The huge Troika-funded bailout of Greece’s private creditors caused a lot of outrage: European citizens complained that they were being held liable for the huge loan packages with which the EU and their new financing instruments – now called the ESM – funded the bailout. Greek citizens complained about the harsh conditionalities that creditors attached to these loans, in a desperate attempt to make them pay off an unsustainable debt burden. IMF Member States from emerging and developing countries – whose banks were not exposed in Greece, and thus did not benefit from the bailout – complained that a large chunk of IMF resources has been used for the benefit of rich countries, and that IMF rules have been bent to make this happen.

Rules made by rich countries for the benefit of richer countries’ banks

The “systemic exemption” was introduced back in 2010 when it became clear that Greece would either need to default on its debt – largely bonds held by private investors – or would need huge bailout loans from the IMF to finance debt service, far beyond what Greece’s IMF quota would permit to borrow. Given that Greece’s debt burden was already assessed as unsustainable at that time, IMF rules had implied that debt due to private creditors needed to be reduced, and that private and bilateral official creditors needed to take a haircut before the IMF could lend.

However, many argued that a debt restructuring in the midst of the financial crisis could have destabilised the European – and perhaps global – banking system. So the IMF introduced the “systemic exemption”, which made borrowing an exceptionally high amount of IMF monies possible, without requiring an upfront debt restructuring operation of the debts due to private creditors.

Obviously, political reasons in combination with the IMF’s unbalanced governance structure have played a key role in this decision. The foreign banks most exposed to Greece were French, German and British banks – thus from three of the five countries that hold the largest share of voting rights at the IMF. The French citizen Dominique Strauss-Kahn, who was planning to run for presidential elections back home, held the post of IMF’s Managing Director. The USA, the IMF’s only veto power, was indirectly affected as US banks were insurers of European banks’ loans, through credit default swaps.

IMF members from non-EU, emerging and developing countries protested early against the systemic exemption, as it was essentially a rule made by rich countries for the benefit of rich countries, or more precisely for those countries’ banks and creditors: Very few developing countries and their banks would be considered so important that a systemic exemption would be institutionalised for them. Given the IMF’s governance model, which benefits richer countries, executive directors’ from developing countries would have little power to even activate an existing clause for their benefit.

The IMF has now finally reacted to the criticism and has removed the systemic exemption, which was controversial in the Fund’s rank and file too. They also acknowledged that the clause did not fix the problem – the unsustainable debt burden – but that the bailouts had delayed a solution. Moreover, that it causes ‘moral hazards’ when private creditors can assume that they are always going to be bailed out.

The IMF bails out, but will this stop the bailouts?

However, the reform does not mean that huge private creditor bailouts will no longer happen. The IMF’s main motivation seems to be to reduce the risk that a crisis country cannot repay IMF loans. A high default risk is the quite logical consequence of the IMF’s practice of lending into an unsustainable debt situation that the systemic exemption clause has triggered. Greece was pretty close to defaulting on IMF loans back in June 2015, before the Eurogroup released the third package of EU bailout loans, which were eventually used to refinance payments due to the IMF (i.e. bailed out the IMF).

The IMF’s Board members have now decided that the IMF bail outs form the current bailout practice. However, they also decided that a country with an unsustainable debt burden can still benefit from exceptional access to IMF loans without an upfront debt restructuring operation, as long as other official creditors provide loans on sufficiently concessional terms to make the debt sustainable. In clearer terms, when other official creditors fund the private creditor bailout, the IMF remains ready to lend generously. This approach is already used in Europe, where the banks’ bailouts are funded by the ESM.

Back to the drawing board

The latest reform should be considered a distraction from fundamental problems related to sovereign debt crises management. It is part of the IMF’s second-best strategy that became necessary when back in 2013 some directors on the IMF Board vetoed IMF staff plans to create a statutory debt resolution framework. What followed since then is a series of piecemeal reforms to address problems that have occurred due to the absence of such a state insolvency framework. In particular there is the problem that once a debtor country needs to reduce its debt burden it has no chance of doing this in a speedy process and distributing the burden fairly on all its different creditors, in a binding manner. Neither does the IMF have the chance to do that, so what they did instead is the following:

 October 2014: Endorse enhanced collective action clauses (CACs) that the International Capital Market Association had developed in an opaque process, and eventually called on sovereign borrowers to include them in new bond issues.
 December 2015: Change its lending into arrears policy to enable it to lend to countries whose official creditors refuse to participate in a debt restructuring operation, which most recently happened in the case of Ukrainian loans due to Russia.
 Lastly, as part of the 29 January reform package, to Introduce debt ‘reprofiling’ (i.e. the extension of maturities that allows for a temporary freeze on debt payments) as an interim ‘third way’ between debt restructuring (i.e. the reduction of the debt burden through an actual haircut on the principle owed) and a full creditor bailout.

Even taken together, these reforms cannot ensure a speedy and comprehensive solution to a debt crisis. The mentioned CACs are for bonds only, while most countries have a mixed debt portfolio that, as well as bonds, also includes loans due to both private and official creditors. There is no way to enforce the participation of official creditors. The December reform of the lending into arrears policy just enabled the IMF to lend even if they don’t actually do so – meaning more debt to over-indebted countries, not less. The removal of the systemic exemption protects the IMF’s resources but not those of a debtor country and its citizens. And while the new debt reprofiling approach could provide a debtor country with some breathing space, it creates incentives for governments and their creditors to procrastinate over an unavoidable haircut, to postpone a sustainable solution to debt crises. There is no way around a more fundamental reform towards a new debt workout mechanism that allows for speedy and comprehensive debt crisis resolution and puts people first. Sufficient reform proposals have been made. What’s missing is just the political will to implement them.