Why Don’t the Bretton Woods Sisters Offer Risk Insurance? (Could Governance Be Part of the Problem?)

March 20, 2009

Why have the IMF and the World Bank been so backward on risk management products — an issue Guillermo Perry explores in a forthcoming CGD book? What is it about their governance, mandate, instruments and/or human nature that leads them like horses to water to lending, even defensive lending, during good times, in effect inviting them, for lack of prior development of insurance and savings products, to “indulge” in a new round of lending in bad times? (Is it a coincidence that the same problem seems to plague microfinance initiatives — where, as David Roodman among others points out, credit eclipses savings and insurance programs by orders of magnitude?) Isn’t this asking countries to acquire more debt to build a new house to replace one that has burned down — when instead they should have had access to fire insurance? Isn’t it the lack of fire insurance that induces the self-insurance of reserve accumulation that has added to the global imbalance that is behind the current meltdown?

Eswar Prasad puts it this way, in a short note summarizing a terrific proposal for an insurance pool for the Group of 20 largest economies. The pool would be designed to reduce the incentive for countries to self-insure with reserves and, via higher premiums, to also discourage risky behavior in the other direction, such as countries running large deficits and accumulating excessive debt (e.g. United States in the last decade).

Everyone is now keenly aware of the imbalances that allowed the financial crisis to develop into a cataclysm. But governments are pursuing the same old policies that brought on the crisis in the first place, because no one has yet succeeded in giving countries incentives to take global financial stability into account when crafting their domestic policies. It’s time for a new approach.

Prasad suggests the Financial Stability Forum administer the global insurance program. One wonders what it is about IMF mandates, instruments, culture, or governance that explains why he proposes the FSF and not the IMF, and why his good idea wasn’t developed in the first place at the IMF (where in fact he used to work). And more broadly, why do good new ideas get developed outside not inside our major global financial institutions?

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1. Tayani Vincent Banda Says:
   May 26th, 2009 at 10:28 am

   Hie
   This is indeed apertinent issue that most financial institutions, especially by the Bank and IMF that are one the mother of finances. I have however knowwledge that the Bank is providing insurance cover to its client countries. In MALAWI for example the Bank has provided weather insurance tio shield against Bad weather because Malawi’s economy is Agrobased ans so anyy shocks in weather has serious repercussions on other macroeconomic and social variables. I have also come across material that the Bank has come up with a new framework for Catastophe risk financing, which is basically insurance.

   Which area is your discussion focussing on? I am not sure if this frameowrk covers both IBRD,IFC and IDA countries….but atleast I know IDA countries are covered.

2. Watch Stargate Says:
   July 12th, 2009 at 12:19 pm

   Found your article on google.com. Thanks for providing this great article Nancy.

3. Del Fitchett Says:
   September 16th, 2009 at 9:37 am

   Governance may be a major issue obstructing the Bretton Woods sisters from providing such insurance coverage. Conflicts of interest are found in many of the Bank/Fund activities. When I looked at the HIPC for the Bank’s IEG several years ago, I pointed out one such conflict of interest. The HIPC was intended to permit the Bank and the Fund to write off LDC debt service payments owed to them. The process for letting the Bank/Fund access the HIPC resources (primarily from the G7 donors) depended on the Bank/Fund approving a country’s HIPC Poverty Reduction Strategy Paper. The Paper was usually primarily written by Bank/Fund staff and submitted for approval to the Bank/Fund Boards. Once approved by the respective Boards, the Sisters had access to the HIPC funds – and then typically started to lend again and often put the country back into an overly indebted status. With such a track record of conflicts of interest, who would trust their assessments of individual countries? (By the way, my observation on this was not included in the final version of my report. So much for transparency!)

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