What Is the Importance of International Financial Institutions & Managing Risks?

International financial institutions provide businesses or governments with a loan for emergency purposes or for normal business functions. When these institutions provide money to another group, an element of risk is present. How the institutions manage these risks depends on the specific situations. High-risk circumstances typically include far more terms and conditions on the loan than a normal business loan.

Government-Backed Institutions

Some financial institutions are inherently linked with a government’s treasury department. The Federal Reserve, the World Bank and the International Monetary Fund are good examples. The IMF is an international institution that provides countries experiencing an economic crisis with a temporary loan to stabilize its economy. This loan is backed by the institution’s founder, the United States government. The World Bank is a specialized institution of the United Nations designed to give aid to governments, private agencies and corporations. The goal of these loans is to assist with development and health-related projects.

Private Institutions

Several international institutions are private, such as Deutsche Bank, HSBC, Goldman Sachs and AIG. These companies make loans based on the risk level of the investment and the potential for profit. As is the case with most financial decisions: The higher the risk, the greater the potential reward. For example, a financial institution may decide to invest in Nigerian oil fields despite the government’s high level of corruption and known vandalism. The primary incentive under which private institutions issue loans is for the sake of increasing wealth to its shareholders.

Managing Risks

International financial institutions measure risk by the government or company’s ability to repay, its level of debt and what the group can offer as collateral in case of default. Government-backed institutions typically issue loans regardless of the amount of debt, primarily because the loan is issued because of economic catastrophes. During the Grecian debt crisis, the IMF offered Greece a bailout package to stabilize its flailing economy. In this case, the risk was mitigated because of the strength of other economies in the European Union, including Germany and France.

Private corporations have other means of managing the risk, primarily through high interest rates, up-front fees and stringent terms and conditions. Private institutions can also request the collection of collateral in the event of default.

Considerations

Some, such as former consultant John Perkins, cite that international financial institutions target Third World countries rich in natural resources for exploitation. During the 1970s in Panama, corporations pitched infrastructure projects to countries knowing they would default on their debt due to high adjustable interest rates. When the default occurred, the institution then collected natural resources such as gas and oil as collateral for a fraction of the price. In these cases, the high risk of defaulting was actually beneficial to the financial institution.

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About the Author

Since 2008 Catherine Capozzi has been writing business, finance and economics-related articles from her home in the sunny state of Arizona. She is pursuing a Bachelor of Science in economics from the W.P. Carey School of Business at Arizona State University, which has given her a love of spreadsheets and corporate life.