International lending by commercial banks has played an increasing role in the flow of capital to developing countries. The servicing of bank debt and the variability in the net flow of financial resources from banks have become important factors in balance of payments management. Service on debt to banks was a major component of debt service in several debt restructurings during the latter part of the 1970s. The experience of six countries is discussed in this section, which focuses on the role of the banks before, during, and after debt crises and on the bank debt restructuring process.
The circumstances of the six countries varied considerably and do not easily lend themselves to generalization; however, they do have a number of elements in common. First, bank lending to each of these countries expanded very rapidly over a short period and then declined sharply, with net flows from banks turning negative at some point. The pattern of rapidly rising loan commitments when prices for main export commodities were rising, followed by a sharp decline to very low levels when export performance turned weak, added an additional destablizing element to the balance of payments. Second, the capital flows were large compared with the debtors’ economies, so that the dramatic shifts in net lending by banks posed significant problems for domestic economic management. Bank credits were mainly cash loans that could be disbursed quickly to finance public sector expenditures and to provide general balance of payments support. In all countries, the period of peak bank borrowing was associated with rising public sector current expenditures and, more generally, with expansionary domestic policies and declining domestic savings rates. Third, even where bank funds were directed toward development efforts, the projects financed often had low rates of return or long pay-back periods. Most of these countries had very low rates of growth in output and exports over the second half of the 1970s.
While the modalities for the multilateral renegotiations of official debt have been fairly well established for some time, the restructuring of debt to commercial banks involved, to a large extent, the breaking of new ground. In the absence of broadly accepted precedents for the organization, terms, and conditions for restructuring commercial bank debt, the consideration of alternative approaches frequently dominated the discussions between the banks and debtor countries. The efforts made to arrive at mutually satisfactory arrangements suggest the evolutionary nature of the process. Moreover, most of the negotiations took place in the context of, and were influenced by, the debtor country’s parallel discussions with other creditors and institutions, particularly the Paris Club and the Fund. All six countries had Fund-supported programs at some stage of the discussions with the banks, and four also obtained a multilateral rescheduling of their debt to official creditors.
The role of the Fund in bank debt restructuring has been less well defined and less systematic than in the multilateral renegotiations of debt to official sources. Generally the banks have urged the countries to negotiate an upper credit tranche arrangement with the Fund to assure that a stabilization program is undertaken. The country authorities and the Fund staff have sought assurance from the banks that the debt relief forthcoming would be consistent with the external capital flows required in the context of a reasonable adjustment effort. Given the necessary interdependence of these concurrent efforts to deal with the countries’ debt and balance of payments problems, there were direct contacts between the Fund staff and the banks in all of these cases. The form of these contacts and the extent of Fund staff involvement in the bank debt restructuring discussions varied considerably.
Evolution of Bank Financing
In five of the countries there was a rapid expansion of bank lending, primarily medium-term syndicated loans, in the first half of the 1970s. The expansion of bank lending came somewhat later in the sixth country and took the form, for the most part, of short-term deposits and credits. Where bank lending was primarily by way of syndicated loans, new bank commitments generally increased by eight to ten times over a period of only two or three years (Table 14). The growth in outstanding debt to banks from 1972 through 1975 ranged from about 300 per cent to more than 700 per cent, and the share of bank debt in total external debt approximately doubled over the three-year period for most of these countries.
Medium-Term and Long-Term Bank Loan Commitments, 1971–78 1
The data in this table on individual countries include commitments from financial institutions, with or without official guarantee, with an original maturity of more than one year.
Here, and in subsequent tables, letters are used instead of country names. The same letter does not correspond to the same country in different tables.
Medium-Term and Long-Term Bank Loan Commitments, 1971–78 1
| Country | 1971 | 1972 | 1973 | 1974 | 1975 | 1976 | 1977 | 1978 | |
|---|---|---|---|---|---|---|---|---|---|
| Peak year = 100 | |||||||||
| A 2 | 4 | 11 | 24 | 87 | 100 | 41 | 13 | — | |
| B | 8 | 20 | 83 | 74 | 55 | 100 | 22 | 14 | |
| C | 11 | 26 | 100 | 90 | 19 | 28 | 15 | 18 | |
| D | 12 | 41 | 68 | 96 | 100 | 16 | 44 | 50 | |
| E | 23 | 46 | 94 | 100 | 66 | 56 | 48 | 26 | |
| Total | 11 | 29 | 95 | 100 | 64 | 72 | 27 | 20 | |
| Memorandum item | In millions of U.S. dollars | ||||||||
| Commitments to five countries above | 169 | 447 | 1,464 | 1,533 | 977 | 1,109 | 407 | 311 | |
| Publicized medium-term bank commitments to non-oil developing countries | 1,053 | 2,902 | 5,434 | 8,635 | 8,881 | 12,629 | 12,891 | 26,617 | |
The data in this table on individual countries include commitments from financial institutions, with or without official guarantee, with an original maturity of more than one year.
Here, and in subsequent tables, letters are used instead of country names. The same letter does not correspond to the same country in different tables.
Medium-Term and Long-Term Bank Loan Commitments, 1971–78 1
| Country | 1971 | 1972 | 1973 | 1974 | 1975 | 1976 | 1977 | 1978 | |
|---|---|---|---|---|---|---|---|---|---|
| Peak year = 100 | |||||||||
| A 2 | 4 | 11 | 24 | 87 | 100 | 41 | 13 | — | |
| B | 8 | 20 | 83 | 74 | 55 | 100 | 22 | 14 | |
| C | 11 | 26 | 100 | 90 | 19 | 28 | 15 | 18 | |
| D | 12 | 41 | 68 | 96 | 100 | 16 | 44 | 50 | |
| E | 23 | 46 | 94 | 100 | 66 | 56 | 48 | 26 | |
| Total | 11 | 29 | 95 | 100 | 64 | 72 | 27 | 20 | |
| Memorandum item | In millions of U.S. dollars | ||||||||
| Commitments to five countries above | 169 | 447 | 1,464 | 1,533 | 977 | 1,109 | 407 | 311 | |
| Publicized medium-term bank commitments to non-oil developing countries | 1,053 | 2,902 | 5,434 | 8,635 | 8,881 | 12,629 | 12,891 | 26,617 | |
The data in this table on individual countries include commitments from financial institutions, with or without official guarantee, with an original maturity of more than one year.
Here, and in subsequent tables, letters are used instead of country names. The same letter does not correspond to the same country in different tables.
With the emergence of syndicated loans as a major vehicle for cross-border lending, very large financing packages could be put together for individual countries with the loan loss risk being spread over a large number of banks. The use of syndications also drew many medium-sized banks into lending to developing countries for the first time, and even among the larger banks this new approach stimulated lending on a broader geographical basis. For example, while a small number of major North American banks had been providing consortium loans to one of these countries since the mid-1960s, after 1972 European and Japanese banks became an important source of funds, and many smaller North American banks also began to participate in the syndications. When that country rescheduled its debt late in the 1970s, 285 banks signed the agreement. These important developments in international financial intermediation facilitated a pattern of expansion of bank lending, which, though quite dramatic in terms of the size of the borrower’s economy, produced relatively small increases in the individual banks’ exposure in the countries under review. It is, therefore, unlikely that the growth in lending to these particular countries attracted special attention from either bank managers or bank regulators at this stage.
These countries shared in the general growth of bank lending during the early 1970s, but there were certain factors that set them somewhat apart. Most of the major developing country borrowers in international capital markets experienced high growth rates of GNP and exports after 1975, but the countries covered here had relatively slow growth of output and exports during the period leading up to the debt crises. Oil exporters and exporters of manufactures were the main recipients of the higher bank flows to developing countries, while most of the countries being discussed here were dependent primarily on exports of primary commodities other than oil.
Two of these countries sought bank credits to finance a large increase in the current account deficit, traceable primarily to a rapid acceleration in imports; in the remaining four, the peak in bank lending preceded the sharp deterioration in the current account of the balance of payments. Bank lending tended to move with the commodity price cycle. Although it would be difficult to regard this as simple cause and effect, the fact is that loan commitments soared during periods of price booms for mineral and primary commodity exports, but declined sharply—and in some cases dropped to almost nothing—when earnings from such exports fell. Other factors played a role in the banks’ decisions to cut back on lending in these countries, including the emergence of arrears on debt service or commercial payments, the failure of the authorities in the countries concerned to adopt credible stabilization programs, and potential or actual political instability. Swings in disbursements and in net flows were almost as sharp as in new loan commitments. Unlike official loans and export credits, an important part of bank loans, being cash loans, were disbursed immediately or shortly after signing.
Data on net bank financing (disbursements minus amortization) and on the net balance of payments flow vis-à-vis banks (disbursements minus amortization and interest) for the six countries are presented in Table 15. Net financing fell to a low level or turned negative within two to three years after the period of peak flows, and the net flow vis-à-vis banks turned negative at some point before the final restructuring agreement was signed. Data on short-term bank lending are not available for most countries, but qualitative information indicates that there were also marked shifts in this component of bank financing. In some cases short-term bank exposure appears to have increased during the early stages of the foreign exchange crisis, as local banks, unable to secure exchange to cover previously issued letters of credit, ran their overdrafts with correspondent banks beyond agreed limits. While these “involuntary overdrafts” were tolerated initially, foreign banks soon began to insist that overdrawn lines be reduced and in some cases honored letters of credit only to the extent that outstanding amounts were repaid. Sometimes the banks also attempted to reduce their overall short-term exposure, causing significant disruptions in trade for certain countries.
Net Bank Financing and Net Balance of Payments Flow Vis-à-Vis Banks, 1973–79 1
(Year of peak net inflows = 100)
Net financing is disbursements minus principal repayments, and the net flow vis-à-vis banks is equal to disbursements minus both amortization and interest payments. Except for one country where short-term credits were the major source of bank financing, the numbers in this table cover only credits with an original maturity of over one year.
Net Bank Financing and Net Balance of Payments Flow Vis-à-Vis Banks, 1973–79 1
(Year of peak net inflows = 100)
| Country | 1973 | 1974 | 1975 | 1976 | 1977 | 1978 | 1979 | |
|---|---|---|---|---|---|---|---|---|
| A | ||||||||
| Capital | 76 | 85 | 100 | –5 | 71 | 9 | 29 | |
| Capital and interest | 89 | 87 | 100 | –51 | 50 | –44 | –29 | |
| B | ||||||||
| Capital | –17 | –6 | 65 | 100 | 67 | 41 | –34 | |
| Capital and interest | –20 | –8 | 68 | 100 | 56 | 18 | –80 | |
| C | ||||||||
| Capital | 52 | 100 | 88 | 80 | 55 | 4 | 91 | |
| Capital and interest | 53 | 100 | 72 | 63 | 28 | –38 | 50 | |
| D | ||||||||
| Capital | 18 | 100 | 23 | 52 | 3 | 5 | … | |
| Capital and interest | 17 | 100 | 13 | 46 | – | – | … | |
| E | ||||||||
| Capital | … | … | 87 | 100 | 87 | 54 | 16 | |
| Capital and interest | 95 | 81 | 74 | 100 | 47 | 41 | –7 | |
| F | ||||||||
| Capital | 59 | 100 | 87 | 43 | –13 | 29 | –8 | |
| Capital and interest | 58 | 100 | 74 | 19 | –40 | 9 | –44 | |
Net financing is disbursements minus principal repayments, and the net flow vis-à-vis banks is equal to disbursements minus both amortization and interest payments. Except for one country where short-term credits were the major source of bank financing, the numbers in this table cover only credits with an original maturity of over one year.
Net Bank Financing and Net Balance of Payments Flow Vis-à-Vis Banks, 1973–79 1
(Year of peak net inflows = 100)
| Country | 1973 | 1974 | 1975 | 1976 | 1977 | 1978 | 1979 | |
|---|---|---|---|---|---|---|---|---|
| A | ||||||||
| Capital | 76 | 85 | 100 | –5 | 71 | 9 | 29 | |
| Capital and interest | 89 | 87 | 100 | –51 | 50 | –44 | –29 | |
| B | ||||||||
| Capital | –17 | –6 | 65 | 100 | 67 | 41 | –34 | |
| Capital and interest | –20 | –8 | 68 | 100 | 56 | 18 | –80 | |
| C | ||||||||
| Capital | 52 | 100 | 88 | 80 | 55 | 4 | 91 | |
| Capital and interest | 53 | 100 | 72 | 63 | 28 | –38 | 50 | |
| D | ||||||||
| Capital | 18 | 100 | 23 | 52 | 3 | 5 | … | |
| Capital and interest | 17 | 100 | 13 | 46 | – | – | … | |
| E | ||||||||
| Capital | … | … | 87 | 100 | 87 | 54 | 16 | |
| Capital and interest | 95 | 81 | 74 | 100 | 47 | 41 | –7 | |
| F | ||||||||
| Capital | 59 | 100 | 87 | 43 | –13 | 29 | –8 | |
| Capital and interest | 58 | 100 | 74 | 19 | –40 | 9 | –44 | |
Net financing is disbursements minus principal repayments, and the net flow vis-à-vis banks is equal to disbursements minus both amortization and interest payments. Except for one country where short-term credits were the major source of bank financing, the numbers in this table cover only credits with an original maturity of over one year.
The large shifts in net financing and net flows reflect not only the speed with which commitments and disbursements were increased and then cut but also the marked rise in debt service to the banks over the last half of the 1970s. The large increase in the share of bank debt in total debt quickly produced a deterioration in the debt service profile for all these countries. Bank lending carried much shorter maturities and grace periods, as well as higher interest charges, than the official bilateral and multilateral loans that had previously constituted the main source of funds.23 In 1974 the average maturity on new medium-term bank commitments in the five countries where this type of lending was important ranged between 6 and 12 years, with grace periods generally between 2 and 4 years. This compares with average maturities of 20 years or more and grace periods in excess of 5 years for official loans to these countries.
In three countries, the impact of the relative shift toward bank financing on the debt service profile was compounded by a marked shortening of maturities and grace periods on bank loans after 1974. For example, the average maturity on new medium-term bank commitments to one of these countries declined from 11 years in 1974 to 6 years in 1975 and to less than 5 years in 1976. Over this same period, the average grace period dropped from about 30 months to 8 months. The progressive shortening of terms during the mid-1970s led to a very rapid buildup in scheduled amortization payments to banks in the final years of the decade. While this hardening of terms paralleled general developments in bank lending during 1974 and 1975, the impact was perhaps more marked for these three countries, since they had been borrowing on somewhat longer terms than average through 1974. For the other two countries where bank lending was primarily medium term, commitments declined sharply in the mid-1970s, but maturities and grace periods did not shorten. This may have been because many commitments made to these two countries during this period carried creditor-country or third-party guarantees.
The fact that interest charges on almost all medium-term bank loans are set at a spread over market rates (e.g., LIBOR or prime) introduces another element of variability in the net flow vis-à-vis banks. Since these base rates declined substantially in 1975 and remained at a low level over the following two years, interest rate variability was not in general a factor underlying the emergence of debt servicing difficulties. The sharp increase in market rates beginning in 1978 did, however, contribute importantly to the large negative net flow vis-à-vis banks recorded for all of these countries in 1978 and/or 1979. The continuation of high market rates will make the adjustment effort in the period after the restructuring agreement considerably more difficult for most of these countries.
Furthermore, as noted below, the accumulation of arrears to banks in some cases and their subsequent reduction following a debt restructuring exaggerates the extent of the swing in net flows vis-à-vis banks.
Bank Lending and Economic Management
The large swings in bank lending and the buildup in debt service to banks might not have posed major problems for economic management if these flows had been small in relation to the borrower’s economy. However, as can be seen from Table 16, in all six cases the flows were large in relation to both GDP and current account receipts. The net flow from banks during the three peak borrowing years was equal to between 2 per cent and 5 per cent of GDP and to between 10 per cent and 26 per cent of current account receipts. Capital inflows of such magnitudes inevitably had a profound impact on these economies and on domestic economic management, as did the subsequent dramatic contraction. The magnitude of the decline from the three peak years to the three subsequent years was equal to between 2 per cent and 5 per cent of GDP and to between 10 per cent and 35 per cent of current account receipts.
Ratio of Net Flow Vis-à-Vis Banks to GDP and to Current Account Receipts, 1973–79
(In per cent)
Unweighted average of three-year period of peak inflow.
Unweighted average of succeeding three years.
Trough periods are succeeding two years.
Ratio of Net Flow Vis-à-Vis Banks to GDP and to Current Account Receipts, 1973–79
(In per cent)
| Ratio of Net Bank Flow to | ||||
|---|---|---|---|---|
| GDP | Current account receipts | |||
| Country | Peak 1 | Trough 2 | Peak 1 | Trough 2 |
| A | 2.7 | 0.4 | 18.7 | 1.4 |
| B | 1.7 | — | 13.1 | — |
| C 3 | 2.4 | –0.3 | 26.2 | –8.8 |
| D | 5.0 | 1.0 | 15.1 | 4.1 |
| E | 3.8 | –0.1 | 9.5 | –0.5 |
| F | 4.9 | –0.6 | 15.9 | –1.7 |
Unweighted average of three-year period of peak inflow.
Unweighted average of succeeding three years.
Trough periods are succeeding two years.
Ratio of Net Flow Vis-à-Vis Banks to GDP and to Current Account Receipts, 1973–79
(In per cent)
| Ratio of Net Bank Flow to | ||||
|---|---|---|---|---|
| GDP | Current account receipts | |||
| Country | Peak 1 | Trough 2 | Peak 1 | Trough 2 |
| A | 2.7 | 0.4 | 18.7 | 1.4 |
| B | 1.7 | — | 13.1 | — |
| C 3 | 2.4 | –0.3 | 26.2 | –8.8 |
| D | 5.0 | 1.0 | 15.1 | 4.1 |
| E | 3.8 | –0.1 | 9.5 | –0.5 |
| F | 4.9 | –0.6 | 15.9 | –1.7 |
Unweighted average of three-year period of peak inflow.
Unweighted average of succeeding three years.
Trough periods are succeeding two years.
The sudden availability of new external financing on a large scale might not have led to severe economic strains if the funds had been invested in projects with a high economic return and if either those projects had generated sufficient foreign exchange to cover the scheduled debt service or overall economic and export performance had been strong. This generally did not occur. Some bank loans were tied to specific investment projects, but most bank financing, even when designated for investment purposes, took the form of rapidly disbursing loans to finance public sector expenditure or to provide general balance of payments support. All periods of peak bank borrowing were associated with a very rapid increase in government expenditure; in three countries, government expenditure more than doubled within one or two years. To some extent the higher government expenditure was directed toward ambitious development programs; in three countries, there was a marked increase in gross domestic capital formation during the period of peak bank lending. However, even where capital expenditure was high, the projects often had low economic rates of return (e.g., loans for infrastructure) or pay-back periods that, in fact, turned out to be inconsistent with the financing terms (e.g., investments in certain minerals that had a poor price performance during the second half of the 1970s).
All of the rapid increases in bank financing were associated with expansionary domestic policies and declining domestic savings rates. In one country, the period of heavy borrowing from foreign banks came after the emergence of severe domestic excess demand pressures and a sharp deterioration in the current account of the balance of payments, and bank financing enabled the authorities to postpone necessary economic adjustment in the wake of the 1974 oil price increase. Otherwise, the expansion in bank lending generally began before the first large increase in oil prices and coincided with a period of rapid growth in domestic expenditure.
Variability in export earnings posed problems for domestic economic management, and it usually was not practicable to offset the balance of payments effect by borrowing from the private markets. Indeed, access to bank credit generally was much easier when export earnings were high or rising. Most of the countries experienced a very slow growth of output and exports during the four years after 1974. Three of them faced very sharp declines in export earnings in 1975 or 1976; for two, export proceeds did not regain previous peaks until the end of the decade, and in the third, export receipts still have not regained 1975 levels. For two of these countries real GDP was actually lower in 1978 than in 1974; for the third it was about the same. These swings in bank financing and export receipts also had a marked impact on the pattern of import growth. For the six countries the value of imports increased on average by 145 per cent over the three years through 1975 but declined by 7 per cent from 1975 to 1978. In the most extreme example, imports rose by 220 per cent from 1972 to 1975 and then dropped in nominal terms by 23 per cent over the following three years; in every case the turnaround was dramatic. While special factors, such as the coming on stream of oil fields or the completion of major investment projects, reduced imports for some countries, major restrictions on imports were imposed at some point by all six countries. These restrictions, in turn, tended to disrupt economic activity and impede growth. Initial efforts made by the authorities to bring domestic demand more in line with resource availability were, by and large, unsuccessful.
Debt Restructuring Process
The spread of international syndicated lending and the increasing tendency for more banks to become involved in lending on a wide geographic basis made the restructuring process itself much more difficult. Some countries had approached bank creditors for debt relief prior to the mid-1970s, but the discussions generally involved a small number of banks from one or a few countries. In contrast, the debt restructuring exercises covered here entailed formidable organizational problems, with nearly 300 banks from a number of countries being party to the final agreements.
Anywhere from two to five years elapsed between the time a problem clearly emerged 24 and the time a restructuring agreement was finally signed. It is perhaps indicative of how procedures have evolved that the two cases where arrears on bank debt service appeared first took the longest to resolve. On average, there was a lag of about one or two years between the time a problem might have been identified and the date discussions between the country and the banks began. For one country formal discussions did not commence until four years after arrears on debt service first emerged in 1975; in another, discussions began only two months after the country fell behind on its interest and principal payments in 1978. The lag between the initiation of discussions between the country and the banks and the signing of a restructuring agreement ranged between one and one-half years and almost four years. The problems that arose during the often protracted discussions and the solutions that emerged are discussed below.
While banks generally acknowledge that their interests are best served by avoiding default, there is a tendency for individual banks to attempt to reduce exposure in the debtor country as soon as a debt service problem emerges or appears likely. Even where a new loan, rather than a restructuring, is being considered, one initial response to emerging debt difficulties is an insistence among the lead creditor banks that responsibility for new funding be parceled out in line with existing exposure and that each bank be accorded “fair treatment” with regard to service on existing debt. In the restructurings considered here, where between 200 and 300 banks from a number of countries were involved, insistence on “fair treatment” necessitated a massive effort by lead banks to ensure coordination and cooperation among all the creditor banks. For example, a group of U. S. banks agreed to try to syndicate a large balance of payments support loan for one country, provided that all U. S. banks having substantial exposure in that country participated in the syndicate and that the country raised a specified sum from Canadian, European, and Japanese banks on comparable terms. The loan package was eventually put together, but the problems that arose from the requirement that the authorities of the debtor country conduct parallel but independent negotiations with several groups of banks led, during subsequent discussions, to the formation of a steering committee of banks representing a wide geographical interest. In another case, an investment banking firm retained by the debtor government took responsibility for contacting more than 200 banks that had lent to the country via short-term deposits. The negotiations for restructuring these deposits into a medium-term loan were protracted. In most instances the lead banks took responsibility for trying to bring the other creditor banks along. In more recent years international steering committees have generally played an important role.
The necessity of securing the cooperation of all creditor banks is underscored by the inclusion of cross-default clauses in most loan agreements: if some banks were to declare a country or institution in default, for example, by putting a lien on its assets, all loans to that borrower covered by cross-default clauses would automatically be classified as in default and become due and payable. The banks as a group (as well as the debtor) have a strong interest in avoiding the enormous difficulties that such a chain reaction would create, but in three of the six cases under review, a declaration of default apparently was only narrowly averted.
The difficulties encountered in organizing a refinancing or restructuring of bank debt were frequently magnified by a lack of adequate statistical information and the absence of a centralized debt reporting and control system in the debtor country. These problems were particularly acute in the two countries where there was a lag of more than five years between the date when debt arrears first emerged and the time a restructuring agreement was signed. In one instance the authorities eventually collected the requisite information by sending a questionnaire to the banks. Four of the countries retained the services of investment banking firms, which assisted them in sorting out their debt statistics and in preparing for discussions with the banks and sometimes negotiated with the banks on behalf of the country.
Apart from the general difficulties of organization, the process was often drawn out because of substantive differences in proposals, including those among the banks. One issue for the banks was whether to reschedule existing debt and/or to provide new money. In the earlier negotiations, some banks initially took the position that a rescheduling would set a bad precedent, that the country should remain current on its debt service, and that the banks should undertake to provide new money to assist the process. In one of the two situations where this view ultimately prevailed, various unsuccessful attempts were made to put together a financing package acceptable to all concerned, but the final agreement signed more than three years later entailed only the formal restructuring of the massive arrears that had by then accumulated and of the remaining principal on that country’s debts to the banks. In the other, a balance of payments support package was finally put together, but this somewhat difficult effort only served to postpone, rather than avert, a formal rescheduling. After these two earlier experiences, however, the banks appeared more inclined in subsquent discussions to consider restructuring, rather than a loosely linked “refinancing,” from the outset.
There were marked differences in the speed and ease with which negotiations proceeded once rescheduling had been accepted in principle. The overall level of relief secured was important for the banks and the debtor country, but the type of relief sought also added to the difficulty of the negotiations. In general, the banks were more willing to reschedule future maturities than to reschedule arrears and much more willing to consider the rescheduling of principal than of interest. A summary of the main features of the final agreements for each of these six countries is provided in Table 17.
Basic Components of Restructuring Agreements
Accrued interest in excess of 7 per cent a year was deferred during the early years of the agreement.
Basic Components of Restructuring Agreements
| Arrears | Future Debt Service | ||||
|---|---|---|---|---|---|
| Country | Principal | Interest | Principal | Interest | New Loans |
| A | Yes | No | No | No | Yes |
| B | No | No | Yes | No | No |
| C | Yes | Yes | No | No | Yes |
| D | No | No | Yes | No | No |
| E | Yes | No | Yes | No | No |
| F | Yes | Yes | Yes | Yes 1 | No |
Accrued interest in excess of 7 per cent a year was deferred during the early years of the agreement.
Basic Components of Restructuring Agreements
| Arrears | Future Debt Service | ||||
|---|---|---|---|---|---|
| Country | Principal | Interest | Principal | Interest | New Loans |
| A | Yes | No | No | No | Yes |
| B | No | No | Yes | No | No |
| C | Yes | Yes | No | No | Yes |
| D | No | No | Yes | No | No |
| E | Yes | No | Yes | No | No |
| F | Yes | Yes | Yes | Yes 1 | No |
Accrued interest in excess of 7 per cent a year was deferred during the early years of the agreement.
The banks have consistently attempted to adhere to the principle that the debtor pay future interest on schedule, and this was reflected in most of the agreements under review. One agreement, however, did contain a provision whereby interest payments in excess of 7 per cent were deferred during the early years of the agreement. Where arrears on interest have emerged, the banks have always initially insisted that the country become current on interest payments before other parts of the rescheduling agreement are implemented. Two of the final agreements, however, provided for a rescheduling of part of the arrears on interest, albeit on much shorter terms than provided for overdue principal. In one agreement, the debtor’s request for such treatment of interest in arrears delayed the negotiations for many months.
The banks generally have been willing to consider the restructuring of principal in arrears, but the existence of large overdue balances has tended to make the negotiations more difficult and the banks less willing to include new money in the restructuring package. This stance reflects partly the concern of the banks to protect the interests of their shareholders and depositors and partly the knowledge that bank regulators will take a negative view of increased exposure in a country where debt servicing arrears have accumulated. The approach of private banks to debt restructuring is governed by conditions that are different from those of official institutions.
None of the formal agreements covered short-term debt except for amounts in arrears. In some instances problems arose for the debtor because individual banks cut back on trade financing or reduced their short-term credit lines while a debt restructuring was being pursued or even after the agreements had been signed. On at least two occasions, the authorities raised the issue of short-term trade financing with the bank steering committees, and informal understandings were reached on the maintenance of short-term exposure. The disbursement of one new medium-term loan—agreed as part of the restructuring package—was tied to letter-of-credit financing for imports to ensure that new money from one bank was not used to repay short-term borrowing from other banks. Thus, the principle of fair treatment among creditor banks, as well as the prospects for the debtors’ balance of payments recovery, depended in part on the extent to which the banks were willing to maintain shorter-term trade financing facilities in these difficult situations.
Although it is difficult to generalize from the diverse experiences of these six countries, it may be helpful to summarize some common features in the two cases where formal negotiations on restructuring, once begun, were concluded most rapidly: (a) discussions with the banks began soon after balance of payments and debt servicing problems were identified; (b) there were no arrears on principal or interest on public sector debt; (c) the country had fairly complete information on its scheduled debt service to the banks; (d) the country sought rescheduling only of principal; (e) the country obtained an agreement covering two or three future years; (f) a Fund program was in place covering the full period for which rescheduling was sought before negotiations began; and (g) although this was not part of the restructuring agreement itself, short-term lines of credit were addressed at some stage, with the lead banks, at least, agreeing to maintain their exposure. Where discussions were more protracted, one or more of these elements were missing.
Financial Impact of Restructuring
The banks cut back new commitments sharply to each of the six countries after the extent of the balance of payments and debt problems became apparent. As disbursements declined and scheduled debt service to banks mounted, the net positive flow fell off rapidly and in most cases became negative before the restructuring agreements were signed. Although a sharp deterioration in the current account generally precipitated the balance of payments crisis, the retrenchment by banks brought additional pressures on the payments situation, even where there was subsequent improvement in other components of the external accounts.
There are wide differences in the terms of the restructuring agreements and in the estimated impact of those agreements on the debt profile and payments situation during the years following the restructuring.25 Most of the restructuring agreements provided for grace periods of about 3 years and total maturities of 5 to 7 years, except that overdue interest, if included, was rescheduled with no grace period and a repayment period of from 2 to 5 years. The agreements generally provided for interest at spreads ranging from 1¾ to 2 percentage points over LIBOR.
One agreement, however, stands apart in a number of respects. Under it, principal in arrears and all future principal payments due on existing debt were restructured with, respectively, grace periods of 5 and 6 years and maturities of 10 and 12 years. The agreement incorporated a small element of debt forgiveness, in that the banks agreed to recalculate interest due but not paid at a spread of ½ per cent over LIBOR during the relevant period, rather than at the higher spread specified in the original contracts. About 80 per cent of the balance of interest in arrears was also rescheduled but with no grace period and a maturity of 5 years. In addition, the agreement incorporated a provision whereby interest actually paid on rescheduled amounts would not exceed 7 per cent a year before 1986, with payment of the amount resulting from the difference between 7 per cent and LIBOR plus the specified spread being deferred and repaid between 1986 and 1990.
Table 18 shows the impact of these restructuring agreements on the net resource transfer from banks or, which is the same thing, the net balance of payments impact of these agreements. These calculations reflect only the transactions provided for in the agreements, that is, amounts of principal or interest rescheduled, disbursements of new money, and the amortization and interest on amounts rescheduled or new money provided. They do not cover disbursements of any new loans that might be agreed outside the rescheduling negotiations.
Impact of Restructuring Agreements on Net Flow Vis-à-Vis Banks During First Six Years 1
(In millions of U.S. dollars)
Includes only transactions provided for in the restructuring agreements; with respect to possible new loan commitments, only those agreed on as part of the restructuring are taken into account.
Includes restructuring of accrued arrears to banks.
For each of the three countries in this group the net flow was positive for the first three years and negative thereafter.
For each of the three countries in this group the net flow was positive only in the first year.
Impact of Restructuring Agreements on Net Flow Vis-à-Vis Banks During First Six Years 1
(In millions of U.S. dollars)
| First Year 2 |
Second Year |
Third Year |
Fourth Year |
Year Fifth |
Sixth Year |
|
|---|---|---|---|---|---|---|
| Group A 3 | 641 | 259 | 323 | –134 | –276 | –422 |
| Group B 4 | 3,922 | –314 | –522 | –798 | –1,408 | –1,163 |
Includes only transactions provided for in the restructuring agreements; with respect to possible new loan commitments, only those agreed on as part of the restructuring are taken into account.
Includes restructuring of accrued arrears to banks.
For each of the three countries in this group the net flow was positive for the first three years and negative thereafter.
For each of the three countries in this group the net flow was positive only in the first year.
Impact of Restructuring Agreements on Net Flow Vis-à-Vis Banks During First Six Years 1
(In millions of U.S. dollars)
| First Year 2 |
Second Year |
Third Year |
Fourth Year |
Year Fifth |
Sixth Year |
|
|---|---|---|---|---|---|---|
| Group A 3 | 641 | 259 | 323 | –134 | –276 | –422 |
| Group B 4 | 3,922 | –314 | –522 | –798 | –1,408 | –1,163 |
Includes only transactions provided for in the restructuring agreements; with respect to possible new loan commitments, only those agreed on as part of the restructuring are taken into account.
Includes restructuring of accrued arrears to banks.
For each of the three countries in this group the net flow was positive for the first three years and negative thereafter.
For each of the three countries in this group the net flow was positive only in the first year.
One of the countries in Group A obtained the somewhat exceptional agreement discussed above. The other two countries in Group A had no arrears on either principal or interest, and both obtained restructurings covering two to three future years. The three countries in Group B each had substantial arrears, and interest on those overdue amounts imposed a significant debt service burden from the start. Also, the agreements for two of the countries in Group B called for some repayment of arrears from the first year in which the agreement became effective. It should be noted, however, that looking only at the final agreements tends to overstate the differences in relief obtained. By running up large amounts of arrears for a number of years before the negotiations were concluded, some of these countries had, in effect, unilaterally forced a rescheduling before the fact.
The accumulation of arrears and the subsequent resumption of repayments after renegotiation exaggerates the switch from net positive to net negative capital flows (as shown in Table 15). The payment of arrears over a reasonably short period has been a precondition for the resumption of a normal commercial relationship (between the banks and the borrower). However, in some cases the lag between agreement on repayment of arrears and the resumption of new bank financing flows has created pressures on the country’s balance of payments.
While the net impact of the restructuring agreements is positive for one to three years, each of them would still result in an overall net outflow to the banks from the outset of the agreement in the absence of additional new disbursements from banks. This simply reflects the fact that, while the agreements substantially reduced amounts payable during the initial period, in all cases some amounts were still being paid to banks, interest generally being the most important factor. Therefore, whether or not the net flow is positive in the post-restructuring period depends crucially on the extent to which the banks are willing to commit new funds. Three of the agreements are too recent to permit an appraisal of the banks’ response. In only one of the other three countries have the banks resumed lending; favorable commodity price developments led to a dramatic turnaround in that country’s balance of payments position. In the remaining two, the banks may have reduced their exposure somewhat since the restructuring agreements were signed.
Relationship to Agreements with Official Creditors
Four of the six countries being discussed in this section also had multilateral official debt restructurings. One country, whose scheduled public sector debt service to official creditors was not large in those years for which a restructuring of bank debt was agreed, did not seek a rescheduling of debt to official sources. Interested governments did, however, commit substantial sums through an aid group for disbursement over the period covered by the bank agreement.
For the four countries that rescheduled their official debt, the agreements incorporated the usual undertakings on comparable treatment of other creditors. One country reached agreement in principle with the banks before the Paris Club convened to discuss its official debt, and the two agreements were almost identical, rescheduling a large percentage of principal due over two future years. For the other three countries, one or more official debt restructurings had been concluded before agreement was reached with the banks. The official creditors rescheduled both principal and interest, not only amounts in arrears but also part of the amounts due in the future. The banks rescheduled principal in arrears for all three countries, but only one agreement covered overdue interest and only one covered future maturities. For two countries, the banks provided new financing as part of the rescheduling agreements, but the creditor governments also provided substantial assistance to these countries outside the restructuring framework. All of the bank agreements carried interest charges at market rates, whereas the official reschedulings were at fixed rates below market levels.
Role of the Fund
When a debtor country is negotiating concurrently with the Fund and with the banks, the discussions are necessarily interdependent, reflecting not only the commonality of interests among all parties but also the need for an exchange of information. The banks need to have a realistic assessment of the economic outlook for the country and want assurances that its authorities are making a reasonable adjustment effort. The country and the Fund staff need an accurate assessment of potential debt relief from banks to formulate a viable stabilization program.
The banks, at some stage in the debt restructuring negotiations, urged most of the six countries being discussed in this section to undertake an upper credit tranche program supported by the Fund. Where a restructuring was sought from official creditors, the multilateral agreements also made a Fund arrangement a prerequisite for the implementation of all or part of the planned official debt relief. For five of the six countries, a stand-by program or extended arrangement was in place at the time the final agreement with the banks was signed. For four of the countries these were the second Fund arrangements that had been approved during the course of the restructuring negotiations; performance had diverged from targets soon after the earlier programs had been approved, and efforts by the banks to arrange a refinancing or rescheduling had, as a consequence, been temporarily suspended.
In general, the Fund’s appraisal of a country’s progress under its program is signaled only by the country’s ability or inability to effect purchases under its arrangement with the Fund. Four of the bank debt restructuring agreements made either the disbursement of new funds or the medium-term consolidation of rescheduled debt contingent on the ability to purchase from the Fund under an upper credit tranche arrangement. At the request of the debtor country, the Fund provided the government with a written communication, which it could pass on to the banks, stating that the country had purchased, or was able to purchase, under its Fund arrangement.
While the banks have generally sought assurances about a country’s stabilization effort by tying debt relief to a program supported by Fund resources, efforts to design a viable stabilization program have, in turn, often resulted in implicit or explicit demands on the banks. For example, one performance clause regarding arrears in a Fund arrangement provided the catalyst for the compilation of the relevant data and the beginning of discussions by the debtor authorities with the banks on regularizing the country’s debt situation. The Fund staff at times not only has sought indications from the banks of the likely magnitudes involved in a restructuring but also has indicated to the banks the level of bank financing that it considered crucial to the success of a reasonable adjustment effort. On one occasion, the banks increased somewhat the amount they were proposing to reschedule when revised data on bank debt indicated that their earlier proposal was inconsistent with the assumptions that had been built into the Fund-supported adjustment program.
The Fund staff participated in some meetings between the debtor authorities and the banks; in some instances, the staff, with the knowledge of the debtor, also participated in meetings where the debtor was not present. The role of the staff at these meetings was generally limited to reviewing the economic outlook, explaining the stabilization program, and replying to technical questions; on occasion, at the request of the debtor authorities, the staff assumed a more active role. Executive Directors representing both debtor and creditor countries have also used their good offices to facilitate discussions between the countries and the banks.
The Fund provided technical assistance to some of the countries in preparing for their discussions with the banks. Where statistical problems were an important obstacle to the discussions, the Fund assigned technical assistance missions and participated in technical meetings with the consultants that had been retained by the country for the negotiations. The Fund also assisted some countries in preparing their presentations for the banks.
Overview of Some Issues
This section has discussed the role of bank financing in the evolution of the debt problems of six countries, the modalities and financial impact of the restructuring of the bank debt, and the linkage of that process to international efforts—in which the Fund has generally played a role—to return the debtor country to a viable economic path. The efforts of the various creditors to assist the debtor countries in dealing with their balance of payments and debt problems were inevitably linked, raising important questions about the appropriate forms of cooperation among the parties concerned and about the responsibilities of each. With respect to commercial bank actions in the few cases studied, three factors stand out: (1) the degree of acceleration of bank lending to the countries in the period preceding the emergence of servicing difficulties; (2) the long time lag in a number of cases between identification of the problem and a negotiated settlement; and (3) the difficulties in maintaining or restoring banking inflows to the countries as adjustment policies were being implemented.
Although these cases characterize instances where bank financing flows tended to be procyclical and thus destabilizing, they are not necessarily typical and no general conclusion should be drawn from that experience about the role of international banks in development finance. In fact, the important role that banks have played in the international transfer of capital—a role that became crucial in the context of the intermediation of oil export surpluses—is well documented. But in the cases considered here, it appears, with the benefit of hindsight, that financing flows from the banks often were overly large in the period prior to the emergence of debt servicing difficulties. The inflows frequently accelerated sharply when mineral and other export commodity prices were favorable, even when it was not clear that the debtor’s general policy orientation was viable over the longer run. The retrenchment in new lending when export earnings declined added to the balance of payments instability.
The experience of these six countries supports the view that large temporary inflows of market financing may have contributed to a delay in needed adjustment efforts, ultimately increasing the problems for the debtor. The greatest assurance that these circumstances will be avoided resides in the balance of payments and external debt management policies of the borrowing countries. These aspects of economic management are systematically covered in the context of the annual Article IV consultation discussions between Fund staff and the authorities of the member countries.
The question arises whether the potential for mistakes in allocation of capital through the private markets poses any serious threat to the adjustment process. Broadly speaking, the mechanism appears to have allocated capital relatively efficiently, as reflected in the distribution of bank lending among a large number of developing countries more or less in line with growth and export performance and potential. But the system (bank management practices and official regulatory guidelines and supervision) is geared to protecting the lending institutions and not to guarding against the possible mismanagement of resources by individual borrowers that by itself would not jeopardize the stability of the system.
Many banks formulate internal exposure limits based on an analysis of the creditworthiness of individual countries as a tool for management of country risk and portfolio diversification. Bank supervisors assess the quality of international asset management on the basis of whether bank lending decisions are based on adequate economic information on the debtor and are consistent with some broad norms of reasonable portfolio diversification. But within such a framework banks are free to make their own lending decisions. In most of the cases under review, the sharp increase in lending involved a large number of banks and a small portion of bank assets, so that the increase in exposure in these countries generally would not have attracted the attention of bank management or the regulatory authorities.
The relatively small amounts involved for each of the banks probably was an important factor in their decision to permit the accelerated use of the margins available under their internal lending limits for the specific countries. In most cases, a large number of smaller banks were involved, and they may have tended to follow the lead banks. Market conditions have become increasingly competitive and, in such circumstances, individual banks tend to be more responsive to the debtors’ demands when a particular bank’s share of the market is not increasing; that is, the market participants tend to move together. Moreover, the negligible losses experienced on international loans to sovereign borrowers over recent decades may have reduced the perceived risk on country lending.
In most of the cases under review, international efforts in support of an adjustment program had been initiated prior to the final agreement between the debtor and the banks. Thus, in the overall financial package in support of the adjustment program, it was in the debtor’s interest to come to terms quickly with the banks. The debtors faced the need to restructure the bank debt on terms that were a priori consistent with their rehabilitation programs, but they also faced the constraint that the settlement had to be sufficiently favorable for the banks so as not to impair the possibility for the resumption of net private inflows necessary to sustain their economic programs over the medium term.
The overall restructuring terms agreed with the private creditors are difficult to compare with those agreed with official creditors. One major difference was that the interest rates on credits from official sources that were rescheduled or refinanced were below market rates, whereas the bank creditors generally operated on the basis of market interest rates. Moreover, the agreements on credits from official sources generally provided for easier repayment terms on interest in arrears; such arrears pose particular problems for banks, since they may have to write off all or part of such nonperforming loans. However, the major differences are not found in the agreements but in their impact on future financial relations between the parties. In restructurings of debt from official sources, the agreements generally were an important step toward normalization of financial relations. In some of the private arrangements, the debtor sought assurances on new medium-term financing in support of the adjustment program, and this sometimes delayed agreement.
New short-term bank trade financing was not provided for in the agreements. Banks have an incentive to limit or reduce their exposure in countries encountering payments difficulties. The most readily available avenue for such adjustment, once it has become necessary to agree to a restructuring of medium-term maturities, is to allow trade credits to run off. The runoff of trade credits has posed problems for economic management in some of the countries in carrying out their internationally supported adjustment efforts.
In some cases, the net outflow (i.e., principal plus interest payments) to the banks by the debtor during the early stages of the adjustment program were sizable relative to the Fund resources being provided. It is clearly to the advantage of the debtor to make timely payments of interest on its private obligations to maintain or restore its perceived market creditworthiness. However, a significant outflow of funds to the banks may make it more difficult to carry out an effective adjustment program; it may also give the appearance that the Fund and the official creditors are financing the reflows to the banks. While any debt restructuring should be regarded as exceptional, once the decision is reached the terms need to be tailored carefully to assure the eventual normalization of payments relations. In some especially difficult circumstances, the agreements could, for example, explicitly provide for net new financing. In such cases, the banks would need assurances that their financing would form part of a concerted international effort to help the country implement a carefully monitored adjustment program.
It is in the interests of all the parties that these difficult situations be resolved quickly and on a basis that is mutually acceptable to the debtor and creditors, that is consistent with the implementation of a viable adjustment program, and that does not impair the debtor’s future financial relations with its creditors. The Fund staff has been responsive to requests by the parties to assist in the restructuring of bank debt within the limitations imposed by the need to maintain the confidentiality of the Fund’s relations with member countries.