IMF Continues Push Toward Enhanced Global Financial Safety Net

Cross-border financial linkages could increase systemic risks

Countries with strong fundamentals not immune to systemic crises

Calls for stronger global financial safety net to assist crisis bystanders

Responding to calls from the international community, IMF staff have taken a closer look at the incidence of, and relationship between, cross-border linkages and past systemic crises—that is, episodes where many countries suffer severe economic and financial distress.

The work is part of a broader IMF effort to make the international monetary system less prone to crisis. “We are now looking more carefully at the causes of such crises and the global liquidity responses to identify any remaining gaps in our lending toolkit,” said Reza Moghadam, Director of the IMF’s Strategy, Policy and Review Department, in an interview earlier this year.

Rising cross-border linkages and risks

The dramatic growth in cross-border financial linkages over time (see Chart 1) can prove a double-edged sword for countries.

The increasing size and complexity of financial linkages between countries can help diversify the risks that individual countries face by reducing exposure to domestic financial system shocks. At the same time, these financial linkages increase the risk of rapid and simultaneous shocks between countries, with dramatic consequences for economic conditions.

Prior to the global crisis, for example, there was very little variation in the degree to which economic conditions abroad would influence an individual country’s economy. When the crisis hit, however, these external factors suddenly became a much stronger driver of domestic economic conditions (see Chart 2).

Crisis ‘bystanders’

Based on a new indicator that identifies systemic crises by synthesizing financial and economic stress across countries, the analysis identifies four systemic crises since 1980: the 1982 Latin American debt crisis, the 1992/93 European Exchange Rate Mechanism (ERM) crisis, the Asian/Russian/Long Term Capital Management combined crises of the late 1990s, and the 2008 global financial crisis (see Chart 3).

The analysis confirms that large systemic crises even affect countries with relatively strong fundamentals that seem unlikely to be prone to an individual crisis. The global crisis had a particularly large number of such “bystander” countries (see Chart 4).

Lessons from past crises

Policy responses in past systemic crises were effective in providing...