The global financial safety net has become increasinglyfragmented, making it harder to respond to crises in a world roiledby volatile capital flows, International Monetary Fund (IMF)staffers warned.

Defenses haven't kept up with the growth of external debt inrecent years, the Washington-based fund said in a report releasedThursday. As a result, a system-wide shock could overwhelm theworld's crisis resources, which include nations' foreign-exchangereserves, central-bank swap lines, regional funds such as the euroarea's European Stability Mechanism, and the IMF itself, the lendersaid.

Financial cycles have been “growing in amplitude and duration,capital flows have become more volatile, and non-banks have gainedimportance, altering the nature of systemic risk,” IMF staff saidin the report, which was presented to the fund's executive board onMarch 7. In a major event, “the needs could exceed the collectiveresources available,” the fund said.

The paper takes stock of the global monetary system that hasprevailed since 1973, the year that marked the collapse of theBretton Woods system of exchange rates pegged to the dollar. At ameeting in Shanghai last month, Group of 20 finance ministers andcentral bankers said the IMF's work would inform the group's studyof the “evolution” of the world's financial architecture.

The current monetary system, with the freedom it offers tocountries to choose their exchange-rate strategy, has proven moreflexible in responding to shocks, the IMF said.

Exposed Weaknesses in Global Economy

But the 2008 crisis exposed the system's weaknesses, including alack of financial oversight. Since then, the global economy hascontinued to undergo major structural shifts that are having asignificant effect on the international monetary landscape, the IMFsaid.

The growth of emerging-market and developing countries has madethe global economy more “multipolar,” fund staff said. Still,financial markets in such nations aren't as deep as in advancedeconomies, and the system remains highly dependent on the dollar asa reserve currency.

The central role of one or two reserve currencies can havesignificant spillover effects on other countries, especially thosewith open economies and less-developed financial markets, the IMFsaid.

At the same time, the globalization of finance has led to adramatic increase in capital flows. “Periodic episodes of highcapital flow volatility appear to have become a feature of the newglobal landscape,” putting pressure on emerging markets inparticular, the IMF said.

Meanwhile, non-banks such as insurers and mutual funds havegrown in importance as creditors, creating new risks, according tothe fund.

The IMF said reforms should focus on bolstering the resilienceof emerging markets to large capital flows, as well as improvingglobal cooperation on stability issues, with countries paying moreattention to how their policies affect the world.

IMF staff said the fund could play a role in monitoring a “largeenough and more coherent” global safety net. The IMF is assessingwhether it has adequate resources to fulfill its central role inthe global system, according to the report.

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