsequently, Canada ($10 billion), South Korea ($10 billion), Norway ($4.5 billion), and Switzerland ($10 billion) agreed to subscribe additional funds. The Obama Administration has asked Congress to approve a U.S. subscription of $100 billion to the IMF’s New Arrangements to Borrow. China reportedly has said it is willing to provide $40 billion through possible purchases of IMF bonds. The sources for the remaining $145.5 billion of the planned increase in the NAB have not been announced. The IMF reportedly is considering issuing bonds, something it has never done in its 60yearhistory16 These would be sold to central banks and government agencies and not to the general public. According to economist and former IMF chief economist Michael Mussa, the United States and Europe previously blocked attempts by the IMF to issue bonds since it could potentially make the IMF less dependent on them for financial resources and thus less willing to take policy direction from them.254 However, several other multilateral institutions such as the

Timothy R. Homan, “IMF Plans to Issue Bonds to Raise Funds for Lending Programs ,”, April 25, 2009. 20

World Bank and the regional development banks routinely issue bonds to help finance their lending. The IMF is not alone in making available financial assistance to crisis-afflicted countries. The International Finance Corporation (IFC), the private-sector lending arm of the World Bank, has announced that it will launch a $3 billion fund to capitalize small banks in poor countries that are battered by the financial crisis. The World Bank Group has an important role to play in helping developing countries assess and respond to the challenges presented by the global economic crisis. The Bank is well positioned to play a role in helping its clients stabilize their economies, preserve and enhance the foundations for longer-term economic growth, and protect the most vulnerable against fallout from the crisis. Because of the magnitude of the crisis and the heterogeneity of its impact on individual developing countries, the Bank is mobilizing a wide range of support, which will be tailored to country and community needs, including through technical assistance and policy advice, direct financing, and by helping to leverage financial support from a variety of public and private sources. The Bank is actively working with other IFIs and MDBs to design, develop and implement many of the new approaches and instruments it is proposing. The World Bank Group is stepping up its financial assistance to its clients on a number of fronts. There is scope to almost triple lending to around $35 billion in FY2009, and lending volumes could potentially reach $100 billion over the next three years. Following its record 15th replenishment, IDA is positioned to assist LICs in dealing with the impact of the global financial crisis, with commitments amounting to nearly $42 billion over the next 3 years, and scope for front-loading this support over the next year. The Bank is at the forefront of global efforts to mobilize resources for developing countries, particularly those without the means to cushion the impact of a crisis not of their making. In addition to direct financial support, the Bank continues to provide developing countries with access to diagnostic and capacity-building instruments like Public Expenditure Reviews (PERs) and Debt Management and Performance Assessments (DEMPA)—the former to help improve budget management and identify priority expenditures to be protected should financing shortfalls persist, the latter as a critical tool for assuring essential fiscal sustainability. The value to developing countries of these instruments has increased in a resource constrained environment, as will the usefulness of technical assistance to improve revenue and customs administration. A number of client countries are also looking for assistance in building bank supervisory capacity to enable them to more effectively monitor developments and respond to weaknesses in domestic financial sectors as they emerge. 21

The role of the G-20 in dealing with the global financial crisis began on November 15, 2008, with the G-20 Summit on Financial Markets and the World Economy that was held in Washington, DC. This was billed as the first in a series of meetings to deal with the financial crisis, discuss efforts to strengthen economic growth, and to lay the foundation to prevent future crises from occurring. This summit included emerging market economies rather than the usual G-7 or G-8nations that periodically meet to discuss economic issues. It was not apparent that the agenda of the emerging market economies differed greatly from that of Europe, the United States, or Japan. The G-20 Washington Declaration to address the current financial crisis was both a laundry list of objectives and steps to be taken and a convergence of attitudes by national leaders that concrete measures had to be implemented both to stabilize national economies and to reform financial markets. The declaration established an Action Plan that included high priority actions to be completed prior to March 31, 2009. Details are to be worked out by the G-20 finance ministers. The declaration also called for a second G-20 summit that was held in London on April 2, 2009. Since the attendees now include the Association for Southeast Asian Nations, the G-20 no longer refers to just 20 nations. At the April 2009 G-20 London Summit, leaders agreed on establishing a new Financial Stability Board (incorporating the Financial Stability Forum) to work with the IMF to ensure cooperation across borders; closer regulation of banks, hedge funds, and credit rating agencies; and a crackdown on tax havens. The leaders could not agree on the need for additional stimulus packages by nations, but they considered the additional funding for the IMF and multilateral development banks as key stimulus directed at developing and emerging market economies. The leaders reiterated their commitment to resist protectionism and promote global trade and investment17. At the November G-20 summit, the leaders agreed on common principles to guide financial market reform: • Strengthening transparency and accountability by enhancing required disclosure on complex financial products; ensuring complete and accurate disclosure by firms of their financial condition; and aligning incentives to avoid excessive risk taking. • Enhancing sound regulation by ensuring strong oversight of credit rating agencies; prudent risk management; and oversight or regulation of all financial markets, products, and participants as appropriate to their circumstances.

G-20, Meeting of Finance Ministers and Central Bank Governors, United Kingdom, 14 March 2009, Communique, March 14, 2009. 22

The leaders agreed that needed reforms will be successful only if they are grounded in a commitment to free market principles, including the rule of law, respect for private property, open trade and investment, competitive markets, and efficient, effectively-regulated financial systems. The Inter-American Development Bank (IDB) announced on October 10, 2008 that it will offer a new $6 billion credit line to member governments as an increase to its traditional lending activities. In addition to the IDB, the Andean Development Corporation (CAF) announced a liquidity facility of $1.5 billion and the Latin American Fund of Reserves (FLAR) has offered to make available $4.5 billion in contingency lines. While these amounts may be insufficient should Brazil, Argentina, or any other large Latin American country need a rescue package, they could be very helpful for smaller countries such as those in the Caribbean and Central America that are heavily dependent on tourism and property investments.


The starting point for the current crisis on the financial markets was a decade of extraordinarily favourable macroeconomic conditions in western industrialised nations characterised by low, stable inflation and ongoing economic growth. The extremely positive economic environment generated a mood of euphoria among market participants, causing them to be increasingly blind to the risks being assumed. The volatility of key economic variables such as growth, inflation and unemployment had been falling steadily in industrialised nations since the mid-eighties, with emerging nations also seeing the same trends a decade later. This “great moderation” was attributed to improved central bank policy, greater deregulation and competition, and last but not least the increasing level of globalisation. Even the USA’s highly expansive monetary policy had no direct negative effects and was therefore not regarded as problematic. There was an increasingly strong belief that the fall in volatilities was a long-term trend. Trends in the emerging economies appeared to be increasingly decoupling themselves from those of the industrialised world, paving the way for genuine diversification and a more stable global economy. In this positive environment, public debate on financial market regulation was largely driven by fears of over-regulation and the promotion of the international competitiveness of financial centres. Few thought it possible that the positive economic environment that had shaped the preceding years could be brought to an end by the securitisation of subprime mortgages in the USA. However, as whould become evident later, people did not take into account the disastrous interplay of various different aspects. In light of this, the stress tests carried out by the big global banks and the International Monetary Fund (IMF) were based on assumptions that were far too mild. The volatilities of certain economic variables and the illiquidity of various securities observed during the crisis were not predicted by even the most conservative extreme scenarios. During this period of growth, various Asian and oil-producing countries recorded very high saving levels. These exceeded domestic investment and, in combination with the fixed or heavily controlled exchange rate policy pursued in order to support the export sector, led to a huge accumulation of foreign currency reserves. The majority of these funds were invested in US Treasury securities and in bonds issued by the government-backed mortgage finance providers in the USA. The resulting increase in demand for government bonds had a negative impact on the risk-free yield. Coupled with the favourable economic environment and a period of falling risk premiums, this boosted the attractiveness of alternative investments. Financial innovations made possible by advances in information technology generated correspondingly high demand and led to an increase in credit securitisation. The raw material for these securitisations came first and foremost from the USA, but also from the UK, the Republic of Ireland, Spain and other countries that had built up large trade deficits in the preceding decade. The new possibilities made debt an 24

even more attractive proposition for private households. However, the low interest rates and risk premiums also led to a rise in debt financing in many other areas, not least among financial institutions. This rising and very widespread level of debt (leverage) was only recognized as a problem in isolated instances. International standard setters and central banks viewed the securitization of risks as a stabilizing factor, and it therefore appeared reasonable to relax capital adequacy requirements for securitized risks. This approach also influenced the formulation of Basel II1, not least as a result of lobbying by financial institutions. The anticipated stabilizing effect was based on the assumption that the capital markets were bottomless and always liquid. The associated risk allocation was deemed to be more efficient than that of the traditional business model, in which banks grant loans themselves and keep them on their own balance sheet until they are repaid by the borrower (buy-and-hold strategy). The new originate-todistribute business model of many international investment banks was designed to convert loans they originally granted themselves or purchased from other banks and financial institutions into marketable securities via the securitisation process and sell them to other investors. The prevailing opinion was that securitisation and credit derivatives offered banks and the entire financial system more protection against shocks thanks to the broader distribution of risks across a large number of investors.2In reality, however, the new business model did not result in the hoped-for risk diversification, as a substantial proportion of the securities were held off-balancesheet in vehicles closely related to the banks. Thus, although the risks were no longer subject to capital adequacy requirements, bank balance sheets were still exposed to the risks, particularly liquidity risks, due to formal and informal guarantees in favour of these vehicles. The one-off or repeated re-securitisation of individual subordinated debt tranches of initial securitisations also increased the leverage effect, without this being visible under the relevant balance sheet item (covered leverage). Financial institutions also sold their products to each other (acquire-toarbitrage), thereby giving the impression that the market was very deep, without the risks ultimately being borne by parties outside the banking system. When this illusion finally collapsed, the huge complexity that had made the bubble possible resulted in a complete absence of demand and an illiquid market. Prior to this point, liquidity had only been seen as a potential problem at the level of individual institutions. However, the idea that entire markets could be illiquid over a long period was never considered. The crisis was finally triggered by the US mortgage market. The influx of foreign capital and the rise in the US balance of trade deficit also led to private households taking on significantly higher levels of debt. The constant rise in real estate prices led borrowers and 25

lenders to assess the risks as low, while low interest rates (partly in the form of loss-leader products with interest rates that only rise at a later date) made mortgages affordable, and in their securitised form they were an attractive alternative investment for investors. The granting of mortgage loans to borrowers with poor credit ratings (subprime borrowers) was actively encouraged by politicians as a means of extending home ownership to disadvantaged sections of the population and was not seen as critical due to the constant rise in real estate prices. If a borrower got into difficulties, in general the mortgage was simply restructured and the loan-tovalue ratio increased. A growing proportion of subprime mortgages were granted by financial institutions that were not subject to banking regulation and arranged by brokers remunerated on the basis of sales, which encouraged the relaxing of due diligence standards for the granting of loans. Real estate prices peaked in 2006. As a result it became impossible to prevent impending loan defaults through restructuring and more and more subprime borrowers defaulted on their mortgages. Borrowers also had little incentive to continue servicing mortgages that exceeded the value of their property, as local US laws enabled them to withdraw from their obligation by transferring ownership of the property to the bank. Securities based on subprime residential mortgages recorded increasing losses. At the start of 2007 the focus was on the tranches with poor risk evaluations; by the summer even those with confirmed good credit quality had been affected. In hindsight, however, the collapse of the subprime market is just one of several events that had the potential to trigger a financial market crisis. In June 2007, when the insolvency of subprime hedge funds caused such severe liquidity problems at Bear Stearns that the bank had to be taken over by JP Morgan Chase in the following year, it was considered unlikely that the difficulties would extend to areas beyond the US subprime market. In early summer of that year, international organisations such as the IMF, the Bank for International Settlements (BIS) and the Financial Stability Forum (FSF) were following the initial turbulence on the financial markets with a degree of concern, but as yet they had no comprehension of the extent of the subsequent financial market crisis. The forecasts issued by these institutions mainly predicted a slowdown in economic growth in the USA, but there was no suggestion whatsoever that the problem would spread to most of the world’s economies. Their assessments were based primarily on a still strong macroeconomic environment, with low inflation and positive growth rates. Even before the crisis broke, a number of central banks, the European Central Bank (ECB) and the Swiss National Bank (SNB) among them, had already highlighted the very low risk premiums, the associated rise in risk tolerance and the high levels of debt at certain financial institutions. The initial turbulence in 2007 was therefore also seen as a necessary correction, but for a long time it was considered


unlikely that the situation would spill over into other sectors or develop into a crisis affecting the entire financial market, let alone a slide into a global recession. When market participants became aware of the negative performance of securities backed by subprime mortgages, there was a rapid rise in the previously extraordinarily low risk premiums, even for securities backed in other ways. The valuations of the complex paper were primarily based on the assessments of rating agencies. When the agencies downgraded a host of these securities by three rating classes in one go, suspicion grew that the risks associated with the paper had not been fully understood. There had never been a mass downgrade on this scale for other types of fixed-income security. Many of the mortgage-backed securities were held by special purpose vehicles that did not appear on bank balance sheets. Refinancing for these vehicles, which previously came from the short-term money market, subsequently dried up. Forced sales and a loss of confidence in products with little transparency caused key securities markets to dry up, triggering further price falls. In line with the principle of fair value measurement, securities held in the trading book have to be booked at market value. The major decline in the value of these securities led to high losses, reducing the equity capital of financial institutions. As the crisis developed it became increasingly difficult and ultimately impossible to raise new funds on the capital market, with the result that many banks no longer possessed the minimum regulatory capital reserves required, so their only option was to massively reduce their balance sheet positions. This in turn led to a further price crash across the board, triggering major criticism of the pro-cyclical effect of fair value accounting. The rules on consolidation, which favoured outsourcing arrangements and did not adequately reflect the existing legal or reputational obligations towards off-balance-sheet vehicles, also came in for criticism. The banks were forced to take large write-downs on the positions they held in their trading books. Certain illiquid trading position were transferred to banking books. To protect their reputations, many banks moved their off-balance-sheet special purpose vehicles (SPV) with heavy investments in asset-backed securities (ABS) back onto their own books, thereby increasing the need for capital and liquidity in the banking sector. At the same time, uncertainty over the economic prospects of counterparties led to a loss of liquidity on the interbank market, which collapsed completely following the failure of Lehman Brothers. Central banks throughout the world were obliged to pump liquidity into the interbank market and reduce key interest rates to record low levels. As monetary policy measures alone were not enough to stabilise the interbank market, other big banks and major insurance conglomerates such as AIG, which had also built up a considerable capital market business in addition to its insurance activities, reached the verge of collapse. This would have further exacerbated the crisis of confidence among


lenders and depositors. As a result, many governments decided to bail out their banks and insurance companies with state rescue packages and take over some of their risk positions. Supervisory authorities were accused of missing the signs, of relying too heavily on the evaluation of the institutions under their supervision and of not building up enough analytical expertise of their own. There was also a feeling that capital requirements had been set too low, as certain risks had been underestimated. Liquidity, too, was felt not to have received the attention it deserved. Corporate governance practices at numerous institutions had also failed, but the supervisory authorities had not intervened. Furthermore, there was a belief that regulation was totally lacking or at best inadequate in certain key areas, and that supervisory tools and processes, particularly for groups operating internationally, had proved to be inadequate. The same complaints were also levelled at international standard setters such as the Basel Committee on Banking Supervision, the International Association of Insurance Supervisors (IAIS), the International Organization of Securities Commissions (IOSCO) and their common body the Joint Forum. It is a fact that the development of the Basel II capital adequacy requirements, which began in 1998, and their eventual implementation from 2006 onwards placed huge demands on the Basel Committee, the various national supervisors and of course the banking industry itself. The burden of Basel II meant that the issuing of quantitative international minimum standards to regulate and monitor liquidity risk was put back and not treated as a priority even at national level until shortly before the crisis. Competition pressures also eroded the quality of the big global banks’ eligible equity capital, notably through the issue of tax-efficient hybrid core capital. Although the Basel Committee did issue a number of guidelines in 1998 to counter this negative trend, which were applied relatively strictly by the Swiss Federal Banking Commission (SFBC), further international harmonisation of equity definitions was deferred until Basel II had been approved. Both supervisors and the banks were also focused too heavily on the risks of individual institutions and did not recognise the risks accumulating throughout the entire system until it was too late. This in turn would primarily have been the task of the central banks, which are charged with ensuring the stability of the system, but they lacked company-specific information on the risk situation. However even institutions such as the US Federal Reserve System (Fed) that perform both macro and micro prudential functions fared no better with regard to recognition of the crisis. It is therefore clear that the failure to adequately recognise the causes of this crisis did not stem from the way an authority is structured, its size or the style of supervision.3


Numerous studies of the causes of the crisis clearly demonstrate that it was brought about by a disastrous combination of various aspects. In particular, the value-at-risk models used by the banks to measure and provide capital cover for market risks proved to be completely inadequate. In stress situations, trading book positions are markedly less liquid than previously assumed. The capital adequacy requirements for these risks were therefore insufficient and set false incentives for shifting from credit to market risks. Through securitisation, fundamentally illiquid loans were converted into marketable securities. Some were subsequently securitised a second and third time and broken down into tranches with differing rankings in the event of bankruptcy, which external rating agencies gave top ratings depending on their ranking. As a result, the trading portfolios of global investment banks were massively inflated with credit derivatives and credit default swaps (CDS). In line with the market risk regime introduced in 1996 as an amendment to Basel I, only a fraction of the capital cover in the traditional bank book was required for securitised loans in the trading book in periods of low volatility. Prior to the crisis, therefore, the large banks’ capital adequacy requirements for market risks accounted for less than 10% of the overall requirement. These models were adopted almost unchanged in the Basel II regulations. The Basel Committee will now rectify this deficiency based on the knowledge acquired during the crisis. In general, both the financial sector and the supervisory authorities relied far too heavily on financial mathematics models. As a result of this, and also the low default probabilities estimated by the rating agencies, people wrongly believed they were in a secure situation. Not enough consideration was given to the fact that these models were based on a host of assumptions and parameters tailored to observations taken during periods of positive economic performance. As the regulatory authorities also used the same models to determine capital requirements, a strong pro-cyclical effect emerged during the crisis. The rapid increase in the volatility of the now illiquid trading portfolios also triggered a rise in the value-atrisk in the market risk models and hence in the capital required, while at the same time the amount of capital available was decimated by losses and write-downs on these positions. At a time of major difficulties, many institutions therefore had to make additional capital available to cover the increased risks. International accounting standards, with their pronounced emphasis on the short-term investor’s viewpoint, market valuation and the extension of fair value measurement to include traditional bank assets and liabilities, made it more difficult to create forward-looking value adjustments from a prudential perspective. They heightened the procyclical effect and encouraged the distribution of short-term gains prior to the crisis. These effects were mitigated to a certain extent, however, thanks to the existing filters for the prudential calculation of regulatory capital. For example, goodwill or fair value gains arising from the devaluation of a bank’s own liabilities (own credit) due to a decline in its 29

creditworthiness must be excluded from regulatory capital. However the full impact of these cyclical fluctuations is felt in the income statement, for instance because it is precisely in periods of stress that goodwill on participations has to be written down, while conversely a fall in a bank’s own creditworthiness creates paper gains that subsequently revert to losses again in the event of a later recovery. One of the key functions performed by banks is maturity transformation, whereby relatively short-term liabilities are loaned for a longer term. This function has an indisputable economic value, but also entails liquidity risks for companies, which is why financial intermediaries are also subject to regulation and enjoy access to central bank facilities. In recent years, however, there has been a pronounced shift of this maturity transformation into vehicles that do not appear on bank balance sheets. As a result, this key financial market function has partially shifted into unregulated territory. The forced sales that had to be made during the crisis to meet the obligations falling due in the short term further exacerbated the liquidity crisis. Clearly, therefore, it is time to consider the extent to which previously unregulated areas of the financial market must in future be covered by the supervisory authorities and if necessary made subject to regulation. Debate is focussed in particular on money market funds, hedge funds and private equity firms. According to the experts, hedge funds did not cause this crisis but as key market participants however, they did amplify the downward trend in the face of deleveraging pressures and demands from investors wishing to withdraw their capital. Remuneration systems were also partly to blame for the crisis. Those of the investment banks, with their lack of any long-term focus, created false incentives that favoured the acceptance of unreasonable risks. Supervisors recognised the problem, but felt that intervention was futile due to competitive pressures or trusted in the smooth functioning of the banks’ own governance and risk control processes. Both the causes of this crisis and the failure to recognise the growing systemic risks were global in nature. The long-lasting positive economic trend and the perceived increase in the stability of the financial system led financial institutions, supervisory authorities and academics to misjudge the situation in the run-up to the crisis. In this respect, it is impossible to identify any specific mistakes on the part of the Swiss supervisory authorities. In terms of recognising the crisis at an early stage or preventing it from happening, they performed no better and no worse than their partner authorities, some of whom have significantly more staff and are much closer to the markets in question.


§ 2.2 The impaс of recent tinternational financial crisis on economic and social issues in the world economy
The world is confronted with the worst financial and economic crisis since the Great Depression. The evolving crisis, which began within the world’s major financial centers, has spread throughout the global economy, causing severe social, political and economic impacts. The global economic and financial crisis is having a significant impact on all countries. However, central, Eastern, and south-Eastern Europe (CESEE) has been particularly hard hit. The crisis poses a significant challenge to budget policies worldwide, and many countries, especially major economies, are relying not just on automatic stabilisers, but are responding to the crisis with discretionary fiscal stimuli and support for the financial sector. Indeed, the current economic environment would seem to call for Keynesian policies to counterbalance both domestic and foreign demand shortages. CESEE countries face significant budgetary challenges. Most have very limited fiscal policy options. Many of them face significant financing constraints, are small and open, have generally lower-quality fiscal institutions than major economies, and should respect investors’ confidence. Although public debt relative to GDP is considerably lower in most CESEE countries than in major economies, markets’ tolerance for public debt in emerging and developing countries is much lower. CESEE countries have been hit severely by the crisis, though there are significant differences within the region. Before the crisis, i.e. up to 2007, CESEE countries seemed to be catching-up with theEU-15 quickly and reasonably smoothly; this was reflected in forecasts made at that time (Figure 1). For example, in October 2007, cumulative GDP growth from 2008 to 2010 was forecast to be 11.4 percent on average in the region, while, by comparison, the EU-15 was predicted to grow by 4.3 percent during these two years. Some CESEE countries had built up various vulnerabilities, such as huge credit, housing and consumption booms and thus high current account deficits and external debt. It was widely expected that these vulnerabilities would have to be corrected at some point in time. However, the magnitude of the correction, as also reflected by the fall in GDP, was amplified by the global financial and economic crisis. Figure 1 indicates that there were substantial downward revisions in economic growth forecasts from October 2007 to October 2009 in all countries. The 2010 GDP level of the CESEE country group was in October 2009 forecast to be 14.8 percent lower than was expected in October 2007. Downward revision in other emerging and developing country groups has been smaller, ranging from 3.3 percent (average of 48 African countries) to 6.9 percent (average of 25 Asian countries excluding China3). CESEE countries not only had to assume the largest downward revision of their forecast GDP level, but the actual fall in GDP is also expected to be 31

the greatest among emerging and developing country groups. The average GDP change in the 26 CESEE countries from 2008 to 2010 was forecast in October 2009 to be minus 4.3 percent. Meanwhile the 25 Latin American countries were expected to maintain their GDP level, and the 25 Asian countries, and the 48 African countries and the 13 Middle East countries were expected to grow by between 5.2 percent and 6.0 percent during the same period. The three Baltic countries were hit the most seriously with GDP projected to fall between 16 and 22 percent from 2008 to 2010, according to October 2009 forecasts18. Forecasts made in 2007 foresaw growth of about 15 percent during the same period. Furthermore, growth in 2008 was -4.6 percent in Latvia and -3.6 percent in Estonia and hence the total output fall experienced by these countries will be even larger than the forecasts for 2009 and 2010 would imply. The downward revision of the 2010 GDP level is between 34 and 39 percent for the three countries.


Darvas, Zsolt (2009) ‘The Baltic Challenge and Euro Area Entry’, Bruegel Policy Contribution. -p8 32














The sensitivity of CESEE countries to the crisis is mainly due to three factors: - Capital flows and financial integration; - Dependence on foreign trade; - Migration and remittances. Darvas and Veugelers (2009) demonstrate that foreign trade played a crucial role in the pre-crisis economic growth of CESEE countries, and that their dependence on foreign trade is greater than many other emerging and developing countries. Remittances are also very important for some countries: Moldova (34 percent of GDP in 2007), Bosnia/Herzegovina (17 percent),

Zsolt Darvas, The Impact of the Crisis on Budget Policy in Central and Eastern Europe, Institute of Economics Hungarian Academy of Science, Budapest, 2009, p.7.


Armenia (14

percent), Albania (13 percent), Georgia (seven percent),

Bulgaria &

Romania (five percent), and between two and four percent for eight further CESEE countries20. In general, CESEE countries entered the crisis more vulnerable than other emerging regions, although there are considerable differences within the region. A key feature of these countries is that their pre-crisis growth was associated with rising current account deficits (with the exception of commodity exporters), that is, the correlation between GDP growth and the current account was negative, as the left-hand panel of Figure 2 indicates. In contrast, correlation was positive in other emerging and developing countries as suggested by the right-hand panel of Figure 2.
Figure 2

In terms of Russia's need mention that it tends to be in a category by itself. Although by some measures, it is an emerging market, it also is highly industrialized. As the case with most of the world’s economies, the Russian economy has been hit hard by the global economic crisis and resulting recession, the effects of which have been apparent since the last quarter of 2008. Even before the financial crisis, Russia was showing signs of economic problems when world oil Zsolt Darvas, The Impact of the Crisis on Budget Policy in Central and Eastern Europe, Institute of Economics Hungarian Academy of Science, Budapest, 2009,


prices plummeted sharply around the middle of 2008, diminishing a critical source of Russian export revenues and government funding. The crisis and other factors brought an abrupt end to a decade of impressive Russian economic growth. In 2008, it faced a triple threat with the financial crisis coinciding with a rapid decline in the price of oil and the aftermath of the country’s military confrontation in August 2008 with Georgia over the break-away areas of South Ossetia and Abkhazia21. These events exposed three fundamental weaknesses in the Russian economy: substantial dependence on oil and gas sales for export revenues and government revenues; a decline in investor confidence in the Russian economy; and a weak banking system. The rapid decline in world oil prices has been a major factor in the overall decline in Russia’s economy. Russian government revenues have diminished because of the drop in oil revenues, but also because of the decline in income tax revenues, which will cause the Russian government to incur a budget deficit in 2009 for the first time in ten years, a deficit of perhaps 8% of GDP22. Russia has also been adversely affected by the world-wide credit crunch that ostensibly began with the proliferation of subprime mortgages in the United States and the subsequent burst of the real estate bubble. Because low interest credit was not available domestically, many Russian firms and banks depended on foreign loans to finance investments. As credit tightened, foreign loans became harder to obtain. The economic downturn has been showing up in Russia’s performance indicators. Although Russia real GDP increased 5.6% in 2008 as a whole, it increased more slowly than it did in 2007 (8.1%) and grew only 1.2% in the fourth quarter of 2008.152 The economic slowdown has been reflected in the Russian ruble exchange rate as well. The ruble has been declining in nominal terms because foreign investors have been pulling capital out of the market to shore up domestic reserves, putting downward pressure on the ruble. Russian official reserves have declined substantially in part because of the Russian Central Bank has intervened to defend the ruble and current account surpluses have shrunk. Russian official reserves declined from $597 billion at the end of July 2008 to $384 billion at the end of February 2009, although they increased to $402 billion by the end of July 2009 23. Russia remains highly dependent on oil and natural gas exports as a source of income. If world oil prices continue to be depressed, the Russian economy would likely experience slow growth, if any. Many economists have argued that, in the long run, for Russia to achieve


See CRS Report RL34618, Russia-Georgia Conflict in August 2008: Context and Implications for U.S. Interests, by Jim Nichol. 22 Economist Intelligence Unit. Country Report—Russia. June 2009. p. 3. 23 23 Central Bank of Russia


sustainable growth, it must reduce its dependence on exports of oil, natural gas, and other commodities and diversify into more stable production. How is the Crisis Unfolding in Asia? The crisis manifested in emerging Asia in early 2008, and is likely to worsen response to slackening demand from advanced economies and growing eased to 101/2 per cent in the first half of 2008, from 12 per cent in in tensions in partly

regional financial markets. A selective review of the evidence is given below. Growth in China 2007, because of slowing exports. Investment and consumption, however, maintained their momentum. In India, growth in the second quarter slowed to 8 per cent, on the back of weakening investment, while private consumption and exports have held up better than feared, with signs of the latter registering a sharp drop in October, 2008 . In fact, exports have fallen sharply in other Asian country too, including South Korea, China, Japan and Taiwan. In the so-called NIEs and ASEAN economies, activity has decelerated. Domestic demand has softened as a result of surge in food and fuel prices, and investment plans have been scaled down. Vietnam, for example, is undergoing a sharp correction as the demand boom caused by large capital inflows unwinds24. Financial markets have weakened due to a pessimistic global outlook and investor risk appetite has declined following the September turbulence. Equity markets that had a bull run during 2005-07-prices more than quadrupled in China and tripled in India-plummeted. In some countries borrowing spreads shot up for banks relying on wholesale funding25. Current accounts are beginning to show strains as well, largely due to rising import bills for commodities and slowing export growth, while capital account and exchange rate developments have varied. Capital inflows to China have remained strong, as reflected in the continuing surge of foreign reserves; capital flows to other countries in the region have become more volatile, particularly to those running large external deficits. Consequently, their currencies have come under pressure, prompting central banks to intervene (India, Pakistan and Vietnam). Differing nominal exchange rate developments underlie differing real exchange rates, with the Chinese renmimbi and the ASEAN currencies continuing to appreciate, and the South Asian and NIE’s currencies weakening. Headline CPI inflation soared in many countries in the first half of 2008, with slight reductions in a few. In China, headline CPI inflation has declined from its peak of 81/2 per cent in April, 2008, as food supply has improved. In India, CPI inflation jumped to 9 per cent in August. Underlying inflationary pressures have increased, as robust credit growth could cause second round effects. It is therefore likely that inflation will remain at elevated rates oven the
24 25

(Business Standard, November 11, 2008). Financial Times (11 November, 2008)


near term. For the region as a whole, headline inflation is project to rise 7 1/4 per cent in 2008, up from 5 per cent in 2007. In 2009, it is projected to be about 6 per cent26. The sharp global contraction is affecting both advanced and developing countries. Global industrial production declined by 20 percent in the fourth quarter of 2008, as highin come and developing country activity plunged by 23 and 15 percent, respectively. Particularly hard hit have been countries in Eastern Europe and Central Asia and producers of capital goods. Global GDP will decline this year for the first time since World War II, with growth at least 5 percentage points below potential. World trade is on track to register its largest decline in 80 years, with the sharpest losses in East Asia, reflecting a combination of falling volumes, price declines, and currency depreciation. Financial conditions facing developing countries have deteriorated sharply. In Latin America financial crises has two unusual dimensions. First it originated in the United States, with Latin America suffering shocks created by collapses in the U.S. housing and credit markets, despite minimal direct exposure to the “toxic” assets in question. Second, it spread to Latin America in spite of recent strong economic growth and policy improvements that have generally increased economic sector. The economies of Latin America and the Caribbean27 grew at an average annual rate of nearly 5.5% for the five years 2004-2008, lending credence to the once prominent idea that they were “decoupling” from slower growing developed economies, particularly the United States. Latin America has experienced two levels of economic problems related to the crisis. First order effects from financial contagion were initially evident in the high volatility of financial market indicators. All major indicators fell sharply in the fourth quarter of 2008, as capital inflows reversed direction, seeking safe haven in less risky assets, many of them, ironically, dollar denominated. Regional stock indexes fell by over half from June to October 2008. Currencies followed suit in many Latin American countries. They depreciated suddenly from investor flight to the U.S. dollar reflecting a lack of confidence in local currencies, the rush to portfolio rebalancing, and the fall in commodity import revenue related to sharply declining prices and diminished global demand. In Mexico and Brazil, where firms took large speculative off-balance sheet derivative positions in the currency markets, currency losses were compounded to a degree requiring central bank intervention to ensure dollar availability28.

Katsushi Imai, Raghav Gaiha, Ganesh Thapa , Financial crisis in Asia and the Pacific Region: Its genesis, severity and impact on poverty and hunger, Economics School of Social Science, The University of Manchester, November 2008.

United Nations. Economic Commission on Latin America and the Caribbean. Latin America and the Caribbean in the World Economies, 2007. Trends 2008. Santiago: October 2008. p. 28.

International Monetary Fund. Global Markets Monitor, June 15, 2009, and Fidler, Stephen. Going South. Financial Times. January 9, 2009. p. 7. 37

The more serious effects of the global crisis for Latin America appear in second order effects, which point to a deterioration of broader economic fundamentals. These will take much longer to recover than financial indicators. GDP growth for the region is expected to be a negative 2% in 2009, with an estimated growth of 3.4% in 2010.124 The fall in global demand, particularly for Latin America’s commodity exports, has been a big factor, as seen in contracting export revenue. Latin American exports are expected to fall by 11% in 2009, the largest decline since 1937. Similarly, imports may fall by 14%, reflecting the decline in world demand in general. The trade account, along with rising unemployment, point to the most severe aspects of the crisis for Latin America29. Remittances have also fallen, ranging between 10% and 20% by country. Although still important financial inflows, the decline in remittances is expected to diminish family incomes and fiscal balances, contributing to the regional slowdown30. Public sector borrowing is expected to rise and budget constraints may threaten spending on social programs in some cases, with a predictably disproportional effect on the poor. Social effects are also seen in the rising unemployment throughout the region. Part of the fallout from the financial crisis has been a precipitous decline in the prices of a large number of basic commodities and the weakness in global demand, is expected to keep commodity prices low for a prolonged period. During the second half of 2008, non-energy commodity prices plunged 38 percent, with most indices ending the year well below where they started. In December, non-energy prices fell 6.8 percent, down for the fifth consecutive month on weak global demand. Primary commodity prices continue to display extraordinary volatility, falling swiftly as the downturn in global activity has intensified. Oil prices fell 69 percent between July and December 2008, reversing the oil price increases of the previous 31/2 years. Non-oil commodities also fell 38 percent on average over the same period, with substantial declines in the dollar prices of food commodities, beverages, agricultural raw materials and metals and minerals.

Ibid. p8,9. Orozco, Manual. Understanding the Continuing Effect of the Economic Crisis on Remittances to Latin America and the Caribbean. Inter-American Development Bank. Washington, DC. August 10, 2009.p.8




The dramatic fall in commodity prices is affecting different developing countries differently. Just as the increase in food and fuel prices between early 2007 and mid 2008 created both winners and losers among developing countries,5 the sharp decline in commodity prices has done the same. Of the 68 developing countries with available data which experienced deteriorating terms of trade during the first three quarters of 2008, all but eight saw a partial reversal of the deterioration in the final quarter of the year. Of the 39 countries for which the terms of trade improved in the first three quarters, all but two saw a partial reversal in the final quarter. Oil-importing emerging market countries—including many Asian countries—were the top gainers from the oil price decline, receiving an income boost of some 2 percent of GDP, on average.6 Many oil exporters, faced with a sharp drop in prices, have been able to draw on savings and reserves accumulated when prices were at historically high levels and indeed many of the countries that gained from recently high prices have been prudent in saving more of their gains than in previous commodity price booms (e.g., Nigeria). Such expenditure smoothing may help mute the impact of extremely volatile commodity prices on the real economy. Nevertheless, for some low-income commodity producers, the cumulative windfall was not large, particularly relative to their development needs. And for some commodity producers, the high prices from 2007 and into 2008 followed on the heels of a prolonged period during which their terms of trade declined. In many countries, commodities generate a large share of government revenue. This is particularly the case for major oil exporters and many LICs. In Africa, for example, oil is 39

responsible for generating more than half of all revenues for Congo, Equatorial Guinea, Gabon and Nigeria; cocoa generates almost one-fifth of Cote d’Ivoire’s revenue as do minerals in Guinea31. On average between 1999 and 2004, cotton and aluminum accounted for almost one fifth of tax revenues in Tajikistan32.For at least nine Latin American countries, commodity revenue was, on average, at least 2 percent of GDP between 2002 and 200733. For Trinidad and Tobago and Bolivia, respectively, this share has recently been as high as 22 and 12 percent of GDP. Respondents to a survey of Bank country teams in LICs have indicated that commodity based revenues have already started to decline in many LICs. Careful monitoring of this trend is needed, while at the same time, it is essential that donors increase budget and other financial support to vulnerable LICs to avoid long-lasting setbacks to poverty reduction efforts. The economic crisis is projected to increase poverty by around 46 million people in 2009. The principal transmission channels will be via employment and wage effects as well as declining remittance flows. While labor markets in the developing world will take a while to experience the full effects of the on-going global contraction, there is already clear evidence of the fall-out. The latest estimates from the Ministry of Labor in China show 20 million people out of work. So far, the most affected sectors appear to be those that had been the most dynamic, typically urban-based exporters, construction, mining and manufacturing. The garment industry has laid off 30,000 workers in Cambodia (10% of workforce) where it represents the only significant export industry. In India, over 500,000 jobs have been lost over the last 3 months of 2008 in export-oriented sectors—i.e., gems and jewelry, autos, and textiles. ILO forecasts suggest that global job losses could hit 51 million, and up to 30 million workers could become unemployed. Workers are increasingly shifting out of dynamic export-oriented sectors into lower productivity activities (and moving from urban back into rural areas). These trends are likely to jeopardize recent progress in growth and poverty reduction resulting from labor shifting to higher return activities. For instance, nearly half of the increase in GDP per capita experienced in Rwanda between 2000 and 2008 is explained by movement of labor away from agriculture into the secondary and tertiary sectors34.


Marinkov and Burger, “The Various Dimensions of Commodity Dependence in Africa”, South African Journal of Economics, Volume 73:2, June 2005 Kumah, F. and J. Matovu, “Commodity Price Shocks and the Odds on Fiscal Performance: a Structural VAR Approach”, IMF Working Paper WP/05/171, August 2005: 33 Vladkova-Hollar, I. and Jeronim Zettelmeyer, “Fiscal Positions in Latin America: Have They Really Improved?” IMF Working Paper 08/173; May 1, 2008 11 In Africa, as a result of a drying up in trade finance, there has been


Declining remittances and migration opportunities are also undermining poverty gains and depressing wages. Remittances are a powerful poverty reduction mechanism, so that the current forecasts for a significant decline in remittances in 2009, will have strong welfare impacts in some countries. Estimates for Tajikistan suggest that halving of the remittance flows would raise the poverty headcount from 53% to 60% and would deepen poverty and inequality 35. According to recent projections in Bulgaria and Armenia, two countries heavily dependent on migration, a decline of 25% in remittances would increase poverty rates among recipients from 7% and 18% respectively to nearly 23% and over 21% respectively36.The international return flows of migrants as well as reduced new departures will reinforce the shortage of employment opportunities and further strain tight labor markets in the developing world. Falling real wages and employment impede households’ ability to provide adequate food and necessities to their members, particularly given their already stretched coping mechanisms from the 2008 food and fuel crises. Compounding this is the very real risk that, in many countries, fiscal pressures will result in reduced services to the poor, which is particularly problematic at a time when people are switching from private to public education and health services. Absent assistance, households may be forced into the additional sales of assets on which their livelihoods depend, withdrawal of their children from school, reduced reliance on health care, inadequate diets and resulting malnutrition. The long-run consequences of the crisis may be more severe than those observed in the short run. When poor households withdraw their children from school, there is a significant risk that they will not return once the crisis is over, or that they will not be able to recover the learning gaps resulting from lack of attendance. And the decline in nutritional and health status among children who suffer from reduced (or lower quality) food consumption can be irreversible. Estimates suggest that the food crisis has already caused the number of people suffering from malnutrition to rise by 44 million.

§ 2.3 The scenarios of international financial crisis management

World Bank (2009) “The Role of Employment and Earnings for Shared Growth: The Case of Rwanda.” . 35 World Bank (2009) Simulation of the impact of reduced migrant remittances on poverty in Tajikistan, 2009. 36 World Bank (2009) Bulgaria, The impact of the Financial Crisis on Poverty, World Bank (2009) Armenia, Implications of Global Financial Crisis for Poverty.


In responding the global economic crisis, developing and emerging market countries will face three main challenges: • Stabilization: The crisis threatens growth, employment, and balance of payments stability even in those countries that have made significant improvements in macroeconomic management in recent years. Give the unprecedented severity of the crisis, few countries will be able to avoid heavy pressures on their fiscal and external positions. The challenge for policymakers in this environment is to assess their ability to undertake countercyclical policies given the resources available to them as well as their institutional and administrative capacity to rapidly expand and adapt existing programs. • Protecting Longer-Term Growth and Development: An important lesson learned during the Asian crisis is that neglecting core development spending during a major crisis can have large long run costs. Responding to immediate fiscal pressures by putting off maintenance of existing infrastructure essential for economic development, for example, can lead to costly rehabilitation over the longer term and also hold back economic recovery. The same can be said of reduced public spending on human capital development, such as basic education • Protecting the Vulnerable. Inevitably, the crisis will impact social and human development objectives. Declining growth rates combined with high levels of initial poverty leave many households in developing countries highly exposed to the crisis. The Bank estimates that of 116 developing countries, 94 have experienced decelerating growth, of which 43 experience high levels of poverty. This implies new spending needs and may warrant a re-prioritization of existing public spending. While impacts are country specific, the crisis entails real risks for future poverty reduction and exposes poor and vulnerable households to potentially severe welfare losses. Households in the poorest countries are the most in danger of falling back into poverty and have less access to safety nets to cushion the impact. To some extent, countries that established or improved the efficiency of social safety nets during the food and fuel crisis can utilize these channels to protect the poorest and most vulnerable. Critical to protecting households in exposed countries will be the ability of governments to cope with the fallout and finance programs that create jobs, ensure the delivery of core services, and provide safety nets. However, given the scarcity of resources, the challenge remains to continue to improve the targeting and effectiveness of social support. Pursuin these objectives can require significant resources. But in an environment characterized by rising needs and scarce resources, policymakers face difficult challenges of setting spending priorities and maximizing the development impact of their spending. These challenges are particularly daunting for debt-distressed countries for which the resources


constraints are often greatest. Even if a country’s public debt is low, it may find it difficult to finance a large fiscal stimulus package. There is also considerable uncertainty with respect to both the severity and length of the economic downturn, further complicating the task of policy makers. A less protracted slowdown would suggest a focus on shorter term measures that are easily reversible, emphasizing (where possible) the acceleration of pre-existing spending plans rather than new initiatives. A more protracted slowdown would lengthen the horizon over which it would be desirable to implement countercyclical polices. With no clear sense of the length and depth of the crisis, contingency planning and enhanced monitoring of evolving economic and fiscal conditions will be critical. To date, all advanced economies and a majority of developing countries in the G-20 have announced plans for coping to crises. In Pittsburgh, at the summit, the G-20 members agreed to support six broad policy goals: 1. The new G-20 “Framework for Strong, Sustainable and Balanced Growth” will launch by November 2009. This framework promotes shifting from public to private sources of demand, establishing a pattern of growth that is sustainable and balanced, avoiding destabilizing booms and busts in asset and credit prices, and adopting macroeconomic policies that are consistent with stable prices. In order to achieve this framework, the G-20 members agreed to implement a “cooperative process of mutual assessment.” This cooperative process is comprised of: shared policy objectives; a medium-term policy framework and an assessment of the impact national policies have on global economic growth and financial stability; and actions to meet common objectives. Within this framework, the G-20 members agreed to: • implement responsible fiscal policies, attentive to short-term flexibility considerations and longer-run sustainability requirements; • strengthen financial supervision to prevent the re-emergence in the financial system of excess credit growth and excess leverage and undertake macro prudential and regulatory policies to help prevent credit and asset price cycles from becoming forces of destabilization; • promote more balanced current accounts and support open trade and investment to advance global prosperity and growth sustainability, while actively rejecting protectionist measures; • undertake monetary policies consistent with price stability in the context of market oriented exchange rates that reflect underlying economic fundamentals; • undertake structural reforms to increase potential growth rates and, where needed, to improve social safety nets; and


• promote balanced and sustainable economic development in order to narrow development imbalances and reduce poverty. 2. To strengthen the regulatory system for banks and other financial firms by raising capital standards, implementing strong international compensation standards, improving the over-the-counter derivatives market, and holding large global firms accountable for their risks. As components of this process, the G-20 agree to: building high quality bank capital and mitigating procyclical actions; reforming compensation practices to strengthen financial stability; improving over-the-counter derivatives markets; and addressing cross-border resolutions and systemically important financial institutions. In addition, the G-20 leaders indicated their support for efforts to improve the financial system by taking actions against non-cooperative jurisdictions, including using “countermeasures against tax havens,” and by tasking the Financial Action Task Force (FATF) to issue a list of high risk jurisdictions by February 2010. 3. To modernize the global architecture by designating the G-20 as the premier forum for international economic cooperation, by establishing the Financial Stability Board (FSB), by having the FSB include major emerging economies, and by having the FSB coordinate and monitor progress in strengthening financial regulation. Also, the G-20 agreed to shift the IMF quota share to dynamic emerging markets and developing countries of at least 5%, using the current IMF quota formula. The change in quotas is keyed to the IMF’s quota review that is scheduled to be completed by January 2010. In addition to reviewing the quotas, the G-20 indicated its support for reviewing the size of any increase in IMF quotas, the size and composition of the Executive Board, ways of enhancing the Board’s effectiveness, the Fund Governors’ involvement in the strategic oversight of the IMF, and the diversity of IMF staff, and the appointment of department heads and senior leadership through an open, transparent and merit-based process. The G-20 countries also agreed to contribute over $500 billion to a renewed and expanded New Arrangements to Borrow facility in the IMF. Additional IMF funding will also be available through gold sales and through additional Special Drawing Rights (SDRs). The G-20 also called for reforming the mission, mandate, and governance of the development banks, including the IMF, which the G-20 indicated must play a “critical role in promoting global financial stability and rebalancing growth.” They also called on the World Bank to play a leading role in responding to problems whose nature requires globally coordinated action, such as climate change and green technology, food security, human development, and private-sector led growth. 4. To take new steps to increase access to food, fuel, and finance among the world’s poorest economies, while clamping down on illicit outflows. The G-20 also agreed to improve energy market transparency and stability, and to improve regulatory oversight of energy markets. 44

5. To phase out and rationalize over the medium term inefficient fossil fuel subsidies while providing targeted support for the poorest. Agreed to stimulate investment in clean and in renewable energy and in energy efficiency, and to take steps to diffuse and transfer clean energy technology. 6. To maintain openness and move toward greener, more sustainable growth. In addition, the G-20 countries are addressing a number of issues related to correcting abuses in the financial markets, particularly those involving non-bank financial institutions and complex financial instruments. Analysts and policymakers generally agree that the lack of regulation of new non-bank financial institutions, such as hedge funds and private equity firms, and the lack of transparency of new complex financial instruments, such as derivatives, were key factors in the current financial crisis. The G-20 leaders also called for common principles for reforming financial markets. These principles include: strengthening the transparency and accountability of firms and financial products, extending regulation to all financial market institutions, promoting the integrity of financial markets (such as bolstering consumer protection) and consistent regulations across national borders, and reforming international financial institutions to better monitor the health of the financial system. The G-20 London Summit reiterated the need for financial supervision, regulation, and transparency of financial products37. The role of the G-20 in dealing with the global financial crisis began on November 15, 2008, with the G-20 Summit on Financial Markets and the World Economy that was held in Washington, DC. This was billed as the first in a series of meetings to deal with the financial crisis, discuss efforts to strengthen economic growth, and to lay the foundation to prevent future crises from occurring. This summit included emerging market economies rather than the usual G-7 or G-8 nations that periodically meet to discuss economic issues. It was not apparent that the agenda of the emerging market economies differed greatly from that of Europe, the United States, or Japan. At the November G-20 summit, the leaders agreed on common principles to guide financial market reform: • Strengthening transparency and accountability by enhancing required disclosure on complex financial products; ensuring complete and accurate disclosure by firms of their financial condition; and aligning incentives to avoid excessive risk taking. • Enhancing sound regulation by ensuring strong oversight of credit rating agencies; prudent risk management; and oversight or regulation of all financial markets, products, and participants as appropriate to their circumstances.

Pittsburg summit


• Promoting integrity in financial markets by preventing market manipulation and fraud, helping avoid conflicts of interest, and protecting against use of the financial system to support terrorism, drug trafficking, or other illegal activities. • Reinforcing international cooperation by making national laws and regulations more consistent and encouraging regulators to enhance their coordination and cooperation across all segments of financial markets. • Reforming international financial institutions (IFIs) by modernizing their governance and membership so that emerging market economies and developing countries have greater voice and representation, by working together to better identify vulnerabilities and anticipate stresses, and by acting swiftly to play a key role in crisis response. At the London Summit, the leaders reviewed progress on the November G-20 Action Plan that set forth a comprehensive work plan to implement the above principles. The Plan included immediate actions to: • Address weaknesses in accounting and disclosure standards for off balance sheet vehicles; • Ensure that credit rating agencies meet the highest standards and avoid conflicts of interest, provide greater disclosure to investors, and differentiate ratings for complex products; • Ensure that firms maintain adequate capital, and set out strengthened capital requirements for banks’ structured credit and securitization activities; • Develop enhanced guidance to strengthen banks’ risk management practices, and ensure that firms develop processes that look at whether they are accumulating too much risk; • Establish processes whereby national supervisors who oversee globally active financial institutions meet together and share information; and • Expand the Financial Stability Forum to include a broader membership of emerging economies. The leaders instructed finance ministers to make specific recommendations in the following areas: • Avoiding regulatory policies that exacerbate the ups and downs of the business cycle; • Reviewing and aligning global accounting standards, particularly for complex securities in times of stress; • Strengthening transparency of credit derivatives markets and reducing their systemic risks; • Reviewing incentives for risk-taking and innovation reflected in compensation practices; and


• Reviewing the mandates, governance, and resource requirements of the International Financial Institutions. The leaders agreed that needed reforms will be successful only if they are grounded in a commitment to free market principles, including the rule of law, respect for private property, open trade and investment, competitive markets, and efficient, effectively-regulated financial systems. The leaders further agreed to: • Reject protectionism, which exacerbates rather than mitigates financial and economic challenges; • Strive to reach an agreement this year on modalities that leads to an ambitious outcome to the Doha Round of World Trade Organization negotiations; • Refrain from imposing any new trade or investment barriers for the next 12months; and • Reaffirm development assistance commitments and urge both developed and emerging economies to undertake commitments consistent with their capacities and roles in the global economy. To respond to the global crisis, the ILO wished to put in place a global jobs pact; a political agreement that would focus on social protection, employment rights, and social dialogue. An analysis of 40 stimulus packages in place had found that they did not respond to those issues. A jobs pact implied a change in approach and a move away from the easy notion that economic recovery would automatically lead to job creation; a jobs crisis had existed even before the economic downturn and that was why there was an informal economy. Within a social market economy, targeted policies that invested in job creation would help to move markets in a productive direction. As Professor Sachs had suggested, investment in green energy and a sustainable environment would be important. At the same time, there needed to be investment in small businesses as they provided most job creation with relatively few resources. Social protection was needed to ensure safe and viable jobs, shorter hours and skills development, limit wasteful layoffs, support job seekers through unemployment benefits and employment services, and reinforce labour market programmes. Governments should use measures that had been proven to work, but which had been marginalized as economic bubbles developed. At the request of the United Nations, the components of a global jobs pact would be discussed at the International Labour Conference and the G20 had requested that ILO measure job creation initiatives that were already in place. There would be no improvement in the economy until the financial system had recovered. There would probably be a little growth in 2009 but the risk was that, as economies recovered, continuing unemployment would be ignored.


The jobs crisis, which had preceded the economic crisis, had arisen due to imbalances in a global economy which overvalued the role of markets and their capacity to regulate themselves and undervalued the role of the state and of governance and regulation. Worse still, the dignity of work had been devalued as salaries in terms of GDP had fallen: both developed and developing countries had reduced the participation of workers in the wealth they were creating. New economies would have to espouse respect for the environment, for public goods and for social welfare; aspects that had been cut in International Monetary Fund programmes. It was not acceptable for Governments to cut social expenditure in order to pay creditors. Parliamentarians should consider what type of globalization would be reasonable and sustainable. Before the present downturn had begun, the World Commission on the Social Aspects of Globalization, established by the ILO in 2002, had found the imbalances in the global economy to be morally unacceptable and politically unsustainable. In order to confront the crisis, it was essential that parliamentarians should set aside internal rivalries and unite to produce a strong, national position. Parliamentarians should listen to the people they represented and respond to their need for jobs, social protection and social safety nets, themes which were set out in the ILO’s Decent Work Agenda. To the OECD level was elaborated a Guide for Multinational Enterprises which covers a wide series of the problem for the behavior and ethic in business. This guide was agreed by the state members of the OECD and signed by 11 member states of the OECD and includes the general principles and recommendations which promotes the compatibility with the laws, with the protection of the consumer interests, respecting the man rights, the care against the occupation, work relations, environment protection. The guide was utilized by the Agencies of Rating and Grants when they elaborated recommendations for the corporate responsibility. Another multilateral instrument refers to the Principles of Corporate Governance (PCG) elaborated by OECD as part of the Forum of Stability regarding the key standards of the healthy financial markets. The principles of the corporate governance solve the structure and the quality of the systems of settlements, distinguishing the importance of some high ethical standards when we develop a business or in relations with the stakeholders. The principles underline the role of the Board of Directors in establishing the ethical standards of some company which doesn’t refers only to the compatibility with the law systems but to an ethical code “of behavior” which can be an effective method to know “the high tone”. If the standards of the high ethic are desired within their nature, the PCG make a direct bound with the performance of the corporations, therefore is underlined the idea that the ethic generate performance (profit)38.

Carmen Năstase1 and Miika Kajanus University Stefan cel Mare, Suceava, Romania Savonia University of Applied Sciences, Finland THE IMPACT OF THE GLOBAL CRISIS ON


OECD works intense to improve the multilateral agreements mentioned as in 2009 to offer increased chances to consolidate the ethical environment in business on different canals. The recovery of the economical growth and the edification of some new international financial system entered into the sphere of preoccupation of the decision factors to the national and international levels. Therefore, OECD elaborated the Strategically Answer to the Economical and Financial Crisis destined to strength the ethic in business in different ways. In this sense, it is to mention the assistance which can give OECD to the countries to strength the transparency in domains like transparency, competition, corporate governance, taxes and pensions, concomitant with promoting of a better financial education and the identification of the domains in which is followed serious difficulties of the settlement instruments. OECD will intensify the efforts and in other domains like: - The Implementation of the Principles of the Corporate Governance into the financial sector in which the re-establishment of the thrust had become a major imperative. To the G-20 Summit from Washington from 2008, the member countries of OECD promised to formulate an action plane to solution the weaknesses of the corporate government connected to the financial crisis, mainly regarding: the management of the risk; the remuneration; the rights of the shareholders; the practices of the administrations councils. - The improvement and the actualization of the OECD guides for Multinational Enterprises elaborated 9 years ago, considering the new elements and changes which brought the present crisis. This guides offer to the enterprises behavior reference adequate to the systems of conformity and management and interpret concrete situations for the financial system. - It will offer mechanisms perfected by peer review in key domains like opened and responsible investments, anticorruption, competition or other aspects of the responsible behavior in business. - The cooperation to build a new frame of settlement for a global economy more secure and global. In this sense, OECD with G-20 sketch an action plan in the domain of “Strengthening the International Cooperation and of the Promoting the Integrity on Financial Markets”. In response to the liquidity pressures on emerging markets, the IMF has created a new facility, the Short-Term Liquidity Facility (SLF), to provide major, up-front, quick-disbursing

Economic Policy in the Wake of the Crisis P756. Vol XII • No. 27 • February 2010


and short-term financing to eligible emerging countries with a good track record of sound economic policies39. The World Bank Group is stepping up its financial assistance to its clients on a number of fronts. There is scope to almost triple lending to around $35 billion in FY2009, and lending volumes could potentially reach $100 billion over the next three years. Following its record 15th replenishment, IDA is positioned to assist LICs in dealing with the impact of the global financial crisis, with commitments amounting to nearly $42 billion over the next 3 years, and scope for front-loading this support over the next year. The Bank is at the forefront of global efforts to mobilize resources for developing countries, particularly those without the means to cushion the impact of a crisis not of their making. Central to this effort is a World Bank proposal for an umbrella Vulnerability Fund to which developed countries could dedicate 0.7 percent of their planned economic stimulus. The Vulnerability Fund, which could channel resources not only through the Bank but also through the UN or other MDBs, would help countries without the resources to respond to the crisis by funding investments in three key areas: • Infrastructure projects that would help put people in developing countries back to work while building a foundation for future growth and productivity. • Safety net programs, such as conditional cash transfers that make it possible for people to keep their children in school, get adequate nutrition and seek health care. • Financing for small and medium-sized businesses and microfinance institutions to help the private sector create jobs. The Bank continues to adapt its financial instruments to the specific needs of its clients.The World Bank Group is also establishing a comprehensive IBRD/IDA Vulnerability Financing Facility (VFF) to streamline its support to protect the poor and vulnerable during global and systemic shocks. The VFF could be one option for countries wishing to contribute to the Vulnerability Fund. Along with its support to the private sector and to sustain infrastructure investment, the VFF is part of an emerging framework for addressing developing country vulnerability to crises. The VFF currently incorporates three initiatives: the Global Food Crisis Response Program (GFRP); the IDA Fast-Track Facility, which will fast-track up to $2 billion of financial assistance, with potential to increase this amount in future; and the Rapid Social


Development Goals — Impact of the Financial Crisis onDeveloping countries
SEC(2009) 445 Brussels, 8.4.2009, p33. 50

Response Fund to help protect the poor and vulnerable in middle and low-income countries affected by different dimensions of the global crisis. These initiatives focus respectively on three key areas of vulnerability response: agriculture, which is the main livelihood for the majority of the world’s poor, programs to protect investments in longer term development in the poorest countries, and employment, safety nets and protection of basic social services to help the poor and vulnerable groups cope with crisis. To respond to the challenges the current crisis presents for the infrastructure sector, the WBG is also launching an Infrastructure Recovery and Assets (INFRA) Platform. The objectives of the three-year INFRA Platform are to: stabilize existing infrastructure assets by restructuring current portfolios, covering maintenance costs, and advising clients on currency and interest rate risk management; (ensure delivery of priority projects through Public Expenditure Reviews and government capacity building, by accelerating disbursements and/or identifying additional financing, and by seizing the opportunity for “green infrastructure” through access to leveraging facilities, (e.g. Carbon Partnership Facility, Clean Technology Fund); support Public Private Partnerships (PPPs) in infrastructure through advisory and restructuring support, use of Bank Group guarantees, innovative instruments, and in coordination with the IFC Infrastructure Crisis Facility; and (iv) support new infrastructure project development and implementation by providing financing and advice to governments launching growth and job enhancement programs, as well as new infrastructure projects. IBRD/IDA aims to support the achievement of the INFRA Platform objective through. • Direct IBRD and/or IDA funding of infrastructure projects of up to $15 billion per year, • Diagnostic and advisory support to identify countries most at risk and projects most appropriate for INFRA support, • Technical assistance to governments in the development of fiscal stimulus packages, • Providing parallel financing to ensure collaboration and complementarity among bilateral and IFI financing for priority projects, • Providing concessional financing for project preparation and financing for priority projects to mobilize additional funds for infrastructure development. In addition to direct financial support, the Bank continues to provide developing countries with access to diagnostic and capacity-building instruments like Public Expenditure Reviews (PERs) and Debt Management and Performance Assessments (DEMPA)—the former to help improve budget management and identify priority expenditures to be protected should financing shortfalls persist, the latter as a critical tool for assuring essential fiscal sustainability. The value to developing countries of these instruments has increased in a resource constrained environment, as will the usefulness of technical assistance to improve revenue and customs 51

administration. A number of client countries are also looking for assistance in building bank supervisory capacity to enable them to more effectively monitor developments and respond to weaknesses in domestic financial sectors as they emerge. The IFC Private Sector Platform will provide support to the private sector in LICs and vulnerable MICs for crisis-related activities. The International Finance Corporation (IFC) has launched or expanded five facilities to address problems experienced by the private sector. Financing for the new facilities is expected to total about US$30 billion over three years, combining IFC funds and externally mobilized resources, including from governments, export credit agencies, and international financial institutions. Among the efforts underway are: - Expansion of the Global Trade Finance Program (GTFP). The existing program, which offers banks partial or full guarantees on the payment risk in trade transactions, was doubled in size and can now support up to US$18 billion in short-term trade finance over the next three years. Since its inception in September 2005, US$3.2 billion in trade guarantees have been issued in support of 2,600 transactions. Of these, 48 percent were for banks in Africa, 70 percent involved small and medium enterprises, half supported trade with the world's poorest countries, and 35 percent facilitated trade between emerging markets. The expanded facility is expected to benefit participating banks in more than 65 developing countries. - Creation of a Global Trade Liquidity Pool (GTLP). While expansion of the GTFP greatly increases the potential to support trade finance through the use of guarantees, the severe shortage of liquidity has made it difficult for many companies to line up the basic financing to be guaranteed. IFC is therefore working with a number of partners to create a funded Global Trade Liquidity Pool and will seek Board approval for its adoption at the end of March. With the involvement of a number of global or regional banks active in trade finance, the GTLP will fund trade transactions for up to 270 days and will be self liquidating once conditions for trade finance improve. - Bank Recapitalization Fund. IFC recently approved a US$3 billion Bank Recapitalization Fund to provide Tier I and Tier II capital to distressed banks in emerging markets which lack alternative sources of financing. It will also provide advisory services to strengthen private sector development and improve economic and financial performance. IFC expects to invest US$1 billion of its own money. Japan has announced its intention to become a key founding partner and provide the remaining US$2 billion in financing. - Infrastructure Crisis Facility. This IFC facility, which is part of the WBG’s broader Infrastructure Recovery and Assets (INFRA) Platform, will help ensure that viable, privately funded infrastructure projects in emerging markets have access to the funding they need to weather the financial crisis by providing temporary financing to private or public-private 52

partnership infrastructure projects in emerging markets. Among other things, it will roll-over financing and temporarily substitute for commercial financing for new infrastructure projects, if funding is unavailable. IFC expects to invest a minimum of US$300 million and mobilize between US$1.5 billion and US$10 billion from other sources. - Microfinance Liquidity Facility. As one of the top three international investors in microfinance, IFC has designed a liquidity facility to help ensure availability of adequate refinancing for Microfinance Institutions amidst the market turmoil. The US$500 million facility is a joint effort with Germany’s KfW. Using three of the industry’s largest fund managers, the facility will provide refinancing options of up to 70 percent of the microfinance market. IFC expects to invest up to $150 million40. In addition, IFC will contribute up to €2 billion in a coordinated effort (with the EBRD and the EIB) to finance assistance to businesses hit by the crisis in Central and Eastern Europe. It will be disbursed through IFC’s various crisis response initiatives in sectors including banking, infrastructure, and trade as well as through its traditional investment and advisory services. This is part of a broader €24.5 billion joint effort to support the banking sectors in the region and to fund lending to businesses hit by the global economic crisis, of which the World Bank Group will provide support of about €7.5 billion. The Multilateral Investment Guarantee Agency (MIGA) continues to focus its guarantee activity in higher risk/low income countries and on difficult structured finance transactions. During December of 2008 and January 2009, MIGA approved US$675 million in guarantees in support of loans to three foreign-owned financial institutions operating in Ukraine. A US$95 million guarantee was provided to a subsidiary of foreign-owned financial institution operating in Russia. Similar guarantees are being explored for banks operating in other Eastern Europe countries and in Africa, in collaboration with IFC. MIGA is in the process of proposing changes to its operational regulations to allow it to respond more rapidly to emerging needs.


“Swimming against the tide: how developing countries are coping with the global crisis” Background Paper prepared by World Bank Staff for the G20 Finance Ministers and Central Bank Governors Meeting, Horsham, United Kingdom on March 13-14, 2009. p14-15. 53