Shadow Banks, the IMF and the Politics of Financial Crisis

This chapter provides a detailed overview of the key features, preferences and objectives of the main actors whose actions can influence the likelihood of currency and sudden reversal crisis under IMF programs—the IMF, the government seeking IMF help, domestic citizens in the IMF-supported country, domestic shadow banks in the Fund-assisted country, foreign portfolio investors and currency traders. It uses data from the IMF to show how frequently the IMF includes reforms targeting shadow banks in its programs and then builds on this foundation to develop a theoretical framework that explains the outbreak of twin currency and sudden reversal crises in the context of IMF programs. The main argument this theoretical framework posits is that domestic private shadow banks in Fund-assisted countries have the incentives and the capacity to collectively pressure the government to renege on IMF-mandated shadow bank reforms only when their market concentration is high. Under these conditions, the relentless anti-IMF reform pressure from a concentrated shadow banking sector compels the government to renege from financial sector reform measures designed by the Fund. Such non-compliance generates a “financial panic” among currency traders and foreign portfolio investors which in turn leads to the joint outbreak of sudden reversal and currency crisis. These arguments generate Hypothesis 1, two corollaries associated with this hypothesis, and numerous theoretical claims.