International Financial Crises

Mexico's 1994-95 financial crisis has prompted efforts by the Group of Seven countries to improve the ability of the International Monetary Fund (IMF), other official sector organizations, and capital market participants to prevent or respond to sovereign financial crises--situations in which countries have been unable or unwilling to pay their debts and, as a result, have lost access to global capital markets. In this report, GAO identifies factors that may increase or decrease the probability that a future sovereign financial crisis will threaten the stability of the international financial system and identifies the limitations of market and governmental mechanisms for preventing and resolving such crises. GAO also evaluates proposals by the Group of Seven countries and others to better (1) anticipate and avoid sovereign financial crises and (2) resolve these crises when they threaten the international financial system. GAO focuses on proposals that have been implemented or are in the process of being implemented. These proposals include the establishment by IMF of voluntary standards that countries may use when disclosing economic and financial data to the public; an expansion of the General Arrangements to Borrow, which are lines of credit that IMF maintains with the Group of Ten countries; and an expedited IMF decision-making procedure to extend financing in exceptional circumstances to member countries.

GAO noted that: (1) the possibility that a future sovereign financial crisis may threaten the stability of the international financial system cannot be ruled out, and current mechanisms to anticipate, avoid, and resolve crisis have limitations; (2) one limitation of mechanisms used to anticipate sovereign financial crises is that countries do not always supply the necessary information for market participants to accurately assess investment risks; (3) G-7 country initiatives may help anticipate and avoid some crises, but a number of obstacles may hinder the potential effectiveness of these initiatives; (4) for example, the International Monetary Fund (IMF) has developed a voluntary standard to improve countries' public disclosures of economic and financial data; (5) although IMF intends to enforce adherence to the standard, an IMF official told GAO that IMF lacks the authority and the resources to ensure the accuracy of these data and plans only limited monitoring to check for adherence to the data standards; (6) the G-7 has proposed an initiative to expand the General Arrangements to Borrow to quickly make more resources available to help resolve sovereign financial crises that threaten the international financial system; (7) GAO's analysis indicated that this initiative could reduce the U.S. share of the burden of resolving future crises, but its use would involve several trade-offs for the United States; (8) under this proposed initiative, the U.S. share would be slightly under the 20 percent of the new arrangements' funds, down from 25 percent under the General Agreements to Borrow; (9) however, although the U.S. share of the lines of credit would fall, the actual amount of funds the United States would contribute to the new lines of credit would increase; (10) use of the New Arrangements to Borrow would reduce the U.S. share of sovereign financial crisis resolution funding compared to the 51-percent share that the United States contributed to the 1995 multilateral financial assistance to Mexico; (11) however, the reduced U.S. participation in the new arrangements could dilute U.S. influence by decreasing its voting power, which might make it harder for the United States to influence activation of the lines of credit by IMF; and (12) use of the lines of credit could help to stem a crisis' spread to other countries and forestall systemic risk, but such use could also increase investors' or countries' moral hazard.