Contingent Liabilities: Issues and Practice; Aliona Cebotari; imf working Paper 08/245; October 1, 2008

a strong regulatory framework. This applies equally to the implicit liabilities stemming 
from subnational governments, state-owned enterprises or the banking system. The two basic 
pillars of the framework for managing risk from these sources include: (i) ex-ante regulation, 
which involves ex-ante controls over the behavior of the institutions (such as limits on 
borrowing, deficits, risk-taking) and monitoring of their fiscal/financial positions by a central 
institution; and (ii) ex-post insolvency mechanisms, which would help enforce hard budget 
constraints and would create clear expectations about ex-post risk sharing, thereby mitigating 
moral hazard associated with the expectation of a possible bailout of these institutions. The 
specific tools used to mitigate risks would of course depend on the source and the nature of 
the risk. For example, in the case of subnational governments, as discussed in Liu (2007),
38
Some countries provide additional appropriations automatically (New Zealand, the United States), although 
the experience in the United States has shown that the additional appropriations could be large (Kraan, 2004). 
39
See Reserve Bank of Australia, Financial Stability Review, March 2006. 

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ex-ante borrowing regulations frequently include: (a) rules that restrict borrowing only to 
long-term capital investments (Brazil, Colombia, India, Peru, Russia, South Africa);
(b) limits on key fiscal variables, such as the overall or primary deficit, debt-service ratios, 
and/or ceilings on guarantees (Brazil, Colombia, India); and (c) procedural requirements that 
subnational governments establish a medium-term fiscal framework and a transparent 
budgetary process (Brazil, Colombia, Peru). Insolvency mechanisms, on the other hand, 
include clear insolvency triggers, fiscal adjustment by the debtor, and debtor-creditor 
negotiations to restructure the debt obligation. The effectiveness of the regulatory framework 
would depend, otherwise, on the overall structure of the intergovernmental relations and on 
ability to maintain macroeconomic stability.