Derivative (finance)

A derivative is a financial contract which derives its value from the performance of another entity such as an asset, index, or interest rate, called the "underlying".[1][2] Derivatives are one of the three main categories of financial instruments, the other two being equities (i.e. stocks) and debt (i.e. bonds and mortgages). Derivatives include a variety of financial contracts, including futures, forwards, swaps, options, and variations of these such as caps, floors, collars, and credit default swaps. Most derivatives are traded over-the-counter (off-exchange) or on an exchange such as the Chicago Mercantile Exchange, while most insurance contracts have developed into a separate industry. Many money managers use derivatives for a variety of purposes, such as hedging--by taking a position in a derivative, losses on portfolio holdings may be minimized or offset by profits on the derivative. Likewise, derivatives can be used to gain quicker and more efficient access to markets; for example, it may be easier and quicker to purchase an S & P 500 futures contract than to invest in the underlying securities.[3]

Basics
Derivatives are a contract between two parties that specify conditions (especially the dates, resulting values and definitions of the underlying variables, the parties' contractual obligations, and the notional amount) under which payments are to be made between the parties.[4][5] The most common underlying assets include commodities, stocks, bonds, interest rates and currencies, but they can also be other derivatives, which adds another layer of complexity to proper valuation. The components of a firm's capital structure, e.g. bonds and stock, can also be considered derivatives, more precisely options, with the underlying being the firm's assets, but this is unusual outside of technical contexts. There are two groups of derivative contracts: the privately traded over-the-counter (OTC) derivatives such as swaps that do not go through an exchange or other intermediary, and exchange-traded derivatives (ETD) that are traded through specialized derivatives exchanges or other exchanges. Derivatives are more common in the modern era, but their origins trace back several centuries. One of the oldest derivatives is rice futures, which have been traded on the Dojima Rice Exchange since the eighteenth century.[6] Derivatives are broadly categorized by the relationship between the underlying asset and the derivative (such as forward, option, swap); the type of underlying asset (such as equity derivatives, foreign exchange derivatives, interest rate derivatives, commodity derivatives, or credit derivatives); the market in which they trade (such as exchange-traded or over-the-counter); and their pay-off profile. Derivatives may broadly be categorized as "lock" or "option" products. Lock products (such as swaps, futures, or forwards) obligate the contractual parties to the terms over the life of the contract. Option products (such as interest rate caps) provide the buyer the right, but not the obligation to enter the contract under the terms specified.

Derivatives can be used either for risk management (i.e. to "hedge" by providing offsetting compensation in case of an undesired event, a kind of "insurance") or for speculation (i.e. making a financial "bet"). This distinction is important because the former is a prudent aspect of operations and financial management for many firms across many industries; the latter offers managers and investors a risky opportunity to increase profit, which may not be properly disclosed to stakeholders. Along with many other financial products and services, derivatives reform is an element of the DoddFrank Wall Street Reform and Consumer Protection Act of 2010. The Act delegated many rule-making details of regulatory oversight to the Commodity Futures Trading Commission and those details are not finalized nor fully implemented as of late 2012.

Size of market
To give an idea of the size of the derivative market, The Economist magazine has reported that as of June 2011, the over-the-counter (OTC) derivatives market amounted to approximately $700 trillion, and the size of the market traded on exchanges totaled an additional $83 trillion.[7] However, these are "notional" values, and some economists say that this value greatly exaggerates the market value and the true credit risk faced by the parties involved. For example, in 2010, while the aggregate of OTC derivatives exceeded $600 trillion, the value of the market was estimated much lower, at $21 trillion. The credit risk equivalent of the derivative contracts was estimated at $3.3 trillion.[8] Still, even these scaled down figures represent huge amounts of money. For perspective, the budget for total expenditure of the United States Government during 2012 was $3.5 trillion,[9] and the total current value of the US stock market is an estimated $23 trillion.[10] The world annual Gross Domestic Product is about $65 trillion.[11] And for one type of derivative at least, Credit Default Swaps (CDS), for which the inherent risk is considered high, the higher, nominal value, remains relevant. It was this type of derivative that investment magnate Warren Buffet referred to in his famous 2002 speech in which he warned against "weapons of financial mass destruction." CDS notional value in early 2012 amounted to $25.5 trillion, down from $55 trillion in 2008.[12]

Usage
Derivatives are used for the following:

Hedge or mitigate risk in the underlying, by entering into a derivative contract whose value moves in the opposite direction to their underlying position and cancels part or all of it out[13] Create option ability where the value of the derivative is linked to a specific condition or event (e.g. the underlying reaching a specific price level) Obtain exposure to the underlying where it is not possible to trade in the underlying (e.g. weather derivatives)[14]

Provide leverage (or gearing), such that a small movement in the underlying value can cause a large difference in the value of the derivative[15] Speculate and make a profit if the value of the underlying asset moves the way they expect (e.g. moves in a given direction, stays in or out of a specified range, reaches a certain level) Switch asset allocations between different asset classes without disturbing the underlining assets, as part of transition management Avoid paying taxes. For example, an equity swap allows an investor to receive steady payments, e.g. based on LIBOR rate, while avoiding paying capital gains tax and keeping the stock.

Mechanics and Valuation Basics

Lock products are theoretically valued at zero at the time of execution and thus do not typically require an up-front exchange between the parties. Based upon movements in the underlying asset over time, however, the value of the contract will fluctuate, and the derivative may be either an asset (i.e. "in the money") or a liability (i.e. "out of the money") at different points throughout its life. Importantly, either party is therefore exposed to the credit quality of its counterparty and is interested in protecting itself in an event of default. Option products have immediate value at the outset because they provide specified protection (intrinsic value) over a given time period (time value). One common form of option product familiar to many consumers is insurance for homes and automobiles. The insured would pay more for a policy with greater liability protections (intrinsic value) and one that extends for a year rather than six months (time value). Because of the immediate option value, the option purchaser typically pays an up front premium. Just like for lock products, movements in the underlying asset will cause the option's intrinsic value to change over time while its time value deteriorates steadily until the contract expires. An important difference between a lock product is that, after the initial exchange, the option purchaser has no further liability to its counterparty; upon maturity, the purchaser will execute the option if it has positive value (i.e. if it is "in the money") or expire at no cost (other than to the initial premium) (i.e. if the option is "out of the money").

Hedging
Main article: Hedge (finance) Derivatives allow risk related to the price of the underlying asset to be transferred from one party to another. For example, a wheat farmer and a miller could sign a futures contract to exchange a specified amount of cash for a specified amount of wheat in the future. Both parties have reduced a future risk: for the wheat farmer, the uncertainty of the price, and for the miller, the availability of wheat. However, there is still the risk that no wheat will be available because of events unspecified by the contract, such as the weather, or that one party will renege on the contract. Although a third party, called a clearing house, insures a futures contract, not all derivatives are insured against counter-party risk.

From another perspective, the farmer and the miller both reduce a risk and acquire a risk when they sign the futures contract: the farmer reduces the risk that the price of wheat will fall below the price specified in the contract and acquires the risk that the price of wheat will rise above the price specified in the contract (thereby losing additional income that he could have earned). The miller, on the other hand, acquires the risk that the price of wheat will fall below the price specified in the contract (thereby paying more in the future than he otherwise would have) and reduces the risk that the price of wheat will rise above the price specified in the contract. In this sense, one party is the insurer (risk taker) for one type of risk, and the counter-party is the insurer (risk taker) for another type of risk. Hedging also occurs when an individual or institution buys an asset (such as a commodity, a bond that has coupon payments, a stock that pays dividends, and so on) and sells it using a futures contract. The individual or institution has access to the asset for a specified amount of time, and can then sell it in the future at a specified price according to the futures contract. Of course, this allows the individual or institution the benefit of holding the asset, while reducing the risk that the future selling price will deviate unexpectedly from the market's current assessment of the future value of the asset.

Derivatives traders at the Chicago Board of Trade Derivatives trading of this kind may serve the financial interests of certain particular businesses.[16] For example, a corporation borrows a large sum of money at a specific interest rate.[17] The interest rate on the loan reprices every six months. The corporation is concerned that the rate of interest may be much higher in six months. The corporation could buy a forward rate agreement (FRA), which is a contract to pay a fixed rate of interest six months after purchases on a notional amount of money.[18] If the interest rate after six months is above the contract rate, the seller will pay the difference to the corporation, or FRA buyer. If the rate is lower, the corporation will pay the difference to the seller. The purchase of the FRA serves to reduce the uncertainty concerning the rate increase and stabilize earnings.

Speculation and arbitrage

Derivatives can be used to acquire risk, rather than to hedge against risk. Thus, some individuals and institutions will enter into a derivative contract to speculate right derivative on the value of the underlying asset, betting that the party seeking insurance will be wrong about the future value of the underlying asset. Speculators look to buy an asset in the future at a low price according to a derivative contract when the future market price is high, or to sell an asset in the future at a high price according to a derivative contract when the future market price is less. Individuals and institutions may also look for arbitrage opportunities, as when the current buying price of an asset falls below the price specified in a futures contract to sell the asset. Speculative trading in derivatives gained a great deal of notoriety in 1995 when Nick Leeson, a trader at Barings Bank, made poor and unauthorized investments in futures contracts. Through a combination of poor judgment, lack of oversight by the bank's management and regulators, and

unfortunate events like the Kobe earthquake, Leeson incurred a US$1.3 billion loss that bankrupted the centuries-old institution.[19]

Proportion Used for Hedging and Speculation

Unfortunately, the true proportion of derivatives contracts used for legitimate hedging purposes is unknown [20] (and perhaps unknowable), but it appears to be relatively small.[21][22] Also, derivatives contracts account for only 36% of the median firms' total currency and interest rate exposure.[23] Nonetheless, we know that many firms' derivatives activities have at least some speculative component for a variety of reasons.[23]

Types
OTC and exchange-traded
In broad terms, there are two groups of derivative contracts, which are distinguished by the way they are traded in the market:

Over-the-counter (OTC) derivatives are contracts that are traded (and privately negotiated) directly between two parties, without going through an exchange or other intermediary. Products such as swaps, forward rate agreements, exotic options and other exotic derivatives are almost always traded in this way. The OTC derivative market is the largest market for derivatives, and is largely unregulated with respect to disclosure of information between the parties, since the OTC market is made up of banks and other highly sophisticated parties, such as hedge funds. Reporting of OTC amounts is difficult because trades can occur in private, without activity being visible on any exchange.

According to the Bank for International Settlements, who first surveyed OTC derivatives in 1995,[24] reported that the "gross market value, which represent the cost of replacing all open contracts at the prevailing market prices, ... increased by 74% since 2004, to $11 trillion at the end of June 2007 (BIS 2007:24)." [24] Positions in the OTC derivatives market increased to $516 trillion at the end of June 2007, 135% higher than the level recorded in 2004. the total outstanding notional amount is US$708 trillion (as of June 2011).[25] Of this total notional amount, 67% are interest rate contracts, 8% are credit default swaps (CDS), 9% are foreign exchange contracts, 2% are commodity contracts, 1% are equity contracts, and 12% are other. Because OTC derivatives are not traded on an exchange, there is no central counter-party. Therefore, they are subject to counterparty risk, like an ordinary contract, since each counterparty relies on the other to perform.

Exchange-traded derivatives (ETD) are those derivatives instruments that are traded via specialized derivatives exchanges or other exchanges. A derivatives exchange is a market where individuals trade standardized contracts that have been defined by the exchange.[26] A derivatives exchange acts as an intermediary to all related transactions, and takes initial margin from both sides of the trade to act as a guarantee. The world's largest[27] derivatives exchanges (by number of transactions) are the Korea Exchange (which lists

KOSPI Index Futures & Options), Eurex (which lists a wide range of European products such as interest rate & index products), and CME Group (made up of the 2007 merger of the Chicago Mercantile Exchange and the Chicago Board of Trade and the 2008 acquisition of the New York Mercantile Exchange). According to BIS, the combined turnover in the world's derivatives exchanges totaled USD 344 trillion during Q4 2005. By December 2007 the Bank for International Settlements reported [24] that "derivatives traded on exchanges surged 27% to a record $681 trillion."[24]

Common derivative contract types

Some of the common variants of derivative contracts are as follows: 1. Forwards: A tailored contract between two parties, where payment takes place at a specific time in the future at today's pre-determined price. 2. Futures: are contracts to buy or sell an asset on or before a future date at a price specified today. A futures contract differs from a forward contract in that the futures contract is a standardized contract written by a clearing house that operates an exchange where the contract can be bought and sold; the forward contract is a non-standardized contract written by the parties themselves. 3. Options are contracts that give the owner the right, but not the obligation, to buy (in the case of a call option) or sell (in the case of a put option) an asset. The price at which the sale takes place is known as the strike price, and is specified at the time the parties enter into the option. The option contract also specifies a maturity date. In the case of a European option, the owner has the right to require the sale to take place on (but not before) the maturity date; in the case of an American option, the owner can require the sale to take place at any time up to the maturity date. If the owner of the contract exercises this right, the counter-party has the obligation to carry out the transaction. Options are of two types: call option and put option. The buyer of a Call option has a right to buy a certain quantity of the underlying asset, at a specified price on or before a given date in the future, he however has no obligation whatsoever to carry out this right. Similarly, the buyer of a Put option has the right to sell a certain quantity of an underlying asset, at a specified price on or before a given date in the future, he however has no obligation whatsoever to carry out this right. 4. Binary options are contracts that provide the owner with an all-or-nothing profit profile. 5. Warrants: Apart from the commonly used short-dated options which have a maximum maturity period of 1 year, there exists certain long-dated options as well, known as Warrant (finance). These are generally traded over-the-counter. 6. Swaps are contracts to exchange cash (flows) on or before a specified future date based on the underlying value of currencies exchange rates, bonds/interest rates, commodities exchange, stocks or other assets. Another term which is commonly associated to Swap is Swaption which is basically an option on the forward Swap. Similar to a Call and Put option, a Swaption is of two kinds: a receiver Swaption and a payer Swaption. While on one hand, in case of a receiver Swaption there is an option wherein you can receive fixed and pay floating, a payer swaption on the other hand is an option to pay fixed and receive floating.

Swaps can basically be categorized into two types:

Interest rate swap: These basically necessitate swapping only interest associated cash flows in the same currency, between two parties. Currency swap: In this kind of swapping, the cash flow between the two parties includes both principal and interest. Also, the money which is being swapped is in different currency for both parties.[28]

Some common examples of these derivatives are the following: CONTRACT TYPES UNDERLYING ExchangeExchangeOTC swap OTC forward traded futures traded options DJIA Index Option on DJIA Back-to-back future Index future Equity swap Repurchase Equity Single-stock Single-share agreement future option Option on Eurodollar Eurodollar Interest rate Forward rate future Interest rate future swap agreement Euribor future Option on Euribor future Credit default Option on Bond swap Repurchase Bond future Credit future Total return agreement swap Currency Option on Currency Currency Foreign future currency future swap forward exchange Iron ore WTI crude oil Weather Commodity forward Commodity futures derivative swap contract

OTC option Stock option Warrant Turbo warrant Interest rate cap and floor Swaption Basis swap Bond option Credit default option Currency option Gold option

Economic function of the derivative market

Some of the salient economic functions of the derivative market include: 1. Prices in a structured derivative market not only replicate the discernment of the market participants about the future but also lead the prices of underlying to the professed future level. On the expiration of the derivative contract, the prices of derivatives congregate with the prices of the underlying. Therefore, derivatives are essential tools to determine both current and future prices. 2. The derivatives market reallocates risk from the people who prefer risk aversion to the people who have an appetite for risk.

3. The intrinsic nature of derivatives market associates them to the underlying Spot market. Due to derivatives there is a considerable increase in trade volumes of the underlying Spot market. The dominant factor behind such an escalation is increased participation by additional players who would not have otherwise participated due to absence of any procedure to transfer risk. 4. As supervision, reconnaissance of the activities of various participants becomes tremendously difficult in assorted markets; the establishment of an organized form of market becomes all the more imperative. Therefore, in the presence of an organized derivatives market, speculation can be controlled, resulting in a more meticulous environment. 5. Third parties can use publicly available derivative prices as educated predictions of uncertain future outcomes, for example, the likelihood that a corporation will default on its debts.[29] In a nutshell, there is a substantial increase in savings and investment in the long run due to augmented activities by derivative Market participant.[30]

Valuation

Total world derivatives from 1998 to 2007[31] compared to total world wealth in the year 2000[32]

Market and arbitrage-free prices

Two common measures of value are:

Market price, i.e. the price at which traders are willing to buy or sell the contract Arbitrage-free price, meaning that no risk-free profits can be made by trading in these contracts (see rational pricing)

Determining the market price

For exchange-traded derivatives, market price is usually transparent (often published in real time by the exchange, based on all the current bids and offers placed on that particular contract at any one time). Complications can arise with OTC or floor-traded contracts though, as trading is handled manually, making it difficult to automatically broadcast prices. In particular with OTC contracts, there is no central exchange to collate and disseminate prices.

Determining the arbitrage-free price

See List of finance topics# Derivatives pricing. The arbitrage-free price for a derivatives contract can be complex, and there are many different variables to consider. Arbitrage-free pricing is a central topic of financial mathematics. For futures/forwards the arbitrage free price is relatively straightforward, involving the price of the underlying together with the cost of carry (income received less interest costs), although there can be complexities. However, for options and more complex derivatives, pricing involves developing a complex pricing model: understanding the stochastic process of the price of the underlying asset is often crucial. A key equation for the theoretical valuation of options is the BlackScholes formula, which is based on the assumption that the cash flows from a European stock option can be replicated by a continuous buying and selling strategy using only the stock. A simplified version of this valuation technique is the binomial options model. OTC represents the biggest challenge in using models to price derivatives. Since these contracts are not publicly traded, no market price is available to validate the theoretical valuation. Most of the model's results are input-dependent (meaning the final price depends heavily on how we derive the pricing inputs).[33] Therefore it is common that OTC derivatives are priced by Independent Agents that both counterparties involved in the deal designate upfront (when signing the contract).

Criticisms
Derivatives are often subject to the following criticisms:

Hidden tail risk

According to Raghuram Rajan, a former chief economist of the International Monetary Fund (IMF), "... it may well be that the managers of these firms [investment funds] have figured out the correlations between the various instruments they hold and believe they are hedged. Yet as Chan and others (2005) point out, the lessons of summer 1998 following the default on Russian government debt is that correlations that are zero or negative in normal times can turn overnight to one a phenomenon they term "phase lock-in." A hedged position can become unhedged at the worst times, inflicting substantial losses on those who mistakenly believe they are protected."[34]

Risks
See also: List of trading losses The use of derivatives can result in large losses because of the use of leverage, or borrowing. Derivatives allow investors to earn large returns from small movements in the underlying asset's price. However, investors could lose large amounts if the price of the underlying moves against them significantly. There have been several instances of massive losses in derivative markets, such as the following:

American International Group (AIG) lost more than US$18 billion through a subsidiary over the preceding three quarters on credit default swaps (CDSs).[35] The United States Federal Reserve Bank announced the creation of a secured credit facility of up to US$85 billion, to prevent the company's collapse by enabling AIG to meet its obligations to deliver additional collateral to its credit default swap trading partners.[36] The loss of US$7.2 Billion by Socit Gnrale in January 2008 through mis-use of futures contracts. The loss of US$6.4 billion in the failed fund Amaranth Advisors, which was long natural gas in September 2006 when the price plummeted. The loss of US$4.6 billion in the failed fund Long-Term Capital Management in 1998. The loss of US$1.3 billion equivalent in oil derivatives in 1993 and 1994 by Metallgesellschaft AG.[37] The loss of US$1.2 billion equivalent in equity derivatives in 1995 by Barings Bank.[38] UBS AG, Switzerland's biggest bank, suffered a $2 billion loss through unauthorized trading discovered in September 2011.[39]

This comes to a staggering $39.5 billion, the majority in the last decade after the Commodity Futures Modernization Act of 2000 was passed.

Counter party risk

Some derivatives (especially swaps) expose investors to counterparty risk, or risk arising from the other party in a financial transaction. Different types of derivatives have different levels of counter party risk. For example, standardized stock options by law require the party at risk to have a certain amount deposited with the exchange, showing that they can pay for any losses; banks that help businesses swap variable for fixed rates on loans may do credit checks on both parties. However, in private agreements between two companies, for example, there may not be benchmarks for performing due diligence and risk analysis.

Large notional value

Derivatives typically have a large notional value. As such, there is the danger that their use could result in losses for which the investor would be unable to compensate. The possibility that

this could lead to a chain reaction ensuing in an economic crisis was pointed out by famed investor Warren Buffett in Berkshire Hathaway's 2002 annual report. Buffett called them 'financial weapons of mass destruction.' A potential problem with derivatives is that they comprise an increasingly larger notional amount of assets which may lead to distortions in the underlying capital and equities markets themselves. Investors begin to look at the derivatives markets to make a decision to buy or sell securities and so what was originally meant to be a market to transfer risk now becomes a leading indicator.(See Berkshire Hathaway Annual Report for 2002)

Financial Reform and Government Regulation

Under US law and the laws of most other developed countries, derivatives have special legal exemptions that make them a particularly attractive legal form to extend credit.[40] The strong creditor protections afforded to derivatives counterparties, in combination with their complexity and lack of transparency however, can cause capital markets to underprice credit risk. This can contribute to credit booms, and increase systemic risks.[40] Indeed, the use of derivatives to conceal credit risk from third parties while protecting derivative counterparties contributed to the financial crisis of 2008 in the United States.[40][41] In the context of a 2010 examination of the ICE Trust, an industry self-regulatory body, Gary Gensler, the chairman of the Commodity Futures Trading Commission which regulates most derivatives, was quoted saying that the derivatives marketplace as it functions now "adds up to higher costs to all Americans." More oversight of the banks in this market is needed, he also said. Additionally, the report said, "[t]he Department of Justice is looking into derivatives, too. The department's antitrust unit is actively investigating 'the possibility of anticompetitive practices in the credit derivatives clearing, trading and information services industries,' according to a department spokeswoman."[42] For legislators and committees responsible for financial reform related to derivatives in the United States and elsewhere, distinguishing between hedging and speculative derivatives activities has been a nontrivial challenge. The distinction is critical because regulation should help to isolate and curtail speculation with derivatives, especially for "systemically significant" institutions whose default could be large enough to threaten the entire financial system. At the same time, the legislation should allow for responsible parties to hedge risk without unduly tying up working capital as collateral that firms may better employ elsewhere in their operations and investment.[43] In this regard, it is important to distinguish between financial (e.g. banks) and non-financial end-users of derivatives (e.g. real estate development companies) because these firms' derivatives usage is inherently different. More importantly, the reasonable collateral that secures these different counterparties can be very different. The distinction between these firms is not always straight forward (e.g. hedge funds or even some private equity firms do not neatly fit either category). Finally, even financial users must be differentiated, as 'large' banks may classified as "systemically significant" whose derivatives activities must be more tightly monitored and restricted than those of smaller, local and regional banks. Over-the-counter dealing will be less common as the DoddFrank Wall Street Reform and Consumer Protection Act comes into effect. The law mandated the clearing of certain swaps at

registered exchanges and imposed various restrictions on derivatives. To implement Dodd-Frank, the CFTC developed new rules in at least 30 areas. The Commission determines which swaps are subject to mandatory clearing and whether a derivatives exchange is eligible to clear a certain type of swap contract. Nonetheless, the above and other challenges of the rule-making process have delayed full enactment of aspects of the legislation relating to derivatives. The challenges are further complicated by the necessity to orchestrate globalized financial reform among the nations that comprise the world's major financial markets, a primary responsibility of the Financial Stability Board whose progress is ongoing.[44] In the U.S., by February 2012 the combined effort of the SEC and CFTC had produced over 70 proposed and final derivatives rules.[45] However, both of them had delayed adoption of a number of derivatives regulations because of the burden of other rulemaking, litigation and opposition to the rules, and many core definitions (such as the terms "swap," "security-based swap," "swap dealer," "security-based swap dealer," "major swap participant" and "major security-based swap participant") had still not been adopted.[45] SEC Chairman Mary Schapiro opined: "At the end of the day, it probably does not make sense to harmonize everything [between the SEC and CFTC rules] because some of these products are quite different and certainly the market structures are quite different."[46]

Country leaders at the 2009 G-20 Pittsburgh summit In November 2012, the SEC and regulators from Australia, Brazil, the European Union, Hong Kong, Japan, Ontario, Quebec, Singapore, and Switzerland met to discuss reforming the OTC derivatives market, as had been agreed by leaders at the 2009 G-20 Pittsburgh summit in September 2009.[47] In December 2012, they released a joint statement to the effect that they recognized that the market is a global one and "firmly support the adoption and enforcement of robust and consistent standards in and across jurisdictions", with the goals of mitigating risk, improving transparency, protecting against market abuse, preventing regulatory gaps, reducing the potential for arbitrage opportunities, and fostering a level playing field for market participants.[47] They also agreed on the need to reduce regulatory uncertainty and provide market participants with sufficient clarity on laws and regulations by avoiding, to the extent possible, the application of conflicting rules to the same entities and transactions, and minimizing the application of inconsistent and duplicative rules.[47] At the same time, they noted that "complete harmonization perfect alignment of rules across jurisdictions" would be difficult, because of jurisdictions' differences in law, policy, markets, implementation timing, and legislative and regulatory processes.[47]

Reporting
Mandatory reporting regulations are being finalized in a number of countries, such as Dodd Frank Act in the US, the European Market Infrastructure Regulations (EMIR) in Europe, as well as regulations in Hong Kong, Japan, Singapore, Canada, and other countries.[48] The OTC Derivatives Regulators Forum (ODRF), a group of over 40 world-wide regulators, provided trade

repositories with a set of guidelines regarding data access to regulators, and the Financial Stability Board and CPSS IOSCO also made recommendations in with regard to reporting.[48] DTCC, through its "Global Trade Repository" (GTR) service, manages global trade repositories for interest rates, and commodities, foreign exchange, credit, and equity derivatives.[48] It makes global trade reports to the CFTC in the U.S., and plans to do the same for ESMA in Europe and for regulators in Hong Kong, Japan, and Singapore.[48] It covers cleared and uncleared OTC derivatives products, whether or not a trade is electronically processed or bespoke.[48][49][50]

Glossary

Bilateral netting: A legally enforceable arrangement between a bank and a counter-party that creates a single legal obligation covering all included individual contracts. This means that a bank's obligation, in the event of the default or insolvency of one of the parties, would be the net sum of all positive and negative fair values of contracts included in the bilateral netting arrangement. Counterparty: The legal and financial term for the other party in a financial transaction. Credit derivative: A contract that transfers credit risk from a protection buyer to a credit protection seller. Credit derivative products can take many forms, such as credit default swaps, credit linked notes and total return swaps. Derivative: A financial contract whose value is derived from the performance of assets, interest rates, currency exchange rates, or indexes. Derivative transactions include a wide assortment of financial contracts including structured debt obligations and deposits, swaps, futures, options, caps, floors, collars, forwards and various combinations thereof. Exchange-traded derivative contracts: Standardized derivative contracts (e.g., futures contracts and options) that are transacted on an organized futures exchange. [Gross negative fair value: The sum of the fair values of contracts where the bank owes money to its counter-parties, without taking into account netting. This represents the maximum losses the bank's counter-parties would incur if the bank defaults and there is no netting of contracts, and no bank collateral was held by the counter-parties. Gross positive fair value: The sum total of the fair values of contracts where the bank is owed money by its counter-parties, without taking into account netting. This represents the maximum losses a bank could incur if all its counter-parties default and there is no netting of contracts, and the bank holds no counter-party collateral. High-risk mortgage securities: Securities where the price or expected average life is highly sensitive to interest rate changes, as determined by the U.S. Federal Financial Institutions Examination Council policy statement on high-risk mortgage securities. Notional amount: The nominal or face amount that is used to calculate payments made on swaps and other risk management products. This amount generally does not change hands and is thus referred to as notional. Over-the-counter (OTC) derivative contracts: Privately negotiated derivative contracts that are transacted off organized futures exchanges. Structured notes: Non-mortgage-backed debt securities, whose cash flow characteristics depend on one or more indices and / or have embedded forwards or options. Total risk-based capital: The sum of tier 1 plus tier 2 capital. Tier 1 capital consists of common shareholders equity, perpetual preferred shareholders equity with noncumulative

dividends, retained earnings, and minority interests in the equity accounts of consolidated subsidiaries. Tier 2 capital consists of subordinated debt, intermediate-term preferred stock, cumulative and long-term preferred stock, and a portion of a bank's allowance for loan and lease losses.

International Monetary Fund

From Wikipedia, the free encyclopedia "IMF" redirects here. For other uses, see IMF (disambiguation). International Monetary Fund

Official logo for the IMF Abbreviation IMF FMI Formally 27 December 1945 (68 years ago) Actually 1 March 1947 (66 years ago) International Financial Organization Washington, D.C., United States 29 countries (founding); 188 countries (to date)

Formation

Type Headquarters Membership

Official languages English, French, and Spanish

Managing Director Main organ Website

Christine Lagarde Board of Governors www.imf.org

The International Monetary Fund (IMF) is an international organization that was initiated in 1944 at the Bretton Woods Conference and formally created in 1945 by 29 member countries. The IMF's stated goal was to assist in the reconstruction of the world's international payment system postWorld War II. Countries contribute money to a pool through a quota system from which countries with payment imbalances can borrow funds temporarily. Through this activity and others such as surveillance of its members' economies and the demand for self-correcting policies, the IMF works to improve the economies of its member countries.[1] The IMF describes itself as an organization of 188 countries, working to foster global monetary cooperation, secure financial stability, facilitate international trade, promote high employment and sustainable economic growth, and reduce poverty around the world.[2] The organization's stated objectives are to promote international economic co-operation, international trade, employment, and exchange rate stability, including by making financial resources available to member countries to meet balance of payments needs.[3] Its headquarters are in Washington, D.C., United States.

Contents

1 Functions o 1.1 Surveillance of the global economy o 1.2 Conditionality of loans 1.2.1 Structural adjustment 1.2.2 Benefits 1.2.3 Criticisms o 1.3 Reform 2 History 3 Member countries o 3.1 Qualifications o 3.2 Benefits 4 Leadership o 4.1 Board of Governors o 4.2 Executive Board o 4.3 Managing Director 5 Voting power o 5.1 Effects of the quota system 5.1.1 Developing countries 5.1.2 United States influence 5.1.3 Overcoming borrower/creditor divide

6 Use 7 IMF and globalization 8 Criticisms o 8.1 Support of military dictatorships o 8.2 Impact on access to food o 8.3 Impact on public health o 8.4 Impact on environment 9 In the media 10 See also 11 Notes and references 12 Further reading 13 External links

Functions
The IMF works to foster global growth and economic stability. It provides policy advice and financing to members in economic difficulties and also works with developing nations to help them achieve macroeconomic stability and reduce poverty.[4] The rationale for this is that private international capital markets function imperfectly and many countries have limited access to financial markets. Such market imperfections, together with balance of payments financing, provide the justification for official financing, without which many countries could only correct large external payment imbalances through measures with adverse effects on both national and international economic prosperity.[5] The IMF can provide other sources of financing to countries in need that would not be available in the absence of an economic stabilization program supported by the Fund. Upon initial IMF formation, its two primary functions were: to oversee the fixed exchange rate arrangements between countries,[6] thus helping national governments manage their exchange rates and allowing these governments to prioritise economic growth,[7] and to provide short-term capital to aid balance-of-payments.[6] This assistance was meant to prevent the spread of international economic crises. The Fund was also intended to help mend the pieces of the international economy post the Great Depression and World War II.[8] The IMF's role was fundamentally altered after the floating exchange rates post 1971. It shifted to examining the economic policies of countries with IMF loan agreements to determine if a shortage of capital was due to economic fluctuations or economic policy. The IMF also researched what types of government policy would ensure economic recovery.[9] The new challenge is to promote and implement policy that reduces the frequency of crises among the emerging market countries, especially the middle-income countries that are open to massive capital outflows.[10] Rather than maintaining a position of oversight of only exchange rates, their function became one of surveillance of the overall macroeconomic performance of its member countries. Their role became a lot more active because the IMF now manages economic policy instead of just exchange rates. In addition, the IMF negotiates conditions on lending and loans under their policy of conditionality,[6] which was established in the 1950s.[8] Low-income countries can borrow on

concessional terms, which means there is a period of time with no interest rates, through the Extended Credit Facility (ECF), the Standby Credit Facility (SCF) and the Rapid Credit Facility (RCF). Nonconcessional loans, which include interest rates, are provided mainly through StandBy Arrangements (SBA), the Flexible Credit Line (FCL), the Precautionary and Liquidity Line (PLL), and the Extended Fund Facility. The IMF provides emergency assistance via the newly introduced Rapid Financing Instrument (RFI) to all its members facing urgent balance of payments needs.[11]

Surveillance of the global economy

The IMF is mandated to oversee the international monetary and financial system[12] and monitor the economic and financial policies of its 188 member countries. This activity is known as surveillance and facilitates international co-operation.[13] Since the demise of the Bretton Woods system of fixed exchange rates in the early 1970s, surveillance has evolved largely by way of changes in procedures rather than through the adoption of new obligations.[12] The responsibilities of the Fund changed from those of guardian to those of overseer of members policies. The Fund typically analyses the appropriateness of each member countrys economic and financial policies for achieving orderly economic growth, and assesses the consequences of these policies for other countries and for the global economy.[12]

IMF Data Dissemination Systems participants: IMF member using SDDS IMF member using GDDS IMF member, not using any of the DDSystems non-IMF entity using SDDS non-IMF entity using GDDS

no interaction with the IMF

In 1995 the International Monetary Fund began work on data dissemination standards with the view of guiding IMF member countries to disseminate their economic and financial data to the public. The International Monetary and Financial Committee (IMFC) endorsed the guidelines for the dissemination standards and they were split into two tiers: The General Data Dissemination System (GDDS) and the Special Data Dissemination Standard (SDDS). The International Monetary Fund executive board approved the SDDS and GDDS in 1996 and 1997 respectively, and subsequent amendments were published in a revised Guide to the General Data Dissemination System. The system is aimed primarily at statisticians and aims to improve many aspects of statistical systems in a country. It is also part of the World Bank Millennium Development Goals and Poverty Reduction Strategic Papers. The primary objective of the GDDS is to encourage IMF member countries to build a framework to improve data quality and increase statistical capacity building. Upon building a framework, a country can evaluate statistical needs, set priorities in improving the timeliness, transparency, reliability and accessibility of financial and economic data. Some countries initially used the GDDS, but later upgraded to SDDS. Some entities that are not themselves IMF members also contribute statistical data to the systems:

Palestinian Authority GDDS Hong Kong SDDS Macao GDDS[14] EU institutions: o the European Central Bank for the Eurozone SDDS o Eurostat for the whole EU SDDS, thus providing data from Cyprus (not using any DDSystem on its own) and Malta (using only GDDS on its own)

Conditionality of loans
IMF conditionality is a set of policies or conditions that the IMF requires in exchange for financial resources.[6] The IMF does not require collateral from countries for loans but rather requires the government seeking assistance to correct its macroeconomic imbalances in the form of policy reform. If the conditions are not met, the funds are withheld.[6] Conditionality is perhaps the most controversial aspect of IMF policies.[15] The concept of conditionality was introduced in an Executive Board decision in 1952 and later incorporated in the Articles of Agreement. Conditionality is associated with economic theory as well as an enforcement mechanism for repayment. Stemming primarily from the work of Jacques Polak in the Fund's research department, the theoretical underpinning of conditionality was the "monetary approach to the balance of payments."[8]

Structural adjustment Further information: Structural adjustment

Some of the conditions for structural adjustment can include:

Cutting expenditures, also known as austerity. Focusing economic output on direct export and resource extraction, Devaluation of currencies, Trade liberalisation, or lifting import and export restrictions, Increasing the stability of investment (by supplementing foreign direct investment with the opening of domestic stock markets), Balancing budgets and not overspending, Removing price controls and state subsidies, Privatization, or divestiture of all or part of state-owned enterprises, Enhancing the rights of foreign investors vis-a-vis national laws, Improving governance and fighting corruption.

These conditions have also been sometimes labelled as the Washington Consensus.
Benefits

These loan conditions ensure that the borrowing country will be able to repay the Fund and that the country won't attempt to solve their balance of payment problems in a way that would negatively impact the international economy.[16][17] The incentive problem of moral hazard, which is the actions of economic agents maximising their own utility to the detriment of others when they do not bear the full consequences of their actions, is mitigated through conditions rather than providing collateral; countries in need of IMF loans do not generally possess internationally valuable collateral anyway.[17] Conditionality also reassures the IMF that the funds lent to them will be used for the purposes defined by the Articles of Agreement and provides safeguards that country will be able to rectify its macroeconomic and structural imbalances.[17] In the judgment of the Fund, the adoption by the member of certain corrective measures or policies will allow it to repay the Fund, thereby ensuring that the same resources will be available to support other members.[15] As of 2004, borrowing countries have had a very good track record for repaying credit extended under the Fund's regular lending facilities with full interest over the duration of the loan. This indicates that Fund lending does not impose a burden on creditor countries, as lending countries receive market-rate interest on most of their quota subscription, plus any of their own-currency subscriptions that are loaned out by the Fund, plus all of the reserve assets that they provide the Fund.[5]
Criticisms

In some quarters, the IMF has been criticised for being 'out of touch' with local economic conditions, cultures, and environments in the countries they are requiring policy reform.[6] The

Fund knows very little about what public spending on programs like public health and education actually means, especially in African countries; they have no feel for the impact that their proposed national budget will have on people. The economic advice the IMF gives might not always take into consideration the difference between what spending means on paper and how it is felt by citizens.[18] For example, some people believe that Jeffrey Sach's work shows that "the Fund's usual prescription is 'budgetary belt tightening to countries who are much too poor to own belts'.[18] " It has been said that the IMF's role as a generalist institution specialising in macroeconomic issues needs reform. Conditionality has also been criticised because a country can pledge collateral of "acceptable assets" to obtain waivers on certain conditions.[17] However, that assumes that all countries have the capability and choice to provide acceptable collateral. One view is that conditionality undermines domestic political institutions.[19] The recipient governments are sacrificing policy autonomy in exchange for funds, which can lead to public resentment of the local leadership for accepting and enforcing the IMF conditions. Political instability can result from more leadership turnover as political leaders are replaced in electoral backlashes.[6] IMF conditions are often criticised for their bias against economic growth and reduce government services, thus increasing unemployment.[8] Another criticism is that IMF programs are only designed to address poor governance, excessive government spending, excessive government intervention in markets, and too much state ownership.[18] This assumes that this narrow range of issues represents the only possible problems; everything is standardised and differing contexts are ignored.[18] A country may also be compelled to accept conditions it would not normally accept had they not been in a financial crisis in need of assistance.[15] It is claimed that conditionalities retard social stability and hence inhibit the stated goals of the IMF, while Structural Adjustment Programs lead to an increase in poverty in recipient countries.[20] The IMF sometimes advocates austerity programmes, cutting public spending and increasing taxes even when the economy is weak, to bring budgets closer to a balance, thus reducing budget deficits. Countries are often advised to lower their corporate tax rate. In Globalization and Its Discontents, Joseph E. Stiglitz, former chief economist and senior vicepresident at the World Bank, criticises these policies.[21] He argues that by converting to a more monetarist approach, the purpose of the fund is no longer valid, as it was designed to provide funds for countries to carry out Keynesian reflations, and that the IMF "was not participating in a conspiracy, but it was reflecting the interests and ideology of the Western financial community."[22]

Reform
The IMF is only one of many international organisations and it is a generalist institution for macroeconomic issues only; its core areas of concern in developing countries are very narrow. One proposed reform is a movement towards close partnership with other specialist agencies to better productivity. The IMF has little to no communication with other international

organisations such as UN specialist agencies like UNICEF, the Food and Agriculture Organization (FAO), and the United Nations Development Program (UNDP).[18] Jeffrey Sachs argues in The End of Poverty: "international institutions like the International Monetary Fund (IMF) and the World Bank have the brightest economists and the lead in advising poor countries on how to break out of poverty, but the problem is development economics".[18] Development economics needs the reform, not the IMF. He also notes that IMF loan conditions need to be partnered with other reforms such as trade reform in developed nations, debt cancellation, and increased financial assistance for investments in basic infrastructure to be effective.[18] IMF loan conditions cannot stand alone and produce change; they need to be partnered with other reforms or other conditions as applicable.

History

IMF "Headquarters 1" in Washington, D.C.

The International Monetary Fund was originally laid out as a part of the Bretton Woods system exchange agreement in 1944.[23] During the earlier Great Depression, countries sharply raised barriers to foreign trade in an attempt to improve their failing economies. This led to the devaluation of national currencies and a decline in world trade.[24] This breakdown in international monetary co-operation created a need for oversight. The representatives of 45 governments met at the Bretton Woods Conference in the Mount Washington Hotel in the area of Bretton Woods, New Hampshire in the United States, to discuss framework for post-World War II international economic co-operation. The participating countries were concerned with the rebuilding of Europe and the global economic system after the war. There were two views on the role the IMF should assume as a global economic institution. British economist John Maynard Keynes imagined that the IMF would be a cooperative fund upon which member states could draw to maintain economic activity and employment through periodic crises. This view suggested an IMF that helped governments and to act as the US government had during the New Deal in response to World War II. American delegate Harry Dexter White foresaw an IMF that functioned more like a bank, making sure that borrowing

states could repay their debts on time.[25] Most of White's plan was incorporated into the final acts adopted at Bretton Woods. The International Monetary Fund formally came into existence on 27 December 1945, when the first 29 countries ratified its Articles of Agreement.[26] By the end of 1946 the Fund had grown to 39 members.[27] On 1 March 1947, the IMF began its financial operations,[28] and on 8 May France became the first country to borrow from it.[27] The IMF was one of the key organisations of the international economic system; its design allowed the system to balance the rebuilding of international capitalism with the maximisation of national economic sovereignty and human welfare, also known as embedded liberalism.[29] The IMF's influence in the global economy steadily increased as it accumulated more members. The increase reflected in particular the attainment of political independence by many African countries and more recently the 1991 dissolution of the Soviet Union because most countries in the Soviet sphere of influence did not join the IMF.[24] The Bretton Woods system prevailed until 1971, when the US government suspended the convertibility of the US$ (and dollar reserves held by other governments) into gold. This is known as the Nixon Shock.[24] As of January 2012, the largest borrowers from the fund in order are Greece, Portugal, Ireland, Romania and Ukraine.[30]

Member countries

IMF member states IMF member states not accepting the obligations of Article VIII, Sections 2, 3, and 4[31]

The 188 members of the IMF include 187 members of the UN and the Republic of Kosovo[a].[32][33] All members of the IMF are also International Bank for Reconstruction and Development (IBRD) members and vice versa.[citation needed] Former members are Cuba (which left in 1964)[34] and the Republic of China, which was ejected from the UN in 1980 after losing the support of then US President Jimmy Carter and was replaced by the People's Republic of China.[35] However, "Taiwan Province of China" is still listed in the official IMF indices.[36]

Apart from Cuba, the other UN states that do not belong to the IMF are Andorra, Liechtenstein, Monaco, Nauru and North Korea. The former Czechoslovakia was expelled in 1954 for "failing to provide required data" and was readmitted in 1990, after the Velvet Revolution. Poland withdrew in 1950allegedly pressured by the Soviet Unionbut returned in 1986.[37]

Qualifications
Any country may apply to be a part of the IMF. Post-IMF formation, in the early postwar period, rules for IMF membership were left relatively loose. Members needed to make periodic membership payments towards their quota, to refrain from currency restrictions unless granted IMF permission, to abide by the Code of Conduct in the IMF Articles of Agreement, and to provide national economic information. However, stricter rules were imposed on governments that applied to the IMF for funding.[38] The countries that joined the IMF between 1945 and 1971 agreed to keep their exchange rates secured at rates that could be adjusted only to correct a "fundamental disequilibrium" in the balance of payments, and only with the IMF's agreement.[39] Some members have a very difficult relationship with the IMF and even when they are still members they do not allow themselves to be monitored. Argentina for example refuses to participate in an Article IV Consultation with the IMF.[40]

Benefits
Member countries of the IMF have access to information on the economic policies of all member countries, the opportunity to influence other members economic policies, technical assistance in banking, fiscal affairs, and exchange matters, financial support in times of payment difficulties, and increased opportunities for trade and investment.[41]

Leadership
Board of Governors
The Board of Governors consists of one governor and one alternate governor for each member country. Each member country appoints its two governors. The Board normally meets once a year and is responsible for electing or appointing executive directors to the Executive Board. While the Board of Governors is officially responsible for approving quota increases, special drawing right allocations, the admittance of new members, compulsory withdrawal of members, and amendments to the Articles of Agreement and By-Laws, in practice it has delegated most of its powers to the IMF's Executive Board.[42] The Board of Governors is advised by the International Monetary and Financial Committee and the Development Committee. The International Monetary and Financial Committee has 24

members and monitors developments in global liquidity and the transfer of resources to developing countries.[43] The Development Committee has 25 members and advises on critical development issues and on financial resources required to promote economic development in developing countries. They also advise on trade and global environmental issues.[43]

Executive Board
24 Executive Directors make up Executive Board. The Executive Directors represent all 188 member-countries. Countries with large economies have their own Executive Director, but most countries are grouped in constituencies representing four or more countries.[42] Following the 2008 Amendment on Voice and Participation, eight countries each appoint an Executive Director: the United States, Japan, Germany, France, the United Kingdom, China, the Russian Federation, and Saudi Arabia.[44] The remaining 16 Directors represent constituencies consisting of 4 to 22 countries. The Executive Director representing the largest constituency of 22 countries accounts for 1.55% of the vote.

Managing Director
The IMF is led by a managing director, who is head of the staff and serves as Chairman of the Executive Board. The managing director is assisted by a First Deputy managing director and three other Deputy Managing Directors.[42] Historically the IMF's managing director has been European and the president of the World Bank has been from the United States. However, this standard is increasingly being questioned and competition for these two posts may soon open up to include other qualified candidates from any part of the world.[45][46] In 2011 the world's largest developing countries, the BRIC nations, issued a statement declaring that the tradition of appointing a European as managing director undermined the legitimacy of the IMF and called for the appointment to be merit-based.[46][47] The head of the IMF's European department is Antnio Borges of Portugal, former deputy governor of the Bank of Portugal. He was elected in October 2010.[48]
Dates 6 May 1946 5 May 1951 3 August 1951 3 October 1956 21 November 1956 5 May 1963 Name Camille Gutt Ivar Rooth Per Jacobsson Nationality Belgian Swedish Swedish French Dutch French

1 September 1963 31 August 1973 Pierre-Paul Schweitzer 1 September 1973 18 June 1978 18 June 1978 15 January 1987 Johan Witteveen Jacques de Larosire

16 January 1987 14 February 2000 Michel Camdessus 1 May 2000 4 March 2004 7 June 2004 31 October 2007 1 November 2007 18 May 2011 5 July 2011 Horst Khler Rodrigo Rato

French German Spanish

Dominique Strauss-Kahn French Christine Lagarde French

On 28 June 2011, Christine Lagarde was named managing director of the IMF, replacing Dominique Strauss-Kahn.

Previous managing director Dominique Strauss-Kahn was arrested in connection with charges of sexually assaulting a New York room attendant. Strauss-Kahn subsequently resigned his position on 18 May.[49] On 28 June 2011 Christine Lagarde was confirmed as managing director of the IMF for a five-year term starting on 5 July 2011.[50][51]

Voting power
Voting power in the IMF is based on a quota system. Each member has a number of "basic votes" (each member's number of basic votes equals 5.502% of the total votes),[52] plus one additional vote for each Special Drawing Right (SDR) of 100,000 of a member country's quota.[53] The Special Drawing Right is the unit of account of the IMF and represents a claim to currency. It is based on a basket of key international currencies. The basic votes generate a slight bias in favour of small countries, but the additional votes determined by SDR outweigh this bias.[53]
The table below shows quota and voting shares for IMF members (Attention: Amendment on Voice and Participation, and of subsequent reforms of quotas and governance which were agreed in 2010 but are not yet in effect.[54])

IMF Member country USA Japan

Quota: Quota: millions of percentage of SDRs the total 42,122.4 15,628.5 17.69 6.56

Governor

Alternate

Number Percentage out of votes of total votes 421,961 157,022 16.75 6.23

Jack Lew Taro Aso Wolfgang Schuble Pierre Moscovici George Osborne Zhou Xiaochuan Fabrizio Saccomanni Ibrahim A. AlAssaf Jim Flaherty Anton Siluanov

Janet Yellen Haruhiko Kuroda Jens Weidmann Christian Noyer Mark Carney

Germany

14,565.5

6.12

146,392

5.81

France

10,738.5

4.51

108,122

4.29

UK

10,738.5

4.51

108,122

4.29

China

9,525.9

4.00

Yi Gang

81 151

3.65

Italy

7,055.5

3.24

Ignazio Visco Fahad Almubarak

95,996

3.81

Saudi Arabia Canada Russia

6,985.5 6,369.2 5,945.4

2.93 2.67 2.50

70,592

2.80 2.56 2.39

Stephen Poloz 64,429 Sergey Ignatyev 60,191

India

5,821.5

2.44

P. Raghuram Chidambaram Rajan Klaas Knot

58,952

2.34

Netherlands Belgium

5,162.4

2.17

Hans Vijlbrief 52,361 Marc Monbaliu

2.08

4,605.2

1.93

Luc Coene

46,789

1.86

Switzerland

3,458.5

1.45

Thomas Jordan Eveline Widmer-

35,322

1.40

Schlumpf Mexico 3,625.7 1.52 Luis Videgaray Luis de Guindos Guido Mantega Agustn Carstens 36,994 1.47

Spain

4,023.4

1.69

Luis M. Linde 40,971 Alexandre Tombini Choongsoo Kim Martin Parkinson

1.63

Brazil

4,250.5

1.79

43,242

1.72

South Korea

3,366.4

1.41

Jaewan Bahk

34,401

1.37

Australia

3,236.4

1.36

Wayne Swan

33,101

1.31

Venezuela

2,659.1

1.12

Jorge Giordani

Nelson Jos 27,328 Merentes Diaz Abdul Wajid Rana respective 11,074

1.08

Pakistan

1,033.7

0.43

Yaseen Anwar

0.44

The rest of 165 62,593.8 countries

28.39

respective

667,438

31.16

Effects of the quota system

The IMF's quota system was created to raise funds for loans.[55] Each IMF member country is assigned a quota, or contribution, that reflects the country's relative size in the global economy. Each member's quota also determines its relative voting power. Thus, financial contributions from member governments are linked to voting power in the organisation.[53] This system follows the logic of a shareholder-controlled organisation: wealthy countries have more say in the making and revision of rules.[56] Since decision making at the IMF reflects each member's relative economic position in the world, wealthier countries that provide more money to the fund have more influence in the IMF than poorer members that contribute less; nonetheless, the IMF focuses on redistribution.[53]
Developing countries

Quotas are normally reviewed every five years and can be increased when deemed necessary by the Board of Governors. Currently, reforming the representation of developing countries within

the IMF has been suggested.[53] These countries' economies represent a large portion of the global economic system but this is not reflected in the IMF's decision making process through the nature of the quota system. Joseph Stiglitz argues "There is a need to provide more effective voice and representation for developing countries, which now represent a much larger portion of world economic activity since 1944, when the IMF was created."[57] In 2008, a number of quota reforms were passed including shifting 6% of quota shares to dynamic emerging markets and developing countries.[58]
United States influence

A second criticism is that the United States' transition to neoliberalism and global capitalism also led to a change in the identity and functions of international institutions like the IMF. Because of the high involvement and voting power of the United States, the global economic ideology could effectively be transformed to match the US's. This is consistent with the IMF's function change during the 1970s after the Nixon Shock ended the Bretton Woods system. Another criticism is that allies of the United States are able to receive bigger loans with fewer conditions.[23]
Overcoming borrower/creditor divide

The IMF's membership is divided along income lines: certain countries provide the financial resources while others use these resources. Both developed country "creditors" and developing country "borrowers" are members of the IMF. The developed countries provide the financial resources but rarely enter into IMF loan agreements; they are the creditors. Conversely, the developing countries use the lending services but contribute little to the pool of money available to lend because their quotas are smaller; they are the borrowers. Thus, tension is created around governance issues because these two groups, creditors and borrowers, have fundamentally different interests in terms of the conditions of these loans.[59] The criticism is that the system of voting power distribution through a quota system institutionalises borrower subordination and creditor dominance. The resulting division of the Fund's membership into borrowers and non-borrowers has increased the controversy around conditionality because the borrowing members are interested in making loan access easier while the creditor members want to maintain reassurance that the loans will be repaid.[60]

Use
A recent study reveals that the average overall use of IMF credit per decade increased, in real terms, by 21% between the 1970s and 1980s, and increased again by just over 22% percent from the 1980s to the 19912005 period. Another study has suggested that since 1950 the continent of Africa alone has received $300 billion from the IMF, the World Bank and affiliate institutions[61] A study done by Bumba Mukherjee found that developing democratic countries benefit more from IMF programs than developing autocratic countries because policy-making, and the process of deciding where loaned money is used, is more transparent within a democracy.[61] One study done by Randall Stone found that although earlier studies found little impact of IMF programs

on balance of payments, more recent studies using more sophisticated methods and larger samples "usually found IMF programs improved the balance of payments."[23]

IMF and globalization

Globalization encompasses three institutions: global financial markets and transnational companies, national governments linked to each other in economic and military alliances led by the US, and rising "global governments" such as World Trade Organization (WTO), IMF, and World Bank.[62] Charles Derber argues in his book People Before Profit, "These interacting institutions create a new global power system where sovereignty is globalized, taking power and constitutional authority away from nations and giving it to global markets and international bodies."[62] Titus Alexander argues that this system institutionalises global inequality between western countries and the Majority World in a form of global apartheid, in which the IMF is a key pillar.[63] The establishment of globalised economic institutions has been both a symptom of and a stimulus for globalisation. The development of the World Bank, the IMF regional development banks such as the European Bank for Reconstruction and Development (EBRD), and, more recently, multilateral trade institutions such as the WTO indicates the trend away from the dominance of the state as the exclusive unit of analysis in international affairs. Globalization has thus been transformative in terms of a reconceptualising of state sovereignty.[64] Following US President Bill Clinton's administration's aggressive financial deregulation campaign in the 1990s, globalisation leaders overturned long-standing restrictions by governments that limited foreign ownership of their banks, deregulated currency exchange, and eliminated restrictions on how quickly money could be withdrawn by foreign investors.[62]

Criticisms
Overseas Development Institute (ODI) research undertaken in 1980 pointed to five main criticisms of the IMF which support the analysis that it is a pillar of what activist Titus Alexander calls global apartheid.[65] Firstly, developed countries were seen to have a more dominant role and control over less developed countries (LDCs) primarily due to the Western bias towards a capitalist form of the world economy with professional staff being Western trained and believing in the efficacy of market-oriented policies. Secondly, the Fund worked on the incorrect assumption that all payments disequilibria were caused domestically. The Group of 24 (G-24), on behalf of LDC members, and the United Nations Conference on Trade and Development (UNCTAD) complained that the Fund did not distinguish sufficiently between disequilibria with predominantly external as opposed to internal causes. This criticism was voiced in the aftermath of the 1973 oil crisis. Then LDCs found themselves with payments deficits due to adverse changes in their terms of trade, with the Fund prescribing stabilisation programmes similar to those suggested for deficits caused by government over-spending. Faced with long-term, externally generated disequilibria, the Group of 24 argued that LDCs should be allowed more time to adjust their economies and that the

policies needed to achieve such adjustment are different from demand-management programmes devised primarily with internally generated disequilibria in mind. The third criticism was that the effects of Fund policies were anti-developmental. The deflationary effects of IMF programmes quickly led to losses of output and employment in economies where incomes were low and unemployment was high. Moreover, it was sometimes claimed that the burden of the deflationary effects was borne disproportionately by the poor. Fourthly is the accusation that harsh policy conditions were self-defeating where a vicious circle developed when members refused loans due to harsh conditionality, making their economy worse and eventually taking loans as a drastic medicine. Lastly is the point that the Fund's policies lack a clear economic rationale. Its policy foundations were theoretical and unclear due to differing opinions and departmental rivalries whilst dealing with countries with widely varying economic circumstances. ODI conclusions were that the Fund's very nature of promoting market-oriented economic approach attracted unavoidable criticism, as LDC governments were likely to object when in a tight corner. Yet, on the other hand, the Fund could provide a 'scapegoat service' where governments could take loans as a last resort, whilst blaming international bankers for any economic downfall. The ODI conceded that the fund was to some extent insensitive to political aspirations of LDCs, while its policy conditions were inflexible.[66] Argentina, which had been considered by the IMF to be a model country in its compliance to policy proposals by the Bretton Woods institutions, experienced a catastrophic economic crisis in 2001,[67] which some believe to have been caused by IMF-induced budget restrictionswhich undercut the government's ability to sustain national infrastructure even in crucial areas such as health, education, and securityand privatisation of strategically vital national resources.[68] Others attribute the crisis to Argentina's misdesigned fiscal federalism, which caused subnational spending to increase rapidly.[69] The crisis added to widespread hatred of this institution in Argentina and other South American countries, with many blaming the IMF for the region's economic problems. The currentas of early 2006trend toward moderate left-wing governments in the region and a growing concern with the development of a regional economic policy largely independent of big business pressures has been ascribed to this crisis. In an interview, the former Romanian Prime Minister Clin Popescu-Triceanu claimed that "Since 2005, IMF is constantly making mistakes when it appreciates the country's economic performances."[70]

Support of military dictatorships

The role of the Bretton Woods institutions has been controversial since the late Cold War period, due to claims that the IMF policy makers supported military dictatorships friendly to American and European corporations and other anti-communist regimes. Critics also claim that the IMF is generally apathetic or hostile to their views of human rights, and labour rights.[citation needed] The controversy has helped spark the Anti-globalization movement.

Arguments in favour of the IMF say that economic stability is a precursor to democracy; however, critics highlight various examples in which democratised countries fell after receiving IMF loans.[71]

Impact on access to food

A number of civil society organisations[72] have criticised the IMF's policies for their impact on people's access to food, particularly in developing countries. In October 2008, former US president Bill Clinton presented a speech to the United Nations World Food Day, which criticised the World Bank and IMF for their policies on food and agriculture: We need the World Bank, the IMF, all the big foundations, and all the governments to admit that, for 30 years, we all blew it, including me when I was president. We were wrong to believe that food was like some other product in international trade, and we all have to go back to a more responsible and sustainable form of agriculture.
Former U.S. president Bill Clinton, Speech at United Nations World Food Day, October 16, 2008[73]

Impact on public health

In 2009 a study by analysts from Cambridge and Yale universities published on the open-access Public Library of Science concluded that strict conditions on the international loans by the IMF resulted in thousands of deaths in Eastern Europe by tuberculosis as public health care had to be weakened. In the 21 countries to which the IMF had given loans, tuberculosis deaths rose by 16.6%.[74] In 2009, a book by Rick Rowden titled The Deadly Ideas of Neoliberalism: How the IMF has Undermined Public Health and the Fight Against AIDS, claimed that the IMFs monetarist approach towards prioritising price stability (low inflation) and fiscal restraint (low budget deficits) was unnecessarily restrictive and has prevented developing countries from being able to scale up long-term public investment as a percent of GDP in the underlying public health infrastructure. The book claimed the consequences have been chronically underfunded public health systems, leading to dilapidated health infrastructure, inadequate numbers of health personnel, and demoralising working conditions that have fuelled the push factors driving the brain drain of nurses migrating from poor countries to rich ones, all of which has undermined public health systems and the fight against HIV/AIDS in developing countries.[75]

Impact on environment
IMF policies have been repeatedly criticised for making it difficult for indebted countries to avoid ecosystem-damaging projects that generate cash flow, in particular oil, coal, and forestdestroying lumber and agriculture projects. Ecuador for example had to defy IMF advice repeatedly to pursue the protection of its rain forests, though paradoxically this need was cited in IMF argument to support that country. The IMF acknowledged this paradox in a March 2010 staff position report[76] which proposed the IMF Green Fund, a mechanism to issue special

drawing rights directly to pay for climate harm prevention and potentially other ecological protection as pursued generally by other environmental finance. While the response to these moves was generally positive[77] possibly because ecological protection and energy and infrastructure transformation are more politically neutral than pressures to change social policy. Some experts voiced concern that the IMF was not representative, and that the IMF proposals to generate only US$200 billion a year by 2020 with the SDRs as seed funds, did not go far enough to undo the general incentive to pursue destructive projects inherent in the world commodity trading and banking systemscriticisms often levelled at the World Trade Organization and large global banking institutions. In the context of the May 2010 European banking crisis, some observers also noted that Spain and California, two troubled economies within Europe and the United States respectively, and also Germany, the primary and politically most fragile supporter of a euro currency bailout would benefit from IMF recognition of their leadership in green technology, and directly from Green Fundgenerated demand for their exports, which might also improve their credit standing with international bankers.[citation needed]
Risk management is an important part of planning for businesses. The process of risk management is designed to reduce or eliminate the risk of certain kinds of events happening or having an impact on the business. Definition of Risk Management Risk management is a process for identifying, assessing, and prioritizing risks of different kinds. Once the risks are identified, the risk manager will create a plan to minimize or eliminate the impact of negative events. A variety of strategies is available, depending on the type of risk and the type of business. There are a number of risk management standards, including those developed by the Project Management Institute, the International Organization for Standardization (ISO), the National Institute of Science and Technology, and actuarial societies. Types of Risk There are many different types of risk that risk management plans can mitigate. Common risks include things like accidents in the workplace or fires, tornadoes, earthquakes, and other natural disasters. It can also include legal risks like fraud, theft, and sexual harassment lawsuits. Risks can also relate to business practices, uncertainty in financial markets, failures in projects, credit risks, or the security and storage of data and records. Goals of Risk Management The idea behind using risk management practices is to protect businesses from being vulnerable. Many business risk management plans may focus on keeping the company viable and reducing financial risks.

However, risk management is also designed to protect the employees, customers, and general public from negative events like fires or acts of terrorism that may affect them. Risk management practices are also about preserving the physical facilities, data, records, and physical assets a company owns or uses. Process for Identifying and Managing Risk While a variety of different strategies can mitigate or eliminate risk, the process for identifying and managing the risk is fairly standard and consists of five basic steps. First, threats or risks are identified. Second, the vulnerability of key assets like information to the identified threats is assessed. Next, the risk manager must determine the expected consequences of specific threats to assets. The last two steps in the process are to figure out ways to reduce risks and then prioritize the risk management procedures based on their importance. Strategies for Managing Risk There are as many different types of strategies for managing risk as there are types of risks. These break down into four main categories. Risk can be managed by accepting the consequences of a risk and budgeting for it. Another strategy is to transfer the risk to another party by insuring against a particular, like fire or a slip-and-fall accident. Closing down a particular high-risk area of a business can avoid risk. Finally, the manager can reduce the risk's negative effects, for instance, by installing sprinklers for fires or instituting a back-up plan for data. Having a risk management plan is an important part of maintaining a successful and responsible company. Every company should have one. It will help to protect people as well as physical and financial assets. How Does Risk Management Apply to Financial Decisions? A very specific type of risk management relates to financial decisions taken in a business. In this context, risk management is not about eliminating risk but rather about controlling the way to take risks. Its different from some other types of risk management. What Is Risk Management? Risk management is a process for mitigating or eliminating risk in a variety of different areas that may impact the operation of a business. Different strategies are used to manage risk depending on the business and the type of risk. In the case of financial risk management, this means making sure the financial risks that are taken are sound risks. This usually means codifying how the company makes these decisions as well as what constitutes a good financial risk. Financial Risk Management

When companies make financial decisions, they always assume some degree of risk, especially when theyre making decisions about investments. Financial risk management is a set of practices that allow a company to optimize the way it takes financial risk. A financial risk management plan may include things like how the company monitors risky activities and applies the risk process. The companys board or senior management decides the plan to guide how financial decisions are made. Market Risks As with other types of risk management, in financial risk management there are a variety of different types of risks the risk managers must take into account and evaluate. Market risk, the exposure to financial loss because of the uncertain future value of stocks, is a key component of financial risk. This type of risk is managed by avoiding day-to-day losses on the stock market. Risk management procedures might impose a level of acceptable risk in investing to mitigate market risk. Credit Risks Credit risk is a type of risk that comes into play when a company is making loans, issuing credit cards, insuring, or investing in the debt of other companies. In these cases, the risk theyre assuming is that the other party will default, in which case theyll lose the investment. A risk management plan for credit risks would apply a procedure for determining how much of a risk a particular investment is. It would also detail how much risk is too much and how much is acceptable. Operational Risks An operation risk is slightly different from market risk and credit risk because it concerns the internal operation of a company, rather than an exterior source of risk. Operational risk is the risk of a loss because of the failure of internal systems or processes or the errors of people working for a company. These may include system errors like computer failures, or losses to physical assets like fire, floods, or earthquakes. It may also include employee-caused problems like errors, fraud, theft, or other criminal activities. Financial risk management involves protecting a company against financial loss due to a variety of factors. While this type of risk management only provides guidelines by which financial decisions should be made, it is still an important safeguard against loss.