Chapter

III Financial Consequences of International Banking Problems

Author(s):
G. Johnson, and Richard Abrams
Published Date:
March 1983
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The immediate consequences of problems in international banking would be financial—the disruption of payments mechanisms and the breakdown of financial intermediation. If unchecked, these could quickly impinge on the real economy, producing declines in production, employment, and trade.

Types of Financial Consequences

While the precise impact of a crisis in international banking would depend on the origin of the problem (for possible origins, see Section IV), three general financial consequences could be envisaged: (1) disruption of the mechanisms for international payments, (2) disruption of domestic banking services supplied by banks with headquarters in other countries, and (3) disruption of international financial intermediation. The first of these problems could be resolved in a relatively straightforward fashion, provided that international transactors had confidence in at least some banks that were able to maintain international correspondent relationships. Some transactors might suffer losses or incur additional costs, however, in seeking out reliable banking connections. By the same token, any loss of domestic services provided by foreign banks could be offset by the domestic expansion of other banks, assuming that domestic banking was not seriously disrupted—though, again, additional costs might be incurred. The central problem would likely be the third: the disruption of international financial intermediation.

A banking crisis could have two major direct consequences for international capital flows: (1) international bank lending could be curtailed, and (2) funds deposited with banks in particular countries could be shifted into bank deposits or other financial instruments in other countries. The intermediation that did continue, moreover, would take place on harder terms, such as higher margins between deposit and lending rates. Unless alternate channels for capital flows could be arranged, countries affected by the change in the magnitude and terms of bank intermediation could be forced into inappropriate economic adjustment—the familiar consequence of an inappropriate contraction of global liquidity. Some of the dimensions of bank involvement in international capital flows are discussed below.

Scale of International Bank Lending

The extent to which non-oil developing countries6 have depended on international bank lending in recent years is shown in Table 1, with each of the 15 countries in that group that have debts to banks in excess of US$5 billion identified. For all non-oil developing countries, taken together, net borrowing from banks amounted to 10 per cent of current account receipts in the years 1977–81. For the large borrowers, the amounts were very large indeed, in some cases as high as 40 per cent of total current account receipts over the period. Bank financing was equivalent to about half the aggregate current account deficit of non-oil developing countries during the period (and substantially more than half for some borrowers).

Table 1.Dependence of Non-Oil Developing Countries on Borrowing from International Banks, 1977–811(Amounts in billions of U.S. dollars; ratios in per cent)
Average Annual Increase

in International Bank Claims2
Ratio to
AmountCurrent

account

receipts3
Current

account

deficit3
Argentina3.90.413.08
Brazil4.70.240.50
Chile1.70.380.86
Colombia0.60.132.14
Greece1.10.140.64
Hungary0.80.090.87
Israel0.60.060.22
Korea0.50.120.82
Mexico7.40.411.18
Philippines0.90.140.52
Portugal1.20.160.95
Romania0.70.060.56
South Africa0.40.024
Thailand0.20.030.11
Yugoslavia1.20.090.64
All non-oil developing countries33.60.100.53
Sources: Bank for International Settlements (BIS), Eurocurrency and Other International Banking Developments; and IMF, International Financial Statistics.

Countries listed had debts to BIS reporting banks in excess of US$5 billion at the end of 1981.

Increase in bank claims as reported by BIS, adjusted for changes in BIS reporting series.

Excludes official transfers.

Surplus on current account.

Sources: Bank for International Settlements (BIS), Eurocurrency and Other International Banking Developments; and IMF, International Financial Statistics.

Countries listed had debts to BIS reporting banks in excess of US$5 billion at the end of 1981.

Increase in bank claims as reported by BIS, adjusted for changes in BIS reporting series.

Excludes official transfers.

Surplus on current account.

As Table 2 indicates, the total obligations of non-oil developing countries to banks at the end of 1981 ranged up to twice their current account receipts and up to 15 times their official international reserves.7 Much of their borrowing has short maturities, moreover, so that the repayment of bank debt scheduled for any particular year is large. For some countries, over half their bank debt at the end of 1981 had a residual maturity of less than one year.

Table 2.International Bank Claims on Non-Oil Developing Countries at the End of 19811(Amounts in billions of U.S. dollars; ratios in per cent)
Total ClaimsClaims Due Within One Year
Ratio toRatio to
AmountCurrent

account

receipts

in 19812
Official

international

reserves
AmountShare

of

total

claims
Current

account

receipts in

19812
Official

international

reserves
Argentina24.82.117.1911.60.470.993.36
Brazil52.71.947.8818.30.350.682.74
Chile10.51.983.204.20.400.791.28
Colombia5.41.101.112.70.500.550.55
Greece9.80.958.313.60.370.353.05
Hungary7.70.744.903.10.400.301.97
Israel6.00.501.694.30.720.361.21
Korea19.90.717.4011.50.580.414.28
Mexico56.91.8813.6527.70.490.926.64
Philippines10.21.1914.495.80.570.672.56
Portugal7.50.855.172.80.370.321.93
Romania5.10.389.271.80.350.133.27
South Africa11.20.4710.776.00.540.255.77
Thailand5.10.552.793.10.610.331.69
Yugoslavia10.70.566.413.00.280.161.80
All non-oil developing countries313.80.673.56140.10.450.301.59
Sources: BIS, The Maturity Distribution of International Bank Lending; IMF, International Financial Statistics; and Fund staff estimates.

Countries listed had debts to BIS reporting banks in excess of US$5 billion at the end of 1981.

Excludes official transfers.

Sources: BIS, The Maturity Distribution of International Bank Lending; IMF, International Financial Statistics; and Fund staff estimates.

Countries listed had debts to BIS reporting banks in excess of US$5 billion at the end of 1981.

Excludes official transfers.

Some industrial countries have also relied heavily on loans from international banks for balance of payments financing in recent years, and they would face difficulties if the flow of such finance were interrupted. Most industrial countries have traditionally been net capital exporters, however, with much of their capital exports channeled through banks. An interruption of international lending by banks would not in itself put the capital accounts of most industrial countries under serious pressure; in fact, capital outflows would be likely to decline.

Scale of International Bank Deposits

The problems for the capital accounts of industrial countries would mainly arise because, while their banks may have large external assets, they also have large external liabilities, most of which are of short maturity. A banking crisis implies—indeed, may be defined in terms of—attempts by depositors to withdraw their funds. If funds successfully withdrawn were placed in other financial instruments within the same country, by definition there would be no associated capital outflow. Depositors might find attractive alternative instruments in few countries, however. Moreover, doubts about banks would probably be focused more on some countries’ banks than others, so that depositors might wish to shift their deposits to the banks of other countries.

Table 3 shows the external liabilities of the banks of countries included in the BIS reporting system. For most of the countries, the liabilities of banks located within their borders at the end of 1981 were rather less than their current account receipts that year, although for Switzerland and the United Kingdom such liabilities were about three times the current account receipts. In some countries, the liabilities were not much greater than the international reserves, but for others they were as much as 28 times the reserves.

Table 3.Foreign Liabilities of Deposit Banks at the End of 19811(Amounts in billions of U.S. dollars; ratios in per cent)
Ratio to
AmountCurrent account

receipts in

19812
Official

international

reserves
Austria25.50.954.16
Belgium83.10.93313.113
Canada59.80.7213.69
Denmark5.30.232.02
France135.60.865.30
Germany, Fed. Rep. of66.80.311.40
Ireland10.41.013.93
Italy51.30.502.25
Japan100.40.533.44
Luxembourg106.11.20316.743
Netherlands65.20.725.86
Sweden14.10.383.66
Switzerland135.03.337.77
United Kingdom441.12.7927.55
United States182.10.496.13
Source: IMF, International Financial Statistics.

Banks located in industrial countries that are included in the BIS reporting area.

Excludes official transfers.

As figures on current account receipts and international reserves are not available separately for Belgium and Luxembourg, the ratios use combined figures for the denominators.

Source: IMF, International Financial Statistics.

Banks located in industrial countries that are included in the BIS reporting area.

Excludes official transfers.

As figures on current account receipts and international reserves are not available separately for Belgium and Luxembourg, the ratios use combined figures for the denominators.

Figures such as those in Table 3 present an oversimplified picture of the potential balance of payments impact of deposit withdrawal. For financial centers with large foreign banking presences—particularly the United Kingdom and Luxembourg, among the countries listed in Table 3—branches or subsidiaries of banks with headquarters elsewhere account for a large proportion of total bank liabilities. The impact of withdrawals of deposits from those banks, particularly deposits denominated in foreign currency, would tend to be shifted to the country of the parent bank. Other aspects of interbank relationships (discussed in the next section) would also tend to spread the balance of payments impact to other countries. Another type of balance of payments impact of banking problems could come about from delays or partial losses in recovering their deposits encountered by countries that deposit part of their official reserves with international banks.

Banking problems could leave countries that have payments surpluses, and that have customarily deposited their funds with banks, with less attractive outlets for such funds. Just as an interruption in bank lending could lead to pressures for inappropriately strong adjustment (or restrictions) by borrowing countries, a lack of desirable banks in which to deposit funds could put exaggerated pressures on countries in surplus to adjust in the opposite direction, particularly when the domestic consequences of such adjustment would be small. Oil exporting countries, which placed about 40 per cent of their 1974–80 cash surplus in bank deposits, are an obvious example.

Cost of Disruption of International Intermediation by Banks

The safeguards described in this paper make it difficult to conceive of a crisis of such proportions that the direct effects on any country’s capital account would approach the outer limits suggested by Tables 1,2, and 3. Aside from the banking safeguards, moreover, capital flows are symmetric, with downward pressure on some countries’ payments balances implying upward pressure on those of others. What would be needed would be to find alternative channels for capital flows to make up for the diminution of the banking channel.

The problem of capital flight from countries whose banks are under pressure would perhaps be the easiest consequence to deal with, because it would be similar to the problems of capital flight that industrial countries have experienced in the past. In this case, the fact that the problem would originate with doubts about a country’s banks, not about its overall economic situation, would facilitate its resolution. A country thus could offer depositors, particularly official depositors, special alternative instruments to mitigate the effect on the balance of payments. Beyond that, the usual mechanisms for mutual financial support of industrial countries would come into play.

The fundamental problem of making up for the loss of banking intermediary services could still remain. The cost to depositors would be measured in terms of the difference in the return on their international assets as they switched from bank deposits to alternative instruments—costs which could include the loss of liquidity, flexibility, confidentiality, and desirable location, as well as lower rates of interest. Borrowers who were considered creditworthy might have to pay more but, like depositors, would not face critical problems of availability of intermediary services. The cost of the cutback by banks in such cases could be measured as the increase in the margin between the return to depositors and the charge to borrowers, adjusted for nonfinancial aspects such as convenience and confidentiality. Other borrowers might suffer a more serious loss of access to the private financial markets.

The 1974 Bank Failures8

The near crisis of 1974 associated with the failures of a number of banks—among them Franklin National Bank and Bankhaus I.D. Herstatt—gives some indication of the potential costs. As a result of the withdrawal of many banks from international banking, publicized medium-term international bank credit commitments dropped abruptly in the third quarter of 1974, and the terms on remaining commitments began to harden sharply. By the middle of 1975, the average spread—the main component of the charges banks make for their intermediary services on medium-term floating rate loans—more than doubled to over 1.5 per cent, and the average maturity of loans dropped from eight years to little more than five. The fact that terms hardened so sharply, while the volume of international lending declined by 20 per cent between 1974 and 1975, indicates the extent to which the capacity and willingness of the international banking system to intermediate were strained. For a number of reasons, however, the banking crisis did not in itself greatly increase the pressures on countries to adjust, rather than finance, their current account imbalances. The coincidental recession in most of the industrial countries, together with the strength of the international bond markets (which was partly a reflection of the sharply higher cost of intermediation by banks), was associated with a sharply reduced demand for international bank credit by borrowers in such countries; as a result, banks looked for customers elsewhere, and the non-oil developing countries did not experience prolonged or significant unavailability of bank credit.

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