Since the mid-1990s, crises have usually been resolved by the provision of – sometimes extremely large – financial assistance packages by the IMF. This practice, however, sets the wrong incentives for all participants. International financial market will only proper function if private creditors and investors not only reap the benefits of their decisions but also bear losses caused by unfavourable developments.
Violating this principle by having the IMF inject massive financial aid at times of crisis inevitably encourages excessive risk-taking by investors. Such behaviour – also termed moral hazard – contributes to emerging market economies overwhelmed by debt and undermines the willingness to reform in borrowing countries. Therefore, we need to rearrange the incentives in an improved framework for crisis resolution.