Press Release No. 16/156

Press Release: IMF Executive Board Discusses the Adequacy of the Fund’s Precautionary Balances

April 6, 2016

On February 19, 2016, the Executive Board of the International Monetary Fund (IMF) reviewed the adequacy of the Fund’s precautionary balances.¹

Precautionary balances are one element of the IMF’s multi-layered framework for managing financial risks. These balances, comprising the Fund’s general and special reserves² and the Special Contingent Account (SCA-1), are ultimately available to absorb possible financial losses, thereby helping protect the value of reserve assets represented by member countries’ positions in the Fund and underpinning the exchange of assets through which the Fund provides financial assistance to countries with balance of payments needs.

This review of the adequacy of the Fund’s precautionary balances took place on the standard two-year cycle. In conducting the review, the Executive Board applied the framework agreed in 2010. This framework includes an indicative range for precautionary balances, linked to developments in IMF total credit outstanding, that is used to guide decisions on adjusting the target for precautionary balances over time.

Executive Board Assessment³

Executive Directors welcomed the biennial review of the adequacy of the Fund’s precautionary balances. They emphasized the importance of maintaining an adequate level of precautionary balances to mitigate credit risks, safeguard the Fund’s balance sheet, and protect the value of members’ reserve positions in the Fund. Directors considered that an adequate level of precautionary balances is an integral part of the Fund’s risk management framework, which includes the strength of the Fund’s lending policies and its preferred creditor status.

Directors supported retaining the current medium-term indicative target for precautionary balances of SDR 20 billion. They observed that, while credit outstanding has fallen since the last review, the risks facing the Fund remain elevated, in light of a highly concentrated lending portfolio and the recent experience of substantial, albeit temporary, arrears on payments to the Fund. They also noted that existing loan commitments, including under precautionary arrangements, remain large, and the uncertain global outlook points to the potential for significant new demand for Fund lending. At the same time, the extremely low capacity of the burden sharing mechanism would increase the potential reliance on precautionary balances in the event of significant new arrears.

Directors generally agreed that the current framework adopted in 2010 for assessing the adequacy of precautionary balances remains broadly appropriate. They reiterated the continued importance of judgment and Board discretion in light of a broad assessment of financial risks facing the Fund. Some Directors saw scope for improving the robustness of the framework, including by taking more explicit account of the Fund’s credit capacity, commitments under precautionary arrangements, and potential demand for the Fund’s resources when setting the target for precautionary balances. Directors saw a need to keep the framework under review and refine it as warranted by further experience in its application.

Most Directors supported raising the minimum floor for precautionary balances from SDR 10 billion to SDR 15 billion, which would be more consistent with maintaining a sustainable income position in the medium term. They noted that this would also provide a larger buffer to protect against risks associated with any unexpected rise in credit, especially in an environment of elevated global economic uncertainty and increased economic and financial interconnectedness. While recognizing the importance of the minimum floor, some other Directors expressed reservations over the scale of the proposed 50 percent increase.

Directors took note of the most recent projections that, regrettably, precautionary balances would not reach the SDR 20 billion target over the medium term. They nevertheless did not see a compelling case at this time for taking additional steps to reach that target, recognizing that a significant build-up of reserves is projected in the next few years. They noted that this would allow time for greater clarity to emerge on the future path of loan demand and the evolution of credit risks, and that the pace of reserve accumulation could pick up if there is an upturn in Fund credit outstanding. Directors stressed the need to monitor these developments carefully, and a few called for measures to adjust the pace of accumulation to meet the indicative target if warranted.

Directors also considered the allocation of Fund income between the special and the general reserves. Many Directors saw merit in the staff’s proposal to allocate total future net income to both reserves, and could support, as a guiding principle initially, an allocation of one-half to two-thirds to the special reserve, given its role as the first line of defense against net income losses. A number of other Directors, noting legal constraints on the distribution of special reserves to members, did not see a strong rationale for moving away from the current practice of allocating surcharge income to the general reserve and net operational income to the special reserve. A few Directors questioned the rationale for segmenting the Fund’s retained earnings. While expressing different preferences, some Directors remained open to alternative allocation approaches and shares, and could go along with a consensus. Directors recognized that the Board would take a decision on the allocation of the Fund’s income to reserves in the annual review of the Fund’s income position.

Noting the strong interlinkages between precautionary balances and other topics, such as access limits and surcharges, income, and the margin for the basic rate of charge, many Directors encouraged a more holistic approach that would better join these issues together in the future.

¹ This press release summarizes the views of the Executive Board as expressed during the February 19, 2016 Executive Board discussion based on the paper entitled Review of the Adequacy of the Fund’s Precautionary Balances.

² Except for SDR 4.45 billion (about USD 6.21 billion) of the Special Reserve attributed to gold sales profits.

³ An explanation of any qualifiers used in summings up can be found here: http://www.imf.org/external/np/sec/misc/qualifiers.htm.