The scenario starts when a country or region faces an unexpected debt or liquidity crisis, such as the Mexican peso crisis of 1994–1995. The private sector makes the first moves, making decisions on investments and capital withdrawals that can shake the economy of the country, a region, or even the world. Then multilateral financial institutions—the IMF, World Bank, IDB and others—step in to assemble a rescue package while the stricken nation agrees to carry out stabilization and reform measures.
After the immediate crisis subsides, the pivotal question arises: how to get the private sector—always quick to bail out of a country when it perceives new risks or liabilities—to bail back in once things settle down.
This process of “burden sharing,” in which the private and public sectors join to rescue nations from a downward financial spiral, was the subject of a recent meeting of Latin American finance ministers, presidents of central banks and multilateral and academic experts held at the IDB’s Washington, D.C., headquarters.
Burden sharing does not come easily. Public officials argue that since the private investment community stands to benefit from a successful rescue package put together from public resources, both the public and private sectors should share the costs of stabilization. Investment bankers and private financial institutions listen politely to these arguments, but at the end of the day shareholder pressure largely determines whatever steps they take to preserve and enhance bottomline performance.
Participants at the IDB meeting cautioned against establishing concrete bail-in mechanisms, stressing the voluntary nature of the arrangements as necessary to prevent an adverse reaction. A country that seeks prevention and relief must pursue its goal with great discretion. Otherwise, it may create the impression of impending uncertainty, provoking the very kind of irrational financial flows that it was trying to prevent in the first place.
Among the mechanisms the officials suggested were voluntary debt contracts that facilitate renegotiation in case of a crisis.
Another way to promote greater stability is to allow countries greater flexibility in making use of contingent credit lines established by the International Monetary Fund. Another is the establishment of revised financial standards that would be well suited to Latin America, especially the capital adequacy standards of the Bank of International Settlements (BIS). The meeting participants suggested that the BIS complement ratings from private agencies with market measures of risk to make the ratings more accurate and less volatile.
The participants proposed further study on giving the IMF a role as international lender of last resort.