Chapter

II Recent Developments in the Markets4

Author(s):
International Monetary Fund
Published Date:
July 1982
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From 1973 to 1980 banks expanded their international claims at an average annual rate of about 23 per cent (Chart 1). Lending through bond markets increased sharply in the early years of the period, but was much less buoyant in later years. Taken together, however, the nominal dollar volume of net market lending in 1980 was almost five times the volume of 1973. The period encompassed two episodes of “recycling” balance of payments surpluses of oil exporting countries to deficit countries, with the intervening period, particularly the years 1977 and 1978, being marked by relatively moderate growth in capital market lending. The second of these episodes began in 1979, and international capital market flows increased sharply in both 1979 and 1980.

Chart 1.Net Lending Through International Capital Markets, 1973–81

1 Measured in U.S. dollars; for the years after 1976, adjusted for valuation effects of exchange rate changes.

2 Net of repayments; excludes double counting due to banks issuing and holding bonds.

3 Net of interbank transactions.

In 1981 a return to greater balance in international payments began. The global sum of current account deficits increased little (Table 8), and in real terms declined, and oil exporting countries’ surpluses fell sharply. For the non-oil developing countries, however, deficits continued to increase, and there were frequent expressions of concern that their prospective demands for capital market finance in an aggregate sense were too great to be handled without strain.

In fact, financial flows through the international capital markets increased again in 1981, albeit by a considerably smaller amount than in 1979 and 1980. Total net new bank and bond financing amounted to $195 billion, up from $179 billion in the previous year (Table 1). While there were some shifts in the composition of the flows, the fact that lending spreads did not increase to any noticeable extent suggests an absence of major strains in the markets.

Table 1.International Capital Market Financing, 1976–81(In billions of U.S. dollars)
197619771978197919801981
International bank lending (net)706890125160165
International bond issues (net)303130332837
New international bond issues343637413848
Less redemptions–4–5–7–8–10–11
Less double counting owing to bank purchases of bonds–4–4–6–9–9–7
Total9695114149179195
Sources: Bank for International Settlements; World Bank; Orion Royal Bank, Ltd. (London); and Fund staff estimates.
Sources: Bank for International Settlements; World Bank; Orion Royal Bank, Ltd. (London); and Fund staff estimates.

Besides the fact that the global sum of current account deficits increased only marginally in 1981, the deceleration in the growth of capital market flows reflected a slowing in the demand for international finance motivated by other than balance of payments management considerations. The continued tightening of monetary policy in a number of the major industrial countries pushed nominal interest rates to where they were, on average, substantially above those in 1980. Although nominal rates trended downward during the year, ex post real rates continued to rise as inflation moderated. Associated with the higher interest rates were slow growth of real output and stagnation of investment in the industrial countries and a decline in the U.S. dollar value of international trade. These factors tended to curb demand for financing from the international capital markets.

International Banking

International bank claims 5 are estimated to have expanded by 21 per cent in 1981, a slower rate of expansion than the 25 per cent recorded in 1980. The amount of the increase in claims (i.e., the amount of net financing flows) was $165 billion, up from $160 billion the previous year. The deceleration largely reflected a continued slowing of international lending by continental European banks, in part because these banks were affected more than most by developments in Eastern Europe. Banks headquartered in the United States, the United Kingdom, and Canada continued the rapid expansion begun in 1980, while Japanese banks, which had substantially reduced their activities in 1980, once again were major participants. Banks with ownership in Arab countries for the first time played a substantial role.

While in 1979 and 1980 deposits from the oil exporting developing countries had been a major source of bank funds, in 1981 net new deposits from those countries were very small, amounting to less than $4 billion, compared with close to $40 billion in both 1979 and 1980 (Chart 2). The decline in depositing by oil exporters was considerably sharper than the decline in the oil exporters’ current account surplus, reflecting that the decline in the overall surplus was concentrated on those countries in that group placing a high proportion of their external assets with banks.

Chart 2.Sources and Uses of International Bank Funds, 1978–81

(In billions of U.S. dollars)

1 Figures shown below graphs represent total of all categories.

2 Excluding Fund member countries except Hungary, which became a member in mid-1982.

Banks turned to the industrial country financial markets to offset the decline in oil exporters’ deposits, and both domestic funding of international operations by banks in the reporting area and international depositing by institutions and individuals in the reporting countries increased markedly. With lending to industrial countries increasing only marginally, the net flow of funds from the industrial countries to the rest of the world via the international banking system rose from $7 billion in 1980 to $42 billion in 1981. The United States was the major net supplier of international banking funds in the latter year. Banks located in the United States, which had re-emerged as large net lenders in 1980, continued that role in 1981. In addition, the foreign deposits of U.S. nonbank institutions and individuals, net of their borrowing from banks abroad, increased by $25 billion.

The distribution of bank lending showed little change in 1981, with the volume of net lending to industrial countries and non-oil developing countries increasing marginally and lending to oil exporting countries declining (Table 2). Net lending to centrally planned economies (excluding Fund member countries except Hungary) showed little change in spite of increasing concern among banks about the creditworthiness of the countries of Eastern Europe. Much of the continued flow reflected the drawdown of commitments arranged in earlier years.

Table 2.Aspects of International Bank and Bond Financing, 1978–81(In billions of U.S. dollars)
1978197919801981
Destination of net bank lending190125160165
Industrial countries387096100
Oil exporting countries15663
Non-oil developing countries25394950
Centrally planned economies27655
Other6417
Destination of new medium-term loan commitments7479801453
Industrial countries342439953
Oil exporting countries10755
Non-oil developing countries27423244
Centrally planned economies23521
Other11
Terms on medium-term loan commitments
Average six-month Eurodollar interbank rate (in per cent)9.412.014.216.5
Average maturity (in years)8.58.67.97.8
Average spread (in per cent)0.980.740.700.70
Distribution of net bond market lending30332837
Industrial countries19222027
Developing countries4323
Other7867
Sources: Bank for International Settlements; Organization for Economic Cooperation and Development; and Fund staff estimates.

Increase in bank claims adjusted for valuation effects of exchange rate changes.

Excludes Fund member countries.

Of which $50 billion was accounted for by multibillion dollar financing by U.S. corporations.

Sources: Bank for International Settlements; Organization for Economic Cooperation and Development; and Fund staff estimates.

Increase in bank claims adjusted for valuation effects of exchange rate changes.

Excludes Fund member countries.

Of which $50 billion was accounted for by multibillion dollar financing by U.S. corporations.

In contrast to the moderate growth of actual bank lending, commitments of funds in the form of publicized medium-term syndicated credits increased sharply to $145 billion in 1981 from $80 billion in 1980 (Chart 3). Of this amount, $50 billion was accounted for by multibillion dollar commitments to U.S. firms, largely in connection with corporate takeover activity. Many of these were not drawn down or were quickly repaid, and in some cases much of the loan involved domestic lending by U.S. banks rather than genuine international lending. Even excluding such exceptional transactions, however, commitments increased by 17 per cent to reach $95 billion, the first substantial rise since 1978. Most of the increase was accounted for by non-oil developing countries.

Chart 3.International Bank Credit Commitments and International Bond Issues, 1973–81

(In billions of U.S. dollars)

1 Excluding multibillion dollar financing of U.S. corporations.

From the viewpoint of borrowers, the rise in real and nominal interest rates in 1981 constituted a significant hardening of terms (Chart 4). Weighted average lending spreads over LIBOR, however, showed little change in 1981, remaining at a level a little below ¾ per cent; with the increasing emphasis on the use of the U.S. prime rate as a reference rate, there was some marginal effective increase in spreads. Some major developing country borrowers faced higher or rising spreads in 1981 and the early months of 1982, while spreads paid by most industrial country borrowers and some developing country borrowers continued to decline. The average maturity of new commitments appears to have stabilized at slightly less than eight years after declining since the middle of 1979 for both industrial and developing country borrowers.

Chart 4.Terms on International Bank Lending, 1973–81

1 Medium-term publicized international bank credit commitments.

International Bond Markets

For the first time since 1975, the proportion of net lending through the international capital markets accounted for by international bonds increased, as net bond issues rose by more than 30 per cent to reach a volume of $37 billion. While industrial country borrowers again accounted for most new issues in 1981, international organizations were responsible for 18 per cent and developing countries for 7 per cent of the total (Chart 5).

Chart 5.Developments in International Bond Markets, 1978–81

1 Three-month deposits.

2 Bonds with remaining maturity of 7 to 15 years.

3 Figures shown below graphs represent total of all categories.

The recovery of bond issuance occurred even though 1981 was a year in which long-term interest rates for some currencies not only rose to their highest in the postwar period but also showed considerable variability. From April to August 1981 there was a general upward trend in long-term interest rates. Nominal interest rates in most markets peaked in September, then declined until December.

Much of the issuing activity during 1981 and early 1982 was concentrated in periods just after nominal interest rates had peaked and had started to decline. For example, almost half the foreign bonds issued on the U.S. market during 1981 were sold during the fourth quarter, and the amount of Eurodollar bonds sold during the first quarter of 1982 equaled almost 45 per cent of all such bonds marketed in 1981. This sharp increase in bond issuance reflected the desire of borrowers to increase the proportion of their debt represented by longer-term financing in their portfolios when market opportunities presented themselves, while the historically high real rates of return being offered on fixed rate bonds were attractive to investors when interest rate declines were expected.

The use of the U.S. dollar as a currency of denomination continued to expand, accounting for approximately 60 per cent of issues in 1981 and the first quarter of 1982, up from 43 per cent in 1980. The shift toward U.S. dollar-denominated bonds reflected their attractiveness to investors due to the continued strengthening of the U.S. dollar relative to other major currencies. In contrast, the share of bonds denominated in deutsche mark declined from 20 per cent in 1980 to only 6 per cent in 1981, reflecting both a weak current account position and restrictions imposed at various times on capital outflows from the Federal Republic of Germany. Although bonds denominated in Japanese yen increased to nearly 7 per cent of all international bonds, this share was still below the nearly 13 per cent share that existed in 1978. A total of $408 million in SDR-denominated bonds was also issued in 1981.

The most rapid growth of international bond issuance occurred in the Eurobond markets. Gross issues of Eurobonds, which accounted for three fifths of total issues in 1981, increased by 27 per cent. The share of dollar bonds increased sharply, accounting for nearly 82 per cent of these issues, while there was a major decline in both deutsche mark and French franc issues. Industrial country issuers increased their share of Eurobonds to 81 per cent in 1981, with developing countries accounting for 8 per cent of such issues.

Gross foreign bond issues and placements grew by 19 per cent, but this encompassed rather diverse behavior in the major financial markets. In Japan, Switzerland, and the United States, foreign bond issues increased from their 1980 values. In Japan, this recovery reflected, in part, the lifting of the suspension of foreign private placements that had been in effect since late 1979. In contrast, foreign bond issues in the Federal Republic of Germany declined by nearly 55 per cent. Industrial country entities accounted for 63 per cent of total foreign bonds and developing countries for 6 per cent.

Prudential Standards and Bank Supervision

The fact that a substantial expansion of banks’ international claims again took place in 1981 without an overall increase in lending spreads or significant shortening of maturities suggests that prudential concerns were not a significant constraint on the aggregate volume of bank lending.

Nonetheless, there were signs of strain which might imply more serious constraints in the future. Bank capital-asset ratios declined to some degree in most capital market countries, with the major exception of the United States (Table 28). Banks themselves, as well as their supervisors, felt that a strengthening of capital positions was necessary. This need perhaps was given increased urgency in 1981 by rising domestic loan losses and increasing questions about the quality of some of the international assets of banks. For banks with home currencies other than the U.S. dollar, the latter concern was especially important, as the appreciation of the dollar had increased the potential strain on capital of losses on loans denominated in that currency. As these problems rose at a time when conditions in equity markets were generally not favorable to raising new capital, some banks began to feel a need to restrain the growth of their balance sheets. These concerns were particularly evident in some continental European banks, notably those in the Federal Republic of Germany.

Bank supervision in most capital market countries has long emphasized the need to improve bank capital positions, but in the last year or two such actions have received stronger formal expression in a number of countries. In the United States in 1981 the supervisory authorities set out formal guidelines for banks, which varied with the size of bank. For some smaller banks, the new guidelines left room for some decline in capital-asset ratios, but for large banks it implied, in general, that no further decline would be permitted. In Canada, closely held banks chartered under the new Bank Act are subject to a legal capital requirement. For existing banks, prudential considerations have led to a strengthening of informal guidelines, and the major banks with large retail deposit bases are now being advised to limit their assets to 30 times their capital. In the United Kingdom, principles relating to the assessment and monitoring of capital adequacy were set out in a paper issued by the Bank of England in September 1980.

The continuing movement toward full consolidation of bank balance sheets for purposes of evaluating capital adequacy is affecting capital requirements in some countries. In Canada, the ratio of capital to assets was higher on a consolidated basis than under the previous system of measurement, making the new guidelines less onerous for large banks than they otherwise would have been. In the Federal Republic of Germany, on the other hand, consolidation is expected to reduce capital ratios so that either the legal requirements will have to be adjusted (as occurred in Switzerland at the time of consolidation) or banks will need to raise new capital. Legislation requiring consolidation is still pending, but under a “gentlemen’s agreement” banks are voluntarily providing information on their capital positions on a consolidated basis. New banking legislation in Luxembourg, in conformity with the 1977 EEC Directive on banking coordination, permits the exchange of information necessary for consolidation of the subsidiaries of German banks in Luxembourg.

While supervisory authorities are tightening capital requirements in some respects, at the same time they are permitting banks to raise capital through new techniques. An increasing number of authorities, for example, have permitted subordinated debt to be counted as capital to some extent. This provides banks with the opportunity to raise capital of medium-term maturity at a time when equity markets are weak. While such new techniques give banks added flexibility, the extent to which they can ameliorate bank capital positions is limited, and in the near future bank lending in a number of countries may be constrained to some extent by capital considerations. Over the medium term, however, capital should not be a constraint on the ability of banks to respond to profitable opportunities, as the profits themselves can result in increased capital, either through retained earnings or through facilitating new issues in the capital markets.

Besides problems of capital adequacy, prudential concerns have also been expressed about the growing international exposures of banks, particularly to the non-oil developing countries. Such concerns are among the topics discussed in the next section.

Progress in the international coordination of banking supervision continued in 1981. The Basle (Cooke) Committee on Banking Regulations and Supervisory Practices, whose recommendation that bank solvency be evaluated on a consolidated basis gave impetus to the progress that has occurred in recent years, continued work in a number of areas, notably on the approach which should be taken to measure and assess country risk. On one major aspect of this question, current thinking seems to be that such risks should be evaluated on a consolidated basis, although it may take some time to achieve that objective. Institutionally, a second International Conference of Bank Supervisors was hosted by the U.S. supervisory authorities in Washington, D.C., in September 1981, following a precedent established by the Bank of England in 1979. The group of offshore banking supervisors which was set up in 1980 held a further meeting in 1981, at which time an agreement was reached on an exchange of information. In general there has been considerable progress in enlarging the number of countries whose banking supervisors are in mutual contact and who are working toward harmonization of supervisory practices.

Recent developments in market lending to developing countries are discussed in more detail in Section III.

As measured by the Bank for International Settlements (BIS) for banks in the BIS reporting area, net of interbank redepositing. The figures cited here have been adjusted to remove valuation effects associated with exchange rate changes.

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