3.   Rates of charge must be uniform for all members but uniformity does not imply that there must be a single rate of charge on all use of Fund resources.⁵ Article V, Section 8(b), as amended in 1978, provides that “the rates of charge normally shall rise at intervals during the period in which the balances are held”—that is, during the period in which Fund credit is outstanding—although this does not preclude graduation by the level of Fund credit outstanding. The Fund can make distinctions among uses of Fund resources, provided these distinctions are based on relevant criteria and are consistent with the purposes of the Fund, and provided they are applied to all members in the same circumstances.

4.   The key features of the historical evolution of the rate of charge are discussed in more detail in the following sections.

II.   Graduation with Time and Level of Credit Outstanding: 1945–74

5.   The original system of charges was based on the amount and maturity of credit. Charges on the use of Fund resources were determined on the basis of separate graduating schedules of charges for each tranche of Fund credit outstanding from the inception of the Fund until June 30, 1974 (Table 1).

• In the first tranche (up to 25 percent of quota), there were no charges for Fund credit outstanding for an initial period, typically up to three months. The initial rate of charge was set at 0.5 percent in the original Articles but was subsequently increased to 2.0 percent. Rates increased first semi-annually and then annually in steps of 0.5 percentage point up to a ceiling of 5.0 percent.

• In the higher tranches, the rate of charge followed a similar pattern; with a higher initial rate, the 5.0 percent ceiling was reached sooner.

6.   This system imposed higher charges for long or large use of Fund resources. The rate of charge was determined first on the basis of the member’s existing level of Fund credit outstanding, from which point the rate of charge would graduate with time. If a new purchase were to cause Fund credit outstanding to advance to a higher tranche, then the portion of Fund credit above the threshold would be subject to the schedule applicable to that tranche, which would normally carry a higher rate of charge.

7.   Graduation was intended to encourage the temporary use of Fund resources. Under the original Articles, there were no fixed periods for repurchase. Moreover, until the inception of the stand-by arrangement in the early years of the Fund, there were no established policies ensuring periodic repurchases in respect of the use of Fund resources. Instead, the Fund and the member would consult on the means by which Fund credit outstanding could be reduced whenever the rate of charge within any tranche had reached 4.0 percent.

8.   The system was complicated by the segmentation of Fund credit. In order to administer what was primarily a time-based surcharge, the Fund had to establish the size and timing of each “segment” of Fund credit arising from purchases, to which a separate schedule of charges would apply (Box 1). For each member, the size of each segment was determined on the basis of changes in the average monthly level of Fund credit outstanding for the member. Segments thus bore little relation to the actual pattern of purchases; moreover, it was not possible for members to calculate the cost of their Fund credit without taking into account the specific timing of each of the purchases and repurchases they had made.

9.   Implementation also gave rise to perverse incentives. For the purpose of determining charges, repurchases were attributed first to the newest segments of Fund credit outstanding, which generally carried a lower rate of charge (rather than to the earlier, more costly purchases). Beyond the problem of complexity, this attribution method tended to work against the objective of discouraging large or long use of Fund resources: the system of charges presented members with only a small incentive to repurchase early (as the most costly segments could be extinguished only by eliminating all Fund credit outstanding) or to forgo additional purchases (as the new segments were always the least costly).

III.   Graduation with Time: 1974–81

10.   Developments in and outside the Fund led to changes in the system of charges. In particular, graduation of charges with respect to the level of Fund credit outstanding was eliminated on July 1, 1974. At the same time, the absolute level of the rates of charge was raised and the schedule of charges graduating with time was simplified by reducing the number of steps (Table 2). The motivation for these changes revolved around three key developments:

• The use of borrowed resources and the establishment of new facilities. The Fund introduced several new facilities that were financed through borrowed resources, such as the two Oil Facilities. The distinction between borrowed and ordinary (quota) resources complicated the system of charges. Financing through borrowed resources necessitated separate schedules of charges for those resources, and argued for a simpler system of charges on the Fund’s ordinary resources, including on purchases under the newly established EFF.

• The evolution of Fund lending policies. Experience with the application of conditionality—that is, more demanding policy requirements for purchases in the upper credit tranches—suggested that Fund policies were likely to be effective in preserving the revolving character of the Fund’s resources.⁶ This was seen as reducing the need for charges to graduate with the level of Fund credit outstanding.

• The increase in market interest rates. Interest rates in the major capital markets had risen substantially since the last revision to the schedule of charges in 1963, and the Fund’s charges were substantially below the prevailing market rates. As the First Amendment of the Articles in 1969 had imposed on the Fund the obligation to pay remuneration on creditor (reserve tranche) positions based on market rates, the Fund’s income position came under increasing strain.⁷

1/ Includes purchases in credit tranches and under EFF, BSFF (Buffer Stock Financing Facility), and CFF (Compensatory Financing Facility).
2/ Supplementary Financing Facility, under which the Fund borrowed resources.
3/ Applied to all Fund credit outstanding in excess of 100 percent of quota under SBAs and 40 percent of quota under EFFs. The base rate for the surcharge was based on U.S. Treasuries of constant five-year maturity.
4/ Increased to 4.375 percent as of April 1, 1977.
5/ Applied after 3½ years.
6/ Applied after 4½ years. Reduced to 0.325 percent in 1980.
7/ Applied only to EFF; maximum period of 8 years.
8/ Maximum period of 7 years.

11.   The time-based graduation feature of the system of charges was retained. The principle of graduation was applied to most facilities, resulting in a variety of highly specific schedules of charges. The calculation of charges remained otherwise unchanged, and continued to involve the division of Fund credit outstanding into segments and the use of an attribution method that divorced segments from the actual schedule of purchases and repurchases. The new system thus left essentially unchanged the incentive structure of the pre-1974 system.

IV.   A Single Rate of Charge: 1981–Present

12.   Pressures to simplify further the system of charges began to mount. With the creation of new facilities and the use of new financing sources in the 1970s, the number of schedules began to proliferate and the system of charges became rather unwieldy and nontransparent. At about the same time, the impact of two changes introduced under the Second Amendment in 1978 were beginning to be felt:

• Fixed repurchase schedules. The repurchase period currently applicable to the use of Fund resources under stand-by arrangements (3¼-5 years) is based on Article V, Section 7(c), introduced in 1978. The formalization of Fund practice in this area through the Second Amendment supported the growing importance of conditionality and other lending policies in ensuring that Fund resources were not used longer than necessary.

• The link between remuneration and market interest rates. Under the First Amendment, remuneration of creditor positions was only loosely linked to market interest rates but had already become an important part of the Fund’s expenses. The Second Amendment strengthened that link, while charges (the primary source of Fund income) continued to be adjusted only infrequently, which could and did lead to operating deficits.⁸

13.   The graduation of charges was eliminated altogether in 1981. At the same time, the various schedules of charges for use of the Fund’s ordinary resources were consolidated into a single rate of charge (Table 3). Separate rates of charge were maintained for the use of Fund resources financed from borrowed resources until 1993, when the Fund adopted a uniform rate of charge on all use of Fund resources. A single, fixed rate of charge continued to be determined annually until 1989, when a variable rate was introduced through the establishment of a direct link between the rate of charge and the SDR interest rate. Thus, the elimination of the time-based graduation of the rate of charge was part of a broader effort to simplify the system of charges and safeguard the Fund’s income position.

1/ Fixed rate until 1989; thereafter rate linked to the SDR interest rate.
2/ Use of Fund credit extended under the SRF/CCL is subject to a surcharge of 3–5 percentage points.

14.   A surcharge and graduation of charges with time was reintroduced in 1997 with the adoption of the SRF. In particular, purchases under the SRF (and now the CCL) are subject to a surcharge over the standard rate of charge. The surcharge graduates with the time that has elapsed since the first purchase. The first step in the graduation of the surcharge coincides with the date of the first repurchase expectation in order to strengthen the incentive to repurchase on or before the expectation date.⁹

15.   The surcharge under the SRF/CCL effectively avoids many of the technical complexities and perverse incentives of the earlier system of charges. In terms of the broad design options for time-based surcharges described in the main paper (paragraph 33 and Annex III), the surcharge under the SRF/CCL follows the first option. A surcharge linked directly to purchases under a specific arrangement avoids the segmentation of credit and provides strong incentives to repurchase early. In contrast, the system of time-based graduation implemented by the Fund through 1981 followed closely the more complex hybrid option (Annex III, Figure 1, Panel 3), with a low incentive to repurchase as well as a zero marginal surcharge on new arrangements.

V.   Conclusion

16.   Experience with graduating rates of charge underlines the importance of three elements:

(a)   Simplicity in the technical design of the system. The system that was in place in one form or another through 1981 came to be regarded as highly complex in large part because the segmentation of Fund credit outstanding and the particular attribution method for repurchases were complicated. This difficulty was magnified by the distinction between borrowed and ordinary resources and the proliferation of facilities in the 1970s.

(b)   Appropriate incentive structure. The system through 1981 had only limited success in encouraging early repurchases because the incentives worked at cross purposes. On the one hand, graduation of charges with time (and until 1974, the level of Fund credit outstanding) provided a clear inducement to reduce the use of Fund resources. On the other hand, the segmentation method greatly reduced the incentives to make repurchases at the margin.

(c)   A basic rate of charge linked to market interest rates. The cost of borrowing from the Fund when graduated rates of charge were in effect was low in absolute terms (see Tables 1 and 2 above). The range of graduation generally added little to the incentive for members to repurchase or to forgo purchases; even at the ceiling, graduated rates remained well below comparable market rates. The rate of charge was formally related to market interest rates in 1981, and linked directly to market rates in 1989. Since then, the rate of charge has been set in relation to the weekly SDR interest rate, which represents rates on high-quality, short-term instruments (see paragraph 30 in the main paper).

17.   More recent experience would suggest that a system of graduated rates of charge can be both simple and effective in encouraging the temporary use of Fund resources. Most important, the pre-condition of a market-related basic rate of charge is now in place. Provided that the system is aimed at a limited number of objectives, it should be possible to design a system of graduated charges that is relatively simple to understand and implement while also providing the right structure of incentives (see in particular paragraph 40 of the main paper).

¹ The Poverty Reduction and Growth Facility has a fixed, flat interest rate and is not considered in this Supplement (see also paragraph 4 of the main paper).

² Formally, the relevant provisions of the Articles of Agreement are framed in terms of a particular definition of currency holdings relative to quota, rather than the financially equivalent Fund credit outstanding. For expositional purposes, the latter formulation is used in this Supplement as in the main paper.

³ Different rates of charge continued to apply to Fund credit financed from borrowed resources until 1993.

⁴ The Fund also levies a service charge on each drawing of Fund credit and a commitment fee in respect of amounts available under Fund arrangements.

⁵Article V, Section 8(b)

⁶ See Remuneration and the Fund’s Charges, EBS/74/114 (4/26/74).

⁷ Previously, members received interest on their creditor positions only when the Fund’s income position was strong enough to allow for a distribution of income.

⁸ The rate of remuneration must be within 80–100 percent of the SDR interest rate (Article V, Section 9(a)).

⁹ As noted in the main paper (paragraph 30), Fund credit extended under the SRF has generally been repaid in advance of the expectation dates—that is, when the first step increase in the time-based surcharge would apply.