IMF lending
...port encourages borrowers and lenders to take unnecessary risks and whether these extra risks outweigh the benefit of IMF financial help in easing the impact of the crisis. Evidence of Moral Hazard Induced by IMF loans Emerging Market Capital Flows International financing often creates problems in the course of cross boarder capital flows.. Often, unspoken guarantees to foreign creditors, by domestic governments, are seen to cause a moral hazard situation, where creditors have no incentives to make sure that their money is carefully invested. Also for poor countries with insufficient capital will be restricted from investment opportunities, this may well be a severe constraint, which means that they will have to take excessive risk and take on large IMF loans which will lead to distortion of debtors or creditors incentives. The capital flows also depend on other factors such as risk aversion among creditors and macro-fundamentals among debtors as well as IMF lending policies. Assessing Financial Redistribution IMF has been acting a major role in assisting countries that are experiencing financial difficulties. Unlike insurance contracts where the it is permanent transfer of funds, IMF loans are only temporary transfer. IMF loans also bring along its negative costs which debtors and creditors each face as a result of crisis. The net result indicated that risk taking behaviour by both debtors and creditors are based on the net transfers, so therefore neither party are better off in the crisis even though there is IMF intervention. Even though IMF intervention may have resulted in average creditors and debtors no better off, but they are still affected by the marginal incentives. Debtors that derive the largest marginal incentives are those that whose macroeconomic polices make them most vulnerable to crisis. For creditors, that extract the marginal benefits are those lending short term. Evidence that IMF lending is being over used can be seen in the IMF loan book which shows that the top five accounts for majority of the credit outstanding, and repeated use of prolonged by borrowers. The increasing credit risk mean that it is a moral hazard. Assessing Financial Costs Borrowing costs faced by countries are considered to be a moral hazard. IMF loans act as a safety net for debtors and creditors from the risk of default. IMF intervention will reduces the borrowing costs for both the debtors and creditors which could result in lending or borrowing beyond practical levels. Borrowing costs may act as a indicative on risk taking incentives. Indirect Moral Hazard Indirect Moral Hazard occurs when IMF intervention support bad policies. When this happens taxpayers at the end will have to bear the bill due to the financial redistribution from taxpayers to private sector. Some bad policies include blanket official deposit guarantee to their banking system. A second indirect moral hazard is when government use IMF as mean to facilitate policies so they could win an election. This could mean that the government would be willing to pursue high risk policy strategies. The net result Market Capitalisation of banks The moral hazard can be detected through assessing the effect of the IMF loans on the market capitalisations of banks that are creditors of the debtors countries. It relies on the market valuation to assess the change price incentives for creditors to engage in risky investments. Critical Analysis of Approach to Creditor Moral Hazard Creditor moral hazard is the assumption that an expected IMF support to a country may provide an implied guarantee to its creditors regarding their returns, which motivates investors to take excessive risks. The IMF support to Mexico in 1995, which preceded financial crises in countries in Asian, North America, has led to the contention that IMF funds to a disaster country cause creditor moral hazard in financial markets. However there are those that prefer debtor country and its private creditors, rather than IMF to take them out of crisis. The problem is when using IMF loans as a mean to resolve crisis could distort the risk taking incentives. The issue that require to be examine is how much borrowing is too much? The two approaches are the ...