The foundations and principles for Preferred Creditor Status in sovereign debt

1. Introduction

Preferred Creditor Status (PCS) establishes a hierarchy of seniority among creditors in processes of debt relief undertaken to restore sovereign debt sustainability. Clarifying the scope and application of PCS is a precondition for implementing the principle of comparability of treatment (CoT) in sovereign debt restructuring, the principle that similarly situated creditors should bear comparable losses, because the treatment afforded to preferred creditors directly shapes what counts as comparable treatment for everyone else.

In recent years, influential private-sector creditors have criticized the granting of PCS to international financial institutions (IFIs) and regional multilateral development banks (MDBs). The application of PCS to IFIs and regional MDBs in the resolution of sovereign debt crises remains unclear on several counts: who should hold the status and why they should receive this seemingly preferential treatment, and what principles should govern the lending that qualifies for it. Resolving this ambiguity matters for enabling a genuinely counter-cyclical, developmental role for global and regional public financial institutions. This commentary aims to provide that clarity. Section 2 develops a conceptual framework for the existence of PCS in sovereign debt. Section 3 assesses current practice and sets out principles for reconciling its application with lending conditions. Section 4 concludes.

2. Preferred Creditor Status: A conceptual framework

A useful point of departure is the benchmark of the Modigliani-Miller (MM) theorem (Modigliani and Miller 1958), which holds that, under a set of idealized conditions, financing structure is irrelevant to a firm’s value. The key assumption is that of perfect capital markets: no transaction costs, no bankruptcy,¹ and, crucially, investors can borrow and lend on the same terms as the firm borrowing itself. Under these conditions, differences in seniority would merely redistribute risk among creditors, fully priced ex ante, leaving borrowing decisions and aggregate outcomes unchanged. In such a world, PCS would be neutral for economic outcomes.

Sovereign debt markets, however, systematically violate the assumptions underlying this neutrality result. Sovereign debt crises are both possible and costly, especially in the absence, under the current system, of a framework for resolving them (Guzman and Stiglitz 2016; Jubilee Report 2025). Once debt becomes unsustainable, the allocation of repayment priority affects real outcomes. Ex post, the availability of a lender when others will not lend can avert the efficiency losses associated with a destabilizing, contractionary adjustment in aggregate demand. Ex ante, that same structure of repayment priority affects the availability and cost of credit. On the one hand, because others have repayment priority, it raises the cost of borrowing for junior creditors, ceteris paribus. On the other hand, it changes the “ceteris paribus” in a way that may increase the size of the pie to be distributed among all creditors, the efficiency gain.

The economic rationale for PCS emerges precisely in this non-MM world. Certain creditors, most notably the IMF and some multilateral development banks, are designed to lend when private financing has evaporated, including during crises and even when a sovereign is already in arrears to other creditors.² By providing liquidity when markets are unwilling or unable to do so, these institutions can, in principle—provided the funds support counter-cyclical policies—avert disorderly balance-of-payments adjustments and thereby reduce efficiency losses. PCS functions as a commitment device that sustains this counter-cyclical lending: by granting repayment priority, it allows public multilateral institutions to keep operating in high-risk environments without jeopardizing their own financial viability. In this sense, PCS is an instrument of systemic stabilization.

The efficiency of PCS depends on the nature and objectives of the creditor to which it is granted. Creditors differ in their lending models, mandates, and incentives. Profit-maximizing lenders, even if granted seniority, may still ration credit in equilibrium under uncertainty and asymmetric information, as Stiglitz and Weiss (1981) showed in their classic analysis of credit rationing. Institutions with public mandates and systemic objectives—crisis management, development financing, and the preservation of trade flows—are, by contrast, meant to use the protection PCS affords to sustain lending precisely in bad states of the world. On this view, PCS is justified not by legal form or historical precedent but by the function it serves in reducing the costs of sovereign debt crises and thus even preventing them from happening or at least reducing their likelihood and the negative consequences they may entail.

However, the absence of clear, rules-based criteria for PCS generates uncertainty about seniority and bargaining positions, uncertainty that gives rise to efficiency losses, just as it would in the world of corporate finance. Once default risk and bankruptcy costs are acknowledged, ambiguity in the recognition of PCS is thus not neutral. When markets, rating agencies, and other creditors cannot anticipate whether a given institution will be treated as preferred in a restructuring, risk becomes harder to price. The likely result is higher risk premia and weaker incentives for counter-cyclical lending.³ Resolving, or at least reducing, such uncertainty is accordingly likely to be welfare-enhancing.

A useful comparison is with private-market practice in corporate distress, particularly debtor-in-possession (DIP) financing. In corporate bankruptcy, market participants recognize that new money extended in distress must be protected through repayment priority, or it will not be forthcoming. Providing such finance preserves market value—even creditors can recognize this. This logic mirrors the rationale for PCS in sovereign debt: in both cases, priority enables lending precisely when default risk is highest. The analogy is nonetheless incomplete. Corporate DIP financing operates within a legal bankruptcy framework that enforces priority claims and coordinates creditors, whereas sovereign debt has no equivalent institutional mechanism (Guzman, Ocampo, and Stiglitz 2016). Moreover, private lenders extend distressed financing only when expected returns justify the risk, and they do not internalize the broader aggregate-demand externalities associated with sovereign debt crises. Private markets can therefore replicate the form of priority under enforceable legal structures, but not the function of system-stabilizing lending in sovereign crises. This institutional gap explains why lending into arrears at the sovereign level has historically fallen to public institutions such as the IMF and MDBs, for which a credible form of PCS is a necessary enabling condition.

The central question, then, is how PCS should be defined and to whom it should apply. A system in which PCS is granted implicitly, selectively, and largely on the basis of power rather than clearly articulated principles undermines the very stabilizing role PCS is meant to play.

This framework motivates the analysis that follows, showing how ambiguity and inconsistency in the practical application of PCS expose regional development financial institutions to systemic disadvantage, with consequences for development finance and macroeconomic stabilization.

3. The practical application of PCS

In practice, PCS is an implicit—informal, not de jure—arrangement in which borrowers prioritize repayment to the IMF and the World Bank to preserve future access to affordable financing, and especially access at times of stress when private creditors will not lend, as discussed above.⁴ The status is meant to reflect several features of these institutions: their non-commercial character; their critical development role; their lending support during crises; lending rates set largely independently of market conditions⁵ and at rates lower than the private sector (and far lower in times of distress); and in the case of the World Bank the need to protect market confidence and AAA credit ratings so as to preserve their capacity to raise cheap financing.

At present, for the other official multilateral financing institutions, the situation is more ambiguous. This ambiguity does not apply equally across regional institutions: established regional MDBs such as the Inter-American Development Bank (IDB) and Asian Development Bank (ADB) are generally recognized as preferred creditors, whereas the status of other regional financial institutions is either more ambiguous ex ante, as with the Development Bank of Latin America and the Caribbean (CAF), or not recognized ex post, as with Afreximbank.

PCS often excludes IFIs from restructurings, shifting the burden of debt relief onto private and bilateral creditors. Private creditors regard this as one factor weakening incentives for effective lending and undermining the catalytic effect that sufficiently large IMF programs can have on private lending (Krahnke 2023). Regional MDBs, meanwhile, are often excluded from this implicit guarantee, in part because they lack the backing of the most powerful countries, and in part because a perception that they do not merit PCS becomes self-reinforcing once they are seen to lend on terms markedly less favorable than the IMF or the World Bank. They will argue, of course, that they have to lend at higher rates than the World Bank precisely because their PCS has not been assured—still they lend at lower rates than private creditors demand.

This asymmetry structurally disadvantages regional development finance institutions based in developing countries and in the Global South in three ways: first, a higher cost of capital, owing to weaker recognition of their preferred status by markets and rating agencies; second, lower credit ratings despite comparable asset quality; and third, reduced crisis-response capacity, as their developmental lending is treated as ordinary commercial exposure rather than as the provision of a public good. As a result, they are subjected not only to higher rates, but also to more extensive credit rationing.

Regional multilateral development banks and other regional public financial institutions typically center their mission on promoting trade through short- and medium-term instruments: trade credit, export development finance, and trade guarantees. Because they have established relationships with regional banks, firms, and public institutions, they may be able to respond quickly when trade finance dries up; for instance, when private financing contracts, or when larger multilateral institutions fail to provide timely support. By preserving access to working capital and to financing for imports and exports, these operations sustain regional supply chains, support productive capacity, and facilitate cross-border trade.⁶ Even institutions without an explicit development mandate thus generate broader developmental benefits by strengthening regional economic integration and resilience. How much they actually contribute, however, depends on the terms, scale, additionality, and counter-cyclical character of the financing provided.

The debate over PCS thus raises a set of fundamental policy questions. Should PCS be determined by legal treaties and formal rules? Should the granting of PCS be associated with constraints on lending conditions such as interest rates and maturity profiles? These questions point to the need to clarify when and how PCS should be applied.

Designing a rules-based PCS system

While we have explained the benefits of conferring PCS status on IFIs and MDBs, and we have noted the ex post complaints of private creditors, there is also an ex ante cost: unconditional PCS risks generating moral hazard, encouraging excessive risk-taking by institutions that assume immunity from restructuring. Eligibility for PCS should accordingly be tied to clear, rules-based criteria. These should include an institution’s development mandate and a measurable degree of concessionality in its lending terms—understood broadly, not merely as below-market interest rates, but as encompassing risk exposure, grace periods, and maturity profiles. This broader conception better reflects the range of ways in which institutions support development.

Importantly, eligibility should also be linked to an institution’s systemic role during crises, and to governance and shareholder structures that ensure a genuinely multilateral character and public-policy purpose, safeguarding development or trade finance, counter-cyclical lending, and regional stability and integration.⁷

PCS frameworks could further exempt essential trade finance from restructuring, such as financing that supports critical food, fuel, or medical imports. This would preserve immediate developmental impact while giving regional banks a clear incentive to continue lending counter-cyclically through crises.

Of course, actions—like lending into arrears, maintaining counter-cyclical lending, lending at lower rates than the private sector makes credit available, or lending when the private sector will not—matter, not just words and policies. In some cases, ascertaining that a financial institution has complied with the conditions required for PCS is easy; in others, it may be difficult. The World Bank’s concessional lending through IDA, for instance, is a strong indication that it should be granted PCS. A higher interest rate need not preclude eligibility—especially if that interest rate is still lower than that provided by the market.

4. Conclusion

PCS is intended to promote economic and social stability by enabling development banks to lend to inherently risky sovereigns—lending that supports the structural transformation needed to make their economies less risky over time and thus less vulnerable to the procyclicality of private capital flows that is inherent to those economies (Guzman and Stiglitz 2026). Yet the absence of codified standards and the inconsistent recognition of PCS across institutions has produced systemic inequities with real developmental consequences: it limits the capacity of regional development banks to perform this role and leaves developing countries more exposed to decisions made by international financial institutions dominated by the most powerful economies. Lending on terms that replicate the features of commercial finance, conversely, should be incompatible with PCS. What is needed is an operational definition of PCS. This commentary has set out the principles on which such a definition should be based.

References

Buchheit, Lee C., and Rosa M. Lastra. 2007. “Lending into Arrears—A Policy Adrift.” International Lawyer 41: 939. https://scholar.smu.edu/til/vol41/iss3/6.

Gallagher, Kevin, Martin Guzman, Joseph Stiglitz, and Marilou Uy. 2024. “Reforming the IMF Surcharge Rate Policy to Avoid Procyclical Lending.” Journal of Globalization and Development 15 (1): 1-14.

Guzman, Martin, José Antonio Ocampo, and Joseph E. Stiglitz, eds. 2016. Too Little, Too Late: The Quest to Resolve Sovereign Debt Crises. New York: Columbia University Press.

Guzman, Martin, and Joseph E. Stiglitz. 2016. “Creating a framework for sovereign debt restructuring that works.” In Too Little, Too Late: The Quest to Resolve Sovereign Debt Crises, edited by Martin Guzman, José Antonio Ocampo, and Joseph E. Stiglitz, 3-32. New York: Columbia University Press.

Guzman, Martin, and Joseph E. Stiglitz. 2026. “The Role and Foundations of Capital Account Regulations.” Policy Brief. Columbia University Initiative for Policy Dialogue. https://ipdcolumbia.org/wp-content/uploads/2026/05/The-foundations-and-role-of-capital-account-regulations.pdf.

Hagan, Sean. 2020. “Sovereign debt restructuring: The centrality of the IMF’s role.” Working Paper 20-13. Peterson Institute for International Economics.

International Monetary Fund. 2025. “A Stocktaking of the Current International Architecture for Resolving Sovereign Debt Involving Private Sector Creditors.” IMF Policy Paper No. 2025/034. Washington, DC: International Monetary Fund.

International Monetary Fund. 2026. Ghana: Staff Report for the 2026 Article IV Consultation, Sixth Review Under the Arrangement Under the Extended Credit Facility, Request for a Waiver of Nonobservance of a Performance Criterion, Financing Assurances Review, and Request for a 36-Month Policy Coordination Instrument—Debt Sustainability Analysis. IMF Country Report No. 26/212.

Jubilee Report: A blueprint for tackling the debt and development crises and creating the financial foundations for a sustainable people-centered global economy. 2025. Chaired by Martin Guzman and Joseph Stiglitz for Pope Francis. Pontifical Academy of Social Sciences and Initiative for Policy Dialogue. https://ipdcolumbia.org/publication/jubilee-debt-development-blueprint/.

Krahnke, Tobias. 2023. “Doing more with less: The catalytic function of IMF lending and the role of program size.” Journal of International Money and Finance 135: 102856.

Meyer, Josefin, Carmen M. Reinhart, and Christoph Trebesch. 2022. “Sovereign bonds since Waterloo.” The Quarterly Journal of Economics 137, (3): 1615-1680.

Modigliani, Franco, and Merton H. Miller. 1958. “The Cost of Capital, Corporation Finance and the Theory of Investment.” The American Economic Review 48 (3): 261-297.

Stiglitz, Joseph E. 1969. “A Re-Examination of the Modigliani-Miller Theorem.” American Economic Review 59, (5): 784-793.

Stiglitz, Joseph E. 1974. “On the Irrelevance of Corporate Financial Policy.” American Economic Review 64, (6): 851-866.

Stiglitz, Joseph E., and Andrew Weiss. 1981. “Credit rationing in markets with imperfect information.” The American Economic Review 71, (3) 393-410.