Credit Tranche

What Is a Credit Tranche?

"Credit tranche" refers to a system of releasing loan funds in phases that the International Monetary Fund (IMF) uses to govern its lending activities with member countries. When a member nation applies for a loan to help with economic difficulties, the IMF will disburse the loan in a series of credit tranches. The credit tranches are portions of the loan that are released to the member country, usually upon the member fulfilling conditions or requirements set forth by the IMF.

Key Takeaways

  • A "credit tranche" is a system of releasing loan funds to member countries used by the International Monetary Fund (IMF).
  • When a member country needs a loan from the IMF, the IMF will disburse the loan in a series of credit tranches.
  • Before a country can receive the following credit tranche loan disbursement, it will have to meet certain criteria as laid out by the IMF.
  • The criteria, or reforms, the IMF stipulates have a free market focus.
  • The loans that the IMF disburses come in four tranches with the first usually being 25% of a member's quota.


Understanding Credit Tranches

Credit tranches are the chunks of credit that the IMF makes available to a member country as they make financial reforms according to IMF guidance. Generally, the reforms have a free market focus and may include making it easier for entrepreneurs to start businesses, reducing public debt, and privatizing nationalized sections of the economy.

An International Monetary Fund loan usually lasts between 18 months and three years. At the start of the loan, the borrowing nation must demonstrate that reasonable efforts have been taken to overcome its financial difficulties. If this requirement is met, the country will receive the first credit tranche of the loan, which is usually kept within 25% of a member’s quota. Quota is assigned to new member countries based on their GDP, economic openness, and international reserves.

190

The number of member countries in the International Monetary Fund (IMF).

The later series of credit tranches will have additional conditions, each of which the borrower must satisfy before receiving the next portion of funding. The purpose of the conditions is to remove the moral hazard that might be created by the IMF essentially bailing out a country. Instead of merely giving over capital, the IMF requires economic reform to ensure that the country is stable and able to weather future challenges.

Real-World Examples

There are many case studies of IMF successes and failures. Successes include countries like Jordan that have completed an IMF program and have emerged as global economies. Failures are sometimes harder to analyze, as one of the criticisms of the IMF is that social spending suffers under the free-market reforms. There is some truth to this, but social spending is usually at the point of being unsustainable before the IMF comes along with the austerity solution.

The IMF granted a three-year, $12 billion bailout program to Egypt in 2016. After the Arab Spring saw Hosni Mubarak’s 30-year regime topple, investors and tourists gave the country a wide berth. This badly damaged the Egyptian economy, and the country’s debt-to-GDP ratio climbed.

In June 2020, the IMF approved a 12-month standby arrangement for Egypt in the amount of $5.4 billion (184.8% of Egypt's quota). The first tranche was an immediate disbursement of $2 billion. The remaining tranches were spread across two reviews, the first in December 2020 and the next in June 2021, each in the amount of $1.7 billion.

What Is a Reserve Tranche Position With the IMF?

The reserve tranche, as stipulated by the IMF, is the difference between the IMF's holdings of a country's currency and the country's IMF quota. The reserve tranche functions as an emergency account for countries that they can access without having to agree to any conditions beforehand.

Who Funds the IMF?

The IMF is funded by its member countries, all of whom pay a capital subscription, known as a quota. Each country has a different quota that is based on the strength and size of its economy.

What Happens If a Country Fails to Pay Back a Loan From the IMF?

If a country fails to pay back a loan from the IMF, the IMF will create a new debt repayment schedule that the country can abide by so that it can pay back its loan over time.

What Is the Difference Between the IMF and the World Bank?

The primary goal of the IMF is to act as a source of stability for the world's monetary system and ensure the stability of currencies. The World Bank, on the other hand, is an organization that works to reduce global poverty through assistance programs for developing nations.

Article Sources
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  1. International Monetary Fund. "Glossary of Selected Financial Terms." Accessed Feb. 7, 2022.

  2. International Monetary Fund. "List of Members." Accessed Feb. 7, 2022.

  3. International Monetary Fund. "IMF Executive Board Approves U.S.$12 Billion Extended Arrangement Under the Extended Fund Facility for Egypt." Accessed Feb. 7, 2022.

  4. International Monetary Fund. "Frequently Asked Questions on Egypt and the IMF." Accessed Feb. 7, 2022.

  5. International Monetary Fund. "Factsheet. Where the IMF Gets Its Money." Accessed Feb. 7, 2022.

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