SUNNY SIDE OF THE STREET: ANALYSIS OF THE FINANCIAL SYSTEM & THE ECONOMY (part 45)

The International Financial System (part D)

by

Charles Lamson

Major International Financial Organizations

The Bretton Woods Accord of 1944 established the fixed exchange rate system that remained in effect until the early 1970s. In addition, the meetings at Bretton Woods resulted in the creation of the International Monetary Fund (IMF) and the World Bank. Although the fixed rate exchange system has not survived, the IMF and world bank did not meet a similar fate. Both have gained in stature, and another international organization, the Bank for International Settlements (BIS), is also discussed in this post. The BIS predates the IMF and the World Bank and is the oldest international financial institution in existence today.

Visit the site of the World Bank, the International Monetary Fund and Bank for International Settlements at www.worldbank.org, www.imf.org, and www.bis.org.

The International Monetary Fund (IMF)

The IMF was designed

to promote international monetary cooperation; to facilitate the expansion and balanced growth of international trade; to promote exchange stability; to assist in the establishment of a multilateral system of payments; to make its general resources temporarily available to its members experiencing balance of payments difficulties under adequate safeguards; and to shorten the duration and lessen the degree of disequilibrium in the international balances of payments of members.

As such, the IMF is a voluntary institution owned and directed by the countries that choose to join. The IMF is much like an overseer of the monetary and exchange rate policies of its members. Member countries agree to exchange their currencies freely with other foreign currencies, to keep the IMF informed of changes in financial and monetary policies that may affect other members, and to adjust these policies based on the recommendations of the IMF.

When joining the IMF, each country is assessed a quota (membership fee) based on its economic importance and the amount of its international trade. A country's voting rights in the organization are proportionate to the amount of its quota. The size of the subscription has grown as more countries have joined the IMF and larger quotas have been assessed. The IMF is headquartered in Washington D.C. Other offices are in Paris, in Geneva, Switzerland, and at the United Nations in New York.

The IMF administers the pool of funds generated by the quotas to assist member countries that, because of deficits in their balance of payments, do not have enough foreign exchange to pay all of the claims that are being presented to them. Members can borrow from the pool of funds to resolve temporary imbalances. This influx of funds gives them time to change their economic policies so that balance of payment deficits are resolved in an orderly manner with minimal damages to themselves and to other countries. Members must request assistance and abide by IMF policy recommendations if receiving the funds. In addition to the pool of funds generated from the quotas, the IMF also has standby agreements to borrow supplemental funds, if needed, from the wealthiest members.

In 1969, the IMF created special drawing rights (SDRs), which are international reserve assets that supplement other international reserves. SDRs were created in response to a shortage in international reserves. The value of the SDR is the weighted average of the U.S. dollar, the euro, Japanese yen, and British pound sterling, so it fluctuates daily. They are bookkeeping entries not backed by other reserve assets, and they provide the international financial system with additional liquidity. Central banks use SDRs, rather than other national currencies, to make payments to other member countries.

The World Bank

Like the IMF, the World Bank was created in 1944 at Bretton Woods and is headquartered in Washington D.C. However, the similarities stop there. The World Bank is an investment bank that issues bonds and uses the proceeds to make long-term low investment rate loans to poor countries for economic development projects. 

The world bank is really two organizations: the International Bank for Reconstruction and Development and the International Development Association. The latter makes interest-free loans with a maturity of 35-40 years to the world's poorest countries. The former makes 12- to 15-year low-interest loans to poor countries. Thus, World Bank makes loans to developing countries that would not have other sources of funds or other venues from which to borrow. The interest rate charged is slightly above the rate the bank pays to borrow when it issues the bonds.

The world bank focuses on public projects, rather than directly assisting private enterprises in developing countries. Another organization, the International Finance Corporation, seeks to mobilize funding for private enterprises. Although legally separate from the World Bank, the corporation is associated with it and is the organization through which the World Bank encourages small business development. The International Finance Corporation has also helped to establish stock markets in many developing countries, thus increasing their ability to attract international capital flows.

The Bank for International Settlements (BIS)

The Bank for International Settlements (BIS) is an independent international financial organization, headquartered in Basel, Switzerland that was created in 1930, 14 years before the Bretton Woods Accord. As such, it is the world's oldest international financial organization. The purpose of the BIS was "to promote the cooperation of central banks and to provide additional facilities for international financial operations." The BIS was originally established to monitor and administer the reparations that the countries defeated in World War I were required to pay to the victorious nations. In addition, the BIS was to provide specialized services to central banks and through them to the international financial system.

The mission statement of the Bank for International Settlements, its latest annual reports and more are available at www.bis.org.

Recap

The IMF, the World Bank, and the BIS all have unique roles in the international financial system. The IMF promotes exchange rate stability, oversees the international financial system, and lends to member countries experiencing temporary balance of payments deficits. The World Bank promotes the economic development of the world's poorest countries by raising funds to make development loans. The BIS acts as a bank for central banks and seeks to establish and monitor international reporting and capital standards for financial institutions and to assist countries in developing safe and sound financial practices.

*SOURCE: THE FINANCIAL SYSTEM & THE ECONOMY, 3RD ED., 2003, MAUREEN BURTON & RAY LOMBRA, PGS. 470-476*

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