Chapter

II Responses to Strains in Financial Markets

Author(s):
Maxwell Watson, Peter Keller, and Donald Mathieson
Published Date:
August 1984
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Introduction

The period since late 1982 has been characterized by continuing strains in the capital markets. A large number of developing country members experienced a sharp deterioration in their ability to meet scheduled debt servicing commitments. Banks and their regulators became seriously concerned about the impaired quality of banks’ domestic and international assets, including notably concentration in their exposure to certain major borrowers among the developing countries. Finally, and partly as a result of these pressures, a highly differentiated market for sovereign credit developed: banks, while liquid and extending some credits on exceptionally fine terms to selected borrowers, became increasingly unwilling to lend spontaneously to many developing countries on a significant scale.

These problems have been met by a number of policy initiatives taken by member countries, by creditor groups, and by the multilateral financial institutions. First, many developing countries engaged in comprehensive adjustment programs, supported by the Fund, with the objective of regaining or preserving access to spontaneous commercial financing. Second, a large number of debt restructurings and concerted financing packages were agreed, to secure financial support for orderly adjustment and to prevent an even more serious cutback in countries’ imports and wider proliferation of payments and trade restrictions. Third, measures were taken to strengthen the financial system, including notably an increase in the financial resources of the Fund and steps to begin to reinforce the soundness of the commercial banking system.

There are further avenues through which multilateral official action is aimed to secure a more balanced development of sovereign credit flows in the future. These include continuing official support for prudent external borrowing policies and the provision of improved information.

With regard to countries’ external borrowing, the Fund’s regular surveillance of member countries’ economic and financial policies has been strengthened substantially in the area of external debt management. There is considerable scope for Fund surveillance—which applies to all member countries—to make an increased contribution to debt management and to stable and balanced conditions for growth in world trade. With regard to information, the Fund has taken initiatives in the area of collecting and disseminating data on international banking flows, in particular through the compilation of International Banking Statistics (which are used in this paper and described in Appendix I). Moreover, the Fund has encouraged member countries to improve the comprehensiveness and timeliness of their own published data. At the request of borrowing countries seeking to resolve their payments difficulties, the Fund has been able to provide information about these countries’ economic situation and policies to creditor groups, a role that may well continue to be helpful as countries seek to regain access to regular commercial financing. Also, it should be noted that the formation of the Institute of International Finance and of the Japan Center for International Finance is evidence of banks’ awareness of information gaps to be filled and of the need for forums in which to exchange experience on international lending issues. Such forums, if broadly supported by banks, could make a contribution to the process of improving the basis on which individual banks form views on international lending.

This section discusses the implications for the banking system, and for capital market flows over the medium term, of the strains that have developed and of these policy responses. It begins with a review of changes that have taken place in the banking system and the response of bank supervisors to the strains that have developed. It continues by assessing the implications of these changes for banks’ international lending during the next few years. Finally, it discusses selected issues that have arisen in connection with bank debt restructurings and new financing packages.

Risks Affecting the Banking System

In recent years, commercial banks have become increasingly concerned about their exposure to lending and funding risks in both domestic and international business. The shift toward a conservative and, on occasion, defensive lending policy has encompassed the interbank market as well as lending to nonbanks. In part, the pressures that developed during recent years were cyclical, but they also reflected a number of structural changes. Their impact on banks’ behavior may well carry implications for international lending activities over the medium term.

First, international banks’ projections of medium-term economic trends, including real interest rates have become more cautious during the past few years. Notwithstanding the continuing economic recovery in major industrial countries, banks now appreciate more fully the risks for both domestic and cross-border lending in the present international environment. Currently, particular concern is focused on the risks inherent in continuing high real interest rates for the international trade and payments outlook. At the same time, banks are disturbed at the spread of trade protection, with its negative impact on export growth and direct investment flows and, thus, on the quality and liquidity of their international assets. Moreover, banks recognize that the risks inherent in both domestic and international assets—and sectors and groupings within these broad categories—are often likely to increase simultaneously during periods of high interest rates and of downswings in economic activity. Consequently, the concentrations in some banks’ exposure to major borrower countries and to some economic sectors appear more problematic than before, and a dilution of these concentrations, over time, now seems essential to banks and their regulators (Chart 3).

Chart 3.Concentration of International Bank Claims, 1973–831

Source: Fund staff estimates based on BIS data provided in International Banking Developments.

1 Excludes interbank transactions within the 15 BIS reporting countries.

2 Excludes Fund member countries.

A second structural factor influencing banks’ behavior is that the flexibility they have gained in recent years in asset and liability management has had associated costs. On the one hand, through floating rate lending in U.S. dollars or in banks’ domestic currencies (where not discouraged by the authorities), the impact of changes in interest rates is now experienced more immediately by banks’ customers. This has relieved banks of much of their exposure to interest rate risk. However, it has passed through this exposure to their customers, including highly “leveraged” commercial borrowers and countries with large external borrowings. Thus, banks’ interest rate risk has, to some degree, been transformed into credit risk. At the same time, developments in the banks’ own liability management and the removal of interest rate ceilings on deposits—especially but not exclusively in the United States—have appeared to be contributory factors underlying wider swings in interest rates in recent years. As a result of these factors, inter alia, borrowers—and especially those with a high proportion of floating rate debt—have experienced severe credit strains at times of monetary restraint. Moreover, the dependence of many banks on the wholesale money markets can leave them open to sudden pressures if concerns about the quality of their assets develop.

Third, the impact of inflation, high interest rates, technological advances, and innovation in financing instruments has been to increase competition for savings in a number of major financial market countries, and to blur some of the dividing lines between depository institutions and other intermediaries, as well as between business based on loans and on securities. A further source of increased competitive pressure has been that some of the banks’ traditional customers among larger nonbank corporations, in response to the adverse financial developments of the last decade, have begun to restructure their finances and to increase their internal financing through retained earnings. Increasingly, major corporations are also in a position to tap external savings directly through security issues in domestic or international capital markets at very fine rates; indeed, for some prime corporations terms have been more favorable than those obtained by some major banks. Banks in the United States and, to differing degrees, in some other financial market countries are increasingly aware of the risk to earnings that results from the more highly competitive nature of banking in a deregulated financial environment.

These changes in the business risk of banks differ widely in their incidence from country to country. In aggregate, they are significant for patterns of international lending—the more so because they derive from structural developments that may continue and spread more widely over time. The moves to strengthen banks’ financial positions, which are described below, reflect an increased awareness of the significant medium-term risks affecting banks’ business. Such factors, among others, have been reflected in a downgrading by rating agencies of the status of securities issued by a number of major banks, and in the level of the share prices of some international banks, which are trading significantly below book value. The willingness of banks to continue to increase their international exposure to many countries will depend upon their ability to deal with these medium-term risks. In this respect, the strengthening of capital ratios and the constitution of appropriate loan-loss provisions appear as prerequisites if banks are to enjoy public confidence and continue to play a part in supporting growth in the international economy.

Developments in Banking Regulation

Overview

As described above, approximately half the growth in banks’ claims on non-oil developing countries in 1983 took the form of concerted lending to a limited number of countries, mainly in Latin America, while much of banks’ other international lending was extended on relatively fine terms, reflecting competition to lend to highly regarded borrowers. These developments in banks’ international lending took place against a background of economic recovery in many of the industrial countries, accompanied in a number of cases by higher bank earnings and an improvement in the quality of some banks’ domestic assets, after several years of heavy loan-loss experience on domestic transactions.

In these circumstances, issues of sovereign or foreign exchange transfer risk continued to command the attention of banks and bank supervisors. Supervisory authorities have become concerned in recent years with the deterioration in the quality of banks’ international assets, about the effect of this on the financial strength of major banks in particular, and about the implications of these developments for the stability of the international financial system. Thus, supervisory authorities in most major financial centers have strived for some time to secure a strengthening in banks’ capital positions and to extend the improvements in banks’ risk monitoring and assessment systems. Banks, in turn, have placed greater emphasis on selectiveness rather than on overall growth in managing their international assets. Various aspects of these issues have been the subject of discussions in the Basle Committee on Banking Regulations and Supervisory Practices and other international supervisory groupings. Through these groupings of bank supervisors, steps have been taken to broaden the coverage of supervision and to promote the principle that banks’ exposure should be managed and supervised on a consolidated basis—that is, including exposure through subsidiaries as well as through branches of the parent bank. At the same time, supervisors have accorded increased importance to the quantity and quality of capital backing the assets of the banking system, and to ensuring that this is strengthened over time in reflection of the pattern of risks to which individual institutions are exposed. To a much greater extent than in the past, banks in a number of financial market countries—often with the encouragement of supervisors—at the same time have made significant provisions against their exposure to sovereign or foreign exchange transfer risks. Bank supervisors have secured this general strengthening of banks’ financial positions in a judicious manner, balancing the need to ensure continuing progress against the dangers of an excessively stringent approach that could have added to the strains in financial markets.

Capital Adequacy

Supervisors’ concerns about the adequacy of banks’ capital positions have reflected, in part, the impaired value of domestic assets owing to the severity of the recent economic downturn. Indeed, large exposures to troubled domestic sectors or companies have been much more serious sources of realized losses, thus far, than international lending. In some countries, such as the United States, domestic loan loss experience worsened initially as the economy emerged from recession. In general, changes in domestic circumstances (including tax regulations, for example) have a very strong potential to weaken or strengthen the position of major banks. At the same time, banks’ international assets grew more rapidly than domestic assets or capital over the past decade (Chart 3), and concern about the quality of these international claims has become a significant factor in the pressure to increase capital ratios.

Banks’ claims on developing countries remain highly concentrated on a few major borrower countries, many of which are experiencing debt servicing difficulties and undergoing debt restructurings. Furthermore, the majority of these assets are held by a relatively small number of major international banks. Thus, for some international banks, claims on large debtor countries experiencing debt servicing difficulties amount to a very high proportion of the banks’ capital. In the United States, where much country exposure information is in the public domain, the exposure of some banks to individual sovereign borrowers that have entered into debt restructurings is well in excess of 50 percent of each bank’s capital. For some of the money-center banks in the United States, exposure to those major developing countries that have experienced payments difficulties exceeds in aggregate 150 percent of capital. High degrees of exposure to individual borrowers also occur in some banks in other countries, although the degree of concentration of cross-border lending exposure is believed to be generally less for most major continental European banks. Thus, the capital and earnings of a number of major international banks remain vulnerable to interruptions in debt service on their international claims. For banks in some countries this situation is compounded by relatively modest provisions against international exposure, especially as regards lending to government and other public sector bodies.

The impaired quality of bank assets, and the general increase in the risks faced by banks, led supervisory authorities in financial market countries to encourage banks to increase their capital resources in 1983. For the immediate future also, banks have been advised in many cases to increase their capital base somewhat more rapidly than the growth in their overall assets, while at the same time shifting their portfolio balance over time to achieve a deconcentration of lending risks. An examination of published capital to assets ratios of banks in major financial market countries does not reveal a uniform trend, but it does suggest a downward tendency in ratios in the period to 1982, followed by a strengthening in many countries in 1983 (Table 4). One reason for the deterioration prior to 1983 was that the rapid accumulation of external claims which occurred prior to 1982 had not been matched by a similar buildup in the capital of banks. Moreover, for nondollar-based banks16 with claims denominated in U.S. dollars, the domestic currency value of international assets was inflated by the increased strength of the dollar, without a corresponding increase in the value of the capital base. A slowdown in the accumulation of external and domestic claims, banks’ improved earnings positions, and bank supervisors’ emphasis on a buildup of capital were factors influencing the reversal of this trend in many countries, in 1983 despite a further strengthening of the U.S. dollar. However, the observed movements in capital-asset ratios must be treated with caution as they do not take into account factors such as the differences in the quality of bank capital and the valuation of bank assets. Differences in national definitions of bank capital, the treatment of provisioning against loan losses, the existence of hidden reserves, and the valuation of bank assets impede intercountry comparisons.

Banks in many countries have accomplished the strengthening of their capital position by issuing equity and other eligible securities. A second and important element in strengthening bank positions in some countries has been a conservative dividend policy and thus an increase in the proportion of earnings that were retained, in various forms, rather than distributed.17 Indeed, despite improved earnings, some banks facing less pressures from shareholders to pay large or increased dividends are forgoing increases in dividends in order to strengthen the capital position of the bank. Distributions can, of course, make an indirect contribution to strengthening the capital of a bank, if the earnings are considered to be of sound quality and investors are prepared to supply additional equity. However, it is very possible that stockholders, in the present international environment, are becoming less concerned with higher dividends than with evidence of prudent asset valuation and a direct strengthening of the reserves of a bank. Some banks and bank supervisors would argue strongly that high retentions and cautious valuation of assets can also increase the underlying profitability of a bank by enhancing the confidence of investors and depositors and reducing its cost of funds.

Table 4.Capital-Asset Ratios of Banks in Major Financial Market Countries, 1977–83 1(In percent)
1977197819791980198119821983
Canada23.403.273.162.983.46 33.654.06
France42.362.082.432.221.991.871.76
Germany, Federal Republic of53.413.323.313.273.263.313.34
Japan65.285.125.135.285.255.035.22
Luxembourg73.523.453.503.59
Netherlands84.413.864.294.204.334.604.68
Switzerland 9
Largest 5 banks6.096.206.116.185.785.515.36
All banks5.595.685.635.665.365.195.09
United Kingdom
Largest 4 banks105.906.306.105.805.204.884.99
All banks 115.205.205.105.004.474.144.35
United States
Largest 10 banksn124.174.063.954.024.234.705.41
Largest 25 banks124.524.414.314.394.574.985.58
Large banks with foreign offices13, 144.584.474.494.544.624.48 15
Sources: Fund staff calculations based on data from official sources, as indicated in footnotes.

Given the problems of consistency across banks and over time in the accounting of bank assets and capital, aggregate figures such as the ones in this table must be interpreted with caution.

Ratio of equity plus accumulated appropriations for losses (beginning with 1981, appropriations for contingencies) to total assets (Bank of Canada Review).

The changeover to consolidated reporting from November 1, 1981 had the statistical effect of increasing the aggregate capital-asset ratio by about 7 percent.

Ratio of reserves plus capital to total assets excludes cooperative and mutual banks (Commission de Controle des Banques, Rapport).

Ratio of capital including published reserves to total assets (Deutsche Bundesbank, Monthly Report).

Ratio of reserves for possible loan losses, specified reserves, share capital, legal reserves plus surplus and profits and losses for the term to total assets (Bank of Japan, Economic Statistics Monthly).

Ratio of capital resources (share capital, reserves excluding current-year profits, general provisions, and eligible subordinated loans) to total payables. Eligible subordinated loans are subject to prior authorization by the Institut Monetaire Luxembourgeois and may not exceed 50 percent of a bank’s share capital and reserves. Data in the table are compiled on a nonconsolidated basis and as a weighted average of all banks (excluding foreign bank branches). An arithmetic mean for 1983 would show a ratio of 7.58 percent. Inclusion of current-year profits in banks’ capital resources would result in a weighted average of 3.91 percent for 1983. Provisions for country risks, which are excluded from capital resources, have been considerably increased in the last three years, including an approximate doubling of the level of provisions in 1983.

Ratio of capital, disclosed free reserves, and subordinated loans to total assets. Eligible liabilities of business members of the agricultural credit institutions are not included (De Nederlandsche Bank N.V., Annual Report).

Ratio of capital plus reserves to total assets (Swiss National Bank, Monthly Report).

Ratio of share capital and reserves, plus minority interests but excluding loan capital, to total assets (Bank of England).

Ratio of capital and other funds (sterling and other currency liabilities) to total assets (Bank of England). Note that these figures include U.K. branches of foreign banks, which normally have little capital in the United Kingdom.

Ratio of primary capital to total assets (Comptroller of the Currency).

Banks with foreign offices with assets of $100 million or over—in 1981 there were 190 such banks (Board of Governors of Federal Reserve System, Federal Reserve Bulletin).

Ratio of total equity capital to total assets.

Through September 30, 1983.

Sources: Fund staff calculations based on data from official sources, as indicated in footnotes.

Given the problems of consistency across banks and over time in the accounting of bank assets and capital, aggregate figures such as the ones in this table must be interpreted with caution.

Ratio of equity plus accumulated appropriations for losses (beginning with 1981, appropriations for contingencies) to total assets (Bank of Canada Review).

The changeover to consolidated reporting from November 1, 1981 had the statistical effect of increasing the aggregate capital-asset ratio by about 7 percent.

Ratio of reserves plus capital to total assets excludes cooperative and mutual banks (Commission de Controle des Banques, Rapport).

Ratio of capital including published reserves to total assets (Deutsche Bundesbank, Monthly Report).

Ratio of reserves for possible loan losses, specified reserves, share capital, legal reserves plus surplus and profits and losses for the term to total assets (Bank of Japan, Economic Statistics Monthly).

Ratio of capital resources (share capital, reserves excluding current-year profits, general provisions, and eligible subordinated loans) to total payables. Eligible subordinated loans are subject to prior authorization by the Institut Monetaire Luxembourgeois and may not exceed 50 percent of a bank’s share capital and reserves. Data in the table are compiled on a nonconsolidated basis and as a weighted average of all banks (excluding foreign bank branches). An arithmetic mean for 1983 would show a ratio of 7.58 percent. Inclusion of current-year profits in banks’ capital resources would result in a weighted average of 3.91 percent for 1983. Provisions for country risks, which are excluded from capital resources, have been considerably increased in the last three years, including an approximate doubling of the level of provisions in 1983.

Ratio of capital, disclosed free reserves, and subordinated loans to total assets. Eligible liabilities of business members of the agricultural credit institutions are not included (De Nederlandsche Bank N.V., Annual Report).

Ratio of capital plus reserves to total assets (Swiss National Bank, Monthly Report).

Ratio of share capital and reserves, plus minority interests but excluding loan capital, to total assets (Bank of England).

Ratio of capital and other funds (sterling and other currency liabilities) to total assets (Bank of England). Note that these figures include U.K. branches of foreign banks, which normally have little capital in the United Kingdom.

Ratio of primary capital to total assets (Comptroller of the Currency).

Banks with foreign offices with assets of $100 million or over—in 1981 there were 190 such banks (Board of Governors of Federal Reserve System, Federal Reserve Bulletin).

Ratio of total equity capital to total assets.

Through September 30, 1983.

While some countries use a ratio of capital to unweighted assets as the primary basis for evaluating capital adequacy, others relate bank capital to different categories of bank assets, weighted according to the nature (or risk category) of the underlying claim. In addition to the tendency toward a selective approach to weighting assets when assessing the adequacy of capital, supervisors in most countries would regard certain components of bank capital as providing a more effective base than others; there is some movement toward harmonization of approaches to this question, both in the European Community and more widely. Subordinated debt would generally be viewed as a less-than-perfect substitute for equity, and some countries, such as the Federal Republic of Germany, do not include subordinated debt in the definition of bank capital. In other countries subordinated debt cannot exceed a certain percentage of equity capital for the purpose of calculating capital ratios. In the United Kingdom, cross holdings of subordinated loan stocks by banks are also deducted from the holding bank’s capital, except where these relate to securities trading activities up to agreed limits, in order to avoid double counting the capital backing the banking system.

In the context of developments in capital adequacy, actual and proposed changes in the United States and the Federal Republic of Germany are particularly noteworthy. In the United States consideration of the quality of bank capital has been addressed in the International Lending Act of 1983, which instructs federal bank supervisory agencies to “establish examination and supervisory procedures to assure that factors such as foreign currency exposure and transfer risk are taken into account in evaluating the adequacy of the capital of banking institutions.” Indeed, the pursuit of higher international standards for capital adequacy has been advocated in this legislation.18 A second notable development is in the Federal Republic of Germany, where, in accordance with the European Community directive on consolidation, a draft amendment to the German Banking Law to require consolidated banking supervision has been submitted to the Federal Parliament. Under this law the gearing rule limiting weighted risk assets to 18 times a bank’s capital would be extended to overseas affiliates of German banks, including those in Luxembourg. It is believed that this would require some major German banks to raise their capital during a phasing-in period of several years, in order to maintain or increase their overall loan volume.

Provisioning

Supervisors have also been directly or indirectly concerned in ensuring that the impaired quality of bank assets—both domestic and international—is reflected in bank balance sheets. In some cases, emphasis has been placed primarily on a progressive increase in capital resources, relative to assets. In other instances, sizable provisions have also been made against exposure to certain sovereign borrowers, as well as to private sector debtors. The extent of provisions, which may have had a material effect on financial confidence in some cases, has reflected a variety of factors relating, inter alia, to patterns in the asset and income concentrations of individual banks and groups of banks. In general, supervisory authorities do not expect absolute uniformity in the approach to provisioning taken by their own country’s banks, because of the different composition of claims held by individual banks. Where there are no specific legal or statutory requirements, supervisory authorities judge the adequacy of provisioning in the light of banks’ overall situations. However, both the need and the ability of banks to make sizable provisions have played a role; for some major banks supervisors will no doubt continue to press for increased provisions or stronger retentions of earnings to build up capital.

Policies regarding banks’ loan-loss provisioning on international exposure thus vary widely across countries. Provisioning against commercial risks in international lending has followed the same guidelines as for domestic lending, but the question of providing against the sovereign or general foreign exchange transfer risk affecting international loans is an area where practices are evolving. Overall, there has been a shift by banks and supervisors toward the view that the stream of income and amortization on any international lending (including sovereign lending) can become seriously impaired, notably on account of foreign exchange shortages. In some countries, banks or their accountants have not felt that this possibility of impairment of sovereign debt has fitted easily into the existing categories of provisions and reserves (which generally distinguish between specific provisions against individual loans that are not expected to be repaid in full, and general reserves that form part of the capital base of a bank). In the United States, the concept of the Allocated Transfer Risk Reserve (ATRR) has been introduced to meet this need.19 In some other countries variants on existing types of provision have been introduced. One variant is the setting up by banks of a “basket” provision against the risks of lending to groups or categories of countries. Such provisions reflect the general risks considered to be latent in banks’ international exposure, but not easily specified or quantified for individual countries or borrowers. There are also important variations in the accounting treatment of provisions. These differences appear across countries and also between published accounts, tax accounts, and supervisory reports. For example, in some cases assets are written down, while in others the asset is shown at full value but an offset is provided on the liability side.

Provisioning against loan-losses may be influenced to a significant extent by the degree of tax deductibility allowed and whether such provisions can be treated as part of general capital. In many countries, for prudential purposes, general provisions against possible loan-losses are treated as part of general capital and reserves but are not tax deductible. Loan-loss provisions on specific debts frequently are not considered as part of general capital but are tax deductible. However, as noted above, loan-loss provisioning on sovereign risks does not necessarily fit neatly into either of these categories. In some European countries, banks benefit from a relatively favorable tax treatment in making provisions against sovereign or foreign exchange transfer risks. In the United States and Japan, banks have had more limited possibilities for deducting provisions against such risks for tax purposes. There may be some trend in the direction of recognizing that prudent asset valuation would be favored by making such provisions tax deductible. In the United States ATRR allocations, which cannot be treated as part of capital, form a deductible charge against current income (as do write-offs). In Japan, banks have recently begun to set aside provisions against sovereign risks out of after-tax profits, but some easement in the tax position has been agreed for the future. In the United Kingdom the tax status of provisions against sovereign risk has been clarified as being closely comparable to that on commercial debt. In a number of continental European countries tax charge-offs are reviewed case-by-case by local fiscal authorities, and a considerable degree of tax deductibility is afforded on sovereign risk provisions.

Reflecting a number of factors, including strong supervisory emphasis on building banks’ general capital and also on the limited tax deductibility available, U.S. banks have not made sizable provisions against exposure to the public sectors of most borrowing countries. Recently, however, ATRRs for varying percentages of exposure have been required for a few countries experiencing very protracted debt servicing difficulties. At the other end of the spectrum are many banks in continental Europe, that have made provisions for loans to many developing countries on the order of 15-25 percent, and at times considerably more, as regards loans to some major borrowing countries. In addition, some major banks in Europe dispose of “hidden” or “inner” reserves (for example, by the use of conservative asset valuation techniques) that enable them to smooth profits to enhance public confidence. In some countries, as the status of domestic loans has improved, provisions released in respect of these loans can be applied to international credits.

Country Risk Assessment

Parallel to the general consensus to strengthen bank capital and to set up provisions against sovereign or foreign exchange transfer risks, bank supervisory authorities have actively addressed the question of inadequate monitoring and control of exposure due to the failure of banks’ risk assessment systems to capture lending through subsidiaries and other affiliates.20 Supervisory authorities represented on the Basle Committee for some time have been pressing for the widespread introduction of consolidated reporting and the supervision of banks on a consolidated basis. Under the existing European Community directive, countries that are members of the European Community are required to implement appropriate legislation in this regard, not later than July 1, 1985. Several countries have already adopted the principle of supervision on a consolidated basis, while others are moving to implement it. In some countries, such as the Federal Republic of Germany, banks are already required to report on a consolidated basis, although the formal capital-asset ratios are not yet calculated on such a basis.

Following the events in Eastern Europe and Latin America, banks, in conjunction with bank supervisors, have also undertaken a basic re-examination of their cross-border lending strategy and risk assessment procedures, particularly as regards lending to developing countries and transactions on the international interbank markets. In assessing the risk of lending to a specific country, the factors most widely considered appear to be the political situation, the condition of the domestic economy and balance of payments, the status of the country’s relations with the Fund, and other banks’ experience. Also, despite the increasing awareness of risks inherent in lending to countries with a large proportion of short-term debt, much recent international lending to developing countries has taken the form of short-term trade financing. This form of lending may be subject, in the final analysis, to transfer risks similar to those for syndicated lending, but banks generally believe that they can monitor more closely the use to which funds are put. In addition, such loans often are relatively remunerative and help to finance the export activities of banks’ domestic clients.

In general, supervisory authorities have viewed the assessment of the quality of banks’ assets, including country risk, as primarily the responsibility of bank management and of external auditors. They have emphasized the importance of ensuring that bank managements have adequate internal procedures to manage such risks and sufficient information on which to base their lending decisions. In addition, some supervisory authorities have taken further initiatives in this area. In the United States, the Interagency Country Exposure Review Committee has the responsibility of determining the transfer-risk rating for individual countries. Assets with substandard ratings are “classified” and listed, which may influence the supervisor’s evaluation of a bank’s capital adequacy. For assets classified as “Value Impaired,” some degree of provisioning must be undertaken and specific criteria for this have been published.21 In some other countries, specific limits or guidelines are placed on the percentage of banks’ capital that may be extended to any one borrower or group of borrowers. Alternatively, loans in some countries must be reported to the supervisory authority if they exceed a certain limit as a percentage of capital or certain absolute levels. In some countries, bank auditors or examiners are required to mention or comment on high exposure concentrations in their reports.

Finally, banks have responded to the present international financial environment by increasing their efforts to obtain information on countries’ economic and financial conditions, and their ability to assess developments in the major borrower countries, by establishing in 1983 the Institute of International Finance.

Liquidity Management

In 1983, there was also a general tendency among banks to strengthen their funding positions. Many nondollar-based banks moved to secure their sources of dollar funding, for example, by issuing floating rate notes and by diversifying their funding sources. At the same time, some banks also placed greater emphasis upon extending international loans in their domestic currency.

The deterioration in the quality of bank assets in the changed economic environment of the past few years has focused particular attention on the potential instability of wholesale deposits. Whereas retail deposits in many countries benefit from deposit insurance or broader assurances of official support, the position of larger domestic and international depositors in the failure of a bank has often been less clear cut. Supervisory authorities face a difficult choice in this area. If they provide absolute assurances that larger deposits will be repaid without loss, this results in a serious moral hazard; it breaks the link between the sound management of a bank and the cost of its funds. On the other hand, to acknowledge that wholesale deposits might not be fully repaid lays open the risk that doubts about a major bank’s solvency could give rise to a preemptive (and potentially self-fulfilling) withdrawal of money market deposits on a scale that might prove difficult to contain and reverse. Generally, supervisors, in conjunction with unaffected major banks, have adopted a pragmatic approach. They have acted swiftly to contain problems if general confidence in the financial markets seemed threatened. One recent example of this was the arrangements made for other banks to take over the business of a German bank (Schroeder, Munchmeyer, Hengst). The experience of the U.S. authorities has also been noteworthy. Notwithstanding the recent trial of a “modified payoff” scheme (i.e., a partial—rather than a full—repayment of wholesale depositors in smaller banks that had failed), the U.S. authorities acted rapidly to avoid the spread of funding problems affecting a money-center bank (Continental Illinois) in May 1984, eventually, inter alia, guaranteeing the totality of its deposit liabilities, much of which represented cross-border deposits.

The experience of the last few years serves to underline that supervisors face multiple objectives in seeking to foster the sound development of banks’ international (as well as their domestic) activities. In a number of areas, including bank debt restructurings, supervisors have at times found it necessary to strike a balance between short-run considerations and the longer-run objective of rebuilding the quality of banks’ assets and maintaining stable conditions in the financial markets.

Disclosure

In the European Community and in other groupings, bank supervisors are working to reduce divergences between countries in disclosure requirements in banks’ financial statements. The present diversity affects banks’ competitive positions, as well as the possibility of assessing risks associated with banking activity. The European Community is currently preparing a directive for a model of annual financial statements of banks, which is a first step toward harmonization of disclosure requirements. Despite the movement toward harmonization among supervisory authorities, notably in Europe, substantial differences remain in the approach to disclosure taken in various countries. International exposure of major U.S. banks is now publicly and regularly available on a country-by-country basis, but this is not so in many countries. More often, the analysis and valuation of assets is based on the responsibility of management, internal auditors, and external auditors in the preparation of bank balance sheets, which are then examined by bank supervisory authorities.

Implications for Banks’ International Activities

The revival of economic growth in the industrial countries in 1983 provided one crucial element for rebuilding financial confidence. Banks in some financial market countries experienced stabilization or improvement in the quality of their domestic assets, after a period of worsening loan-loss experience. In a number of countries, banks recorded substantially increased operating income, and many banks took advantage of their improved position to begin to increase their capital resources (Table 4). At the same time, many banks added to loan-loss provisions against their international exposure, but the impaired quality of some of these loans has been reflected in the valuation of assets to quite widely differing degrees. While most international banks were relatively liquid in 1983, there was also a general move to strengthen further their funding and general treasury management. Many nondollar-based banks took steps to secure their dollar funding, in particular by issuing floating rate notes, or issuing fixed rate bonds and “SWAPPING” interest obligations with an issuer of floating rate notes. There was also an increasing disposition among some non-U.S. banks to move toward building up their external business in domestic currency, where their profit margins may be better protected and their refunding position on the market, and in terms of lender-of-last-resort facilities, more clear cut. The actions that banks have taken often represent only a partial and continuing response to the risks they perceive. Thus, in certain cases, significant weaknesses remain in the international banking system; their elimination will no doubt take several years and will require an environment of relative economic and financial stability.

General Lending Strategy

Two general implications arise from the responses of bank managements and bank supervisors to changes in the international economy. First, over time, the development of bank lending—domestic and international—will be linked increasingly to the growth of the banks’ capital base. Indeed, to the extent this occurs, Euromarket business, taken together with other lending, will tend to become subject to an overall capital multiplier. Second, partly as a result of this and of the experience of some “overlending” in recent years, banks that had pursued primarily an objective of balance sheet growth have begun to temper this with a greater emphasis on the risk-adjusted return on their assets. This evolution—if coupled with improved, forward-looking risk assessment and better risk-related pricing—should contribute to a more balanced growth in banks’ international lending. To some extent, it has already resulted in greater emphasis being placed on activities with a low capital weighting for risk-asset ratios or that are “off balance sheet” and generate fee income. However, such a shift does not necessarily imply that banks will find it viable to concentrate, over the medium term, only or mainly on lending to the highest quality borrowers. The competition for such assets from nonbank investors and intermediaries is likely to remain considerable, and the risk-adjusted return on them—taken in isolation—would not suffice to cover existing banking overheads.

Banks acknowledge, of course, that it is easier to formulate a “return on assets” objective, and a policy for balanced and selective growth in their international business, than to achieve these results in practice. In the area of exposure monitoring, it is clear that significant improvements have been effected. Loans and guarantees to borrowers extended by different departments of a bank, or by various of its branches and subsidiaries, are now generally integrated within overall country risk limits. In turn, these are formally reviewed on a regular basis; and, with room under existing limits often substantially reduced, increases in lending to particular countries have tended increasingly to become a matter for decision by senior management. A remaining area where practices vary is the treatment of transactions with offshore centers. In view of recent experience, transactions with offshore center branches that combine both local and offshore business are increasingly placed under a country risk limit for the center concerned. Some, but by no means all, banks would still make an exception for deposits with banking units in offshore centers that operate under licenses allowing them to conduct offshore business only, on the grounds that they do not consider such deposits to be subject to foreign exchange transfer risk as a result of developments in the offshore center’s domestic economy.

The general enhancement of exposure monitoring, including the more comprehensive application of country risk limits, does eliminate some factors that contributed to an unduly rapid increase in lending to a number of countries up to mid-1982. However, it must also be recognized that banks continue to find it difficult to assess sovereign risk on a forward-looking basis and to reflect this in graded pricing. In many cases, sophisticated economic projections are made, but credit judgments may well depend on more immediate factors. Countries’ ability and willingness to demonstrate strong economic management, and to take forceful adjustment measures in the face of adverse economic developments, have become crucial elements influencing banks’ willingness to extend new credit. This is a positive factor, but it must be recognized that banks do not find these elements easy to project into the future. Another—less helpful—factor may well continue to be implicit comparisons with the activities of other peer-group banks. In some cases, the forward-looking implications of deteriorating or improving trends in a country’s performance may escape notice for some time, and this can result in abrupt changes of perceptions of creditworthiness (in both directions). Thus, it is by no means clear that unduly rapid increases in lending to individual countries are a thing of the past. The exceptionally rapid growth in early 1984 in floating rate note business on very fine terms is acknowledged by a number of banks to suggest that problems of “feast and famine” in international banking activity have not been overcome entirely. This difficulty in risk-related pricing may account in part for the extremes of the present “split” market—in which much lending is polarized between very finely priced transactions, on the one hand, and concerted financing, on the other, with many developing countries enjoying little or no access to new bank lending.

The difficulties that banks experience in judging the terms, scale, and timing of international lending may not be diminished by a growing preponderance of trade and project financing, or use of negotiable instruments. In the event of a sharp change in market perceptions, such flows are not necessarily less vulnerable to “overshooting,” or less subject to foreign exchange transfer risks, than syndicated lending for general balance of payments purposes. Nonetheless, the shift in banks’ preferences in favor of trade and project finance, especially in support of domestic clients, and also toward co-financing with the World Bank, may possibly over the next few years be part of a trend toward a growing reintegration of international financing with underlying “real” transactions and—correspondingly—of countries’ external borrowing with the growth of sectors of the domestic economy. In many cases, banks feel better able to judge the ultimate risk attaching to these transactions. At the same time, the emphasis on growth in banks’ domestic currency lending in support of home country exports, while in many respects healthy, could result over time in a somewhat less “multilateral” trade and financial system.

While problems remain in the area of risk assessment, the more pessimistic forecasts of banking developments have so far proved to be incorrect. In this connection, two developments are striking. The first is the fact that payments difficulties did not spread by contagion in Asia, notwithstanding the difficulties of the Philippines. Bankers took account of the export effort and adjustment measures of individual countries in this region. The second is the success of banks in mustering extensive support for concerted financing packages where countries entered into Fund-supported adjustment programs. By virtue of these two elements, lending to non-oil developing countries grew by more than 6 percent in 1983, very much in line with official forecasts. Over time, countries that can demonstrate flexibility and export orientation in their economies, and that are able to restrain their net financing requirements through comprehensive adjustment measures, should be able to retain or restore their access to credit markets. Nevertheless, while banks are likely to continue to expand their general international business over the medium term, lending to developing countries in the period ahead is likely to be somewhat restrained and relatively selective. One important factor in this, which is likely to remain operative for several years, lies in the discomfort felt by some leading banks over the extent of the concentration of their existing capital and income exposure to some of the major borrowers among the developing countries. While some asset swaps or sales have taken place to even out positions, it appears that the scope of these has been modest. There are reasons, therefore, in terms of banking developments, as well as in countries’ external debt management, that point toward a relatively slow growth in the bank debt of some of the major borrowing countries during the next few years.

Interbank Market

Attention has focused on the impact of recent changes in the international interbank market and on the potential medium-term implications of these for lending to the developing countries. Some general developments in cross-border interbank lending already were touched on above, while the broad characteristics of interbank activity have not evolved greatly since the comprehensive study of the international interbank market was published by the Bank for International Settlements in July 1983.22 Nonetheless, some points appear worthy of comment.

First, the factors which have led to a deceleration in interbank lending, both within financial centers and across borders, are in part structural. One such factor is the pressure on banks to strengthen their overall capital-asset ratios, a reason cited by some major U.S. and European banks for a relative decrease in their gross assets deployed in the interbank market. The impact of such pressures on banks may vary considerably depending on the capital weighting (for gearing or risk-asset ratios) that national regulatory systems attribute to interbank loans. A weighting below 100 percent of the equivalent weighting for commercial loans lessens the impact of interbank business on capital-to-assets ratios and effectively increases the return on capital that interbank earnings provide.

A second influence on the potential growth of inter-bank lending lies in the changes in country-risk classification that banks have made during the last two years. These changes followed the onset of payments difficulties in certain major borrowing countries, when in some instances it became apparent that such loans had not been used for the borrowing banks’ liquidity management but had been transformed into balance of payments funding. Exposure to branches of foreign banks in major financial centers is now monitored under the lending limits both for their parent banks and for their countries of origin. Indeed, much greater attention is given to inquiries about the standing and commitments of all counterparty banks. For the most part, this transition is over, although (as noted above) there is not yet an entire consensus on the treatment of some transactions with offshore centers. Thus, as a result of the experience of the last two years, there has been a return to a somewhat narrower role for the interbank market. The core of the interbank market as traditionally conceived (undocumented lending without a premium) is now restricted as a major source of net financing to a relatively select list of banks taking deposits in a number of highly regarded centers; such banks are typically sizable takers and placers of funds in the market. Lending to banks outside this circle is much more limited in terms of volume and maturity—as part of banks’ overall risk exposure to particular countries—and especially as regards lending to banks that use the market primarily for funding purposes. In particular, short-term “interbank business” in the traditional sense is not viewed as an appropriate vehicle for medium-term balance of payments finance. The earlier weak management of some interbank lending by creditor banks, and inappropriate use by some debtor banks, are now seen to have played a part in the emergence of payments difficulties through the substantial maturity mismatching that arose. In this respect, despite major problems associated with the transition, the retrenchment in the interbank market over the last two years has had the positive aspects that interbank exposure has been brought within the framework of country-risk assessment, and inappropriate maturity mismatching diminished.

A further issue arising in connection with the interbank market is the impact of the recent deceleration in its growth on international lending to end-users of funds—and, within this general picture, the significance of the decline in new deposits of oil exporting countries and the recent switch in U.S. banks’ new lending and depositing toward net funding from the market (Table 20).23 The question has been raised whether smaller nondollar-based banks would tend to reduce their external lending, particularly to developing countries, as a result of the deceleration in the growth of the interbank market. A first point in this regard is that the present level of lending to individual countries is overwhelmingly a reflection of their perceived credit-worthiness. Indeed, the terms of other lending by banks—directly or through floating rate notes—underscore that funding and liquidity were not constraints on lending in 1983. Moreover, the deceleration in the growth of interbank lending is much less marked when scaled by the growth in final lending. To some degree, interbank activity may mirror, rather than determine, the level of final lending. Nonetheless, some nondollar banks without a secure source of liquidity in the U.S. market undoubtedly are concerned about future funding hazards. For some, external lending in domestic currency may not be a significant alternative. In this respect, the slower growth in the interbank market could have some implication, over time, for the breadth of participation in syndicated lending in U.S. dollars. However, this does not necessarily imply that borrowers perceived as creditworthy will find any overall supply constraint on raising funds from the international banking system or the securities markets.

Finally, while these developments have resulted in a market somewhat less vulnerable to risk, the fact remains that the interbank market, reflecting its informal nature, is built on confidence: thus, it will remain a sensitive barometer of banking conditions, and it has the potential to transmit disturbances from one financial institution or center to areas not originally affected. In that respect, it was particularly encouraging that the difficulties in the Philippines in 1983 did not produce more widespread problems in the international interbank market. More recently, the U.S. authorities acted swiftly and comprehensively following the withdrawal of wholesale deposits from a major bank in May 1984, illustrating the seriousness with which disturbances in this market are viewed by the authorities.

Developments in Bank Debt Restructurings

Overview

The restructuring of cross-border bank debt has emerged as a central issue in international capital market developments, and the related financing packages accounted for about half of new lending to non-oil developing countries in 1983. Recent Multilateral Debt Restructurings with Official and Bank Creditors, IMF Occasional Paper No. 25 (Washington, December 1983), provided an overview of developments in restructurings until early October 1983. Since then, 4 additional countries, including 1 nonmember of the Fund, formally have reached restructuring agreements with banks, and 8 countries have completed or are in the process of completing a second round of restructuring or new money packages. In addition, some other countries have declared their intention to seek debt relief agreements from banks. Altogether, from January 1983 to June 1984, 24 restructuring agreements were signed, involving 19 countries (including 2 non-members of the Fund), while 14 agreements remained under negotiation. Over the same period, as regards Fund member countries, amounts restructured (excluding short-term debt) and new financing related to bank debt restructuring reached some $95 billion, or the equivalent of 22 percent of the external bank debt of developing countries. In 1983, bank debt restructurings reduced the debt service of non-oil developing countries by $24 billion, or the equivalent of 5 percent of their exports of goods and services. Further relief was provided by agreements on maintenance or rollover of short-term debt. Reschedulings agreed to in the first six months of 1984 are projected to result in a reduction of debt service payments by at least $10 billion.

Selected Issues in Recent Restructurings

Agreements have differed widely across countries, but a number of common themes have emerged in recent years. First, in those countries that have undergone restructuring and are seeking to resolve their payments difficulties, a new pattern of debtor-creditor relationships has continued to evolve. Banks’ steering committees, set up at the time of initial restructuring, have maintained continuing liaison between the borrowing country and the creditor banks. This concerted approach, as well as helping to prevent an even sharper reduction in net new lending by commercial banks, has allowed the banks to monitor more closely policies pursued by the debtor country. As a result, banks’ managements are gaining greater experience in assessing countries’ economic and financial policies. The objective of these arrangements is to assist countries to return, over time, to more spontaneous borrowing relationships. Meanwhile, the experience of the advisory committees may be contributing to a better assessment of countries’ policies and prospects and thus to a more appropriate flow of lending in the future.

The existence of the present framework has also greatly facilitated subsequent rounds of restructuring. A significant and encouraging sign that has emerged from these subsequent rounds of negotiations is that, with countries where successful adjustment efforts are being carried out, banks have been willing to agree to terms more favorable to the debtor countries, namely, lower margins and fees and longer repayment and grace periods. Nearly all agreements signed since October 1983 with countries that had previously undergone debt restructuring show a narrowing of spreads and a lengthening of grace periods compared with the original agreement. Whereas Occasional Paper No. 25 noted on page 26 that spreads for agreements signed over the 1978–83 period typically ranged from 1¾ to 2¼ percent over LIBOR, the most recent agreements show spreads from 1¾ to 2.0 percent. Maturities for restructurings and concerted new lending to member countries have recently ranged up to ten years with a five-year grace period, compared with typical maturities of up to eight years with a three-year grace period previously.

In contrast, where no improvement in economic performance was apparent, or where the country was unable to fulfill the terms of an existing restructuring agreement, banks have been increasingly unwilling to enter into new agreements and have preferred de facto or informal deferment agreements that are periodically renewed. As a consequence, there has been some tendency among countries that have undergone restructuring to become polarized into two groups. First, those where firm adjustment policies are implemented and where signs of a gradual return to more normal payments relations seem to be emerging. Second, those where, despite restructurings and because of lack of adjustment, no solution to the debt problem is yet in sight. In the latter countries, new lending from commercial banks has largely dried up, and banks are reducing their exposure to the extent possible; hence, a return to creditworthiness is not envisaged for a long time.

Lately, banks have been encountering difficult choices regarding some smaller debtor developing countries. These are countries that have repeatedly undergone a debt restructuring over the last few years, each time failing to meet their new restructuring obligations and requiring further rounds of restructuring. Some banks view the prospect of repayment of these loans as fairly remote but consider there is little alternative, under present circumstances, to a repeated deferment of payments. Thus, the recent experience with restructurings has underlined the crucial significance of establishing viable repayment schedules and of countries’ actions in undertaking comprehensive and timely adjustment measures. Experience has shown that, with delays in implementing stabilization programs, conditions could rapidly deteriorate, greatly increasing banks’ reluctance to concede more favorable terms and provide new lending. On the other hand, in those countries that have implemented timely adjustment policies, combined with well-conceived debt relief packages, banks’ confidence has strengthened and there are signs that some elements of spontaneous lending may resume. Thus, recent developments have confirmed the continuing need for strong links between bank debt restructuring and economic adjustment programs in resolving external payments difficulties.

Finally, the question has been raised whether the diversity of regulatory practices has adversely affected the cohesion of groups of banks participating in “new money” packages and debt restructurings. Generalizations in this area are difficult, but four observations appear particularly relevant. First, it is evident that a wide variety of considerations has been reflected in banks’ attitudes to participation in these packages, and such business factors as relative exposure and traditional trade links have perhaps been more important than regulatory differences per se. Second, different accounting and valuation conventions are at times important, but mainly where they reflect differing philosophies on the general conduct of banking business. In some countries, banks place more emphasis on full and regular disclosure and, in particular, on maximizing distributable earnings; in these circumstances, for example, the accrual of income on sizable loan exposures may for market reasons be a prime consideration. At the other end of the spectrum are cases where stress is laid on very cautious asset valuation and on qualified disclosure, in part with a view to smoothing the earnings of a bank during periods of turbulence. Third, with the possible exception of tax authorities, official bodies generally dispose of considerable flexibility in dealing with banks’ affairs, although they face difficult issues in resolving the conflicting pressures to protect depositors in the short term and to support a restoration of the longer-term quality of bank assets. Where necessary, this flexibility has been used effectively by bank supervisors to avoid actions that could jeopardize the orderly resolution of countries’ payments difficulties—for example, in ensuring that lending limits did not operate in a way that prevented new loans in support of countries’ adjustment programs. More broadly, bank supervisors have taken the approach that concentrations of international exposure in relation to capital should be diluted only progressively and over a period of years. Where supervisors are involved in giving specific guidance to banks on asset classification, the timely recognition of favorable developments in borrowing countries (and—where applicable—of the regular service of trade-related debt) may well be an area where forward-looking actions might play a role in supporting the adjustment efforts of borrowers, thus helping to enhance the quality of bank assets. Fourth, and most important, the possible impact of regulatory differences on the cohesion of banking groups must be assessed against the remarkable success that has been achieved in mustering financing from widely different financial institutions during the last two years, in support of countries pursuing Fund-supported economic adjustment programs.

Factors Influencing a Return to More Normal Market Access

In assessing sovereign risks, banks and bank regulators have attached much importance to a debtor country’s progress under a Fund-supported program. Hence, the speed with which a country regains normal market access is likely to depend, to a large extent, on the timely and successful implementation of measures set out in such programs. Also, strictly at the country’s request, Fund management and staff could assist in apprising creditor banks of the progress in adjustment efforts, to help assure that banks’ lending decisions are based on comprehensive and accurate information regarding the member’s payments position and prospects. In those countries where significant improvement has been achieved under Fund-supported programs, the Fund’s role in helping to secure additional external financing may lessen upon the return of countries to more spontaneous forms of lending. However, the adoption of this latter course of action would very much depend on a country’s circumstances, and on a case-by-case assessment whether satisfactory financing can be assumed at the outset of the program period. The prospects for countries to regain access to private financing on a more spontaneous basis will also depend crucially on developments in the external environment, changes that have the potential to affect individual countries in widely differing ways; moreover, countries’ financing needs cannot be forecast in isolation from these external factors.

While certain countries are at a relatively early stage in seeking to resolve their external payments problems, others already have made considerable progress and have well-established adjustment programs. Thus, attention is increasingly directed to the issues that will need to be resolved to restore the full debt service capacity of borrowing countries. Of particular significance is the problem of a “hump” in the amortization payments of some major borrowers over the next few years, which coincides with the ending of grace periods and rollover arrangements that resulted from restructurings in 1982 and 1983. Aspects of this debt service profile were discussed in the 1984 World Economic Outlook and are summarized in Table 5. Even in those countries that have made significant progress in implementing adjustment policies, the prospect of this “hump” in debt service, and thus in gross financing requirements, could weaken confidence and seriously delay a return to more normal market access. To restore the conditions under which countries can regain access to credit on a spontaneous basis, restructuring arrangements for countries with well-established adjustment programs will need to become more forward-looking and cover more than one year of maturities falling due. In general, banks so far have been reluctant to commit themselves for periods of more than 12 months, for fear of losing influence over the policies pursued by the debtor countries. A new initiative, however, was taken in Mexico, in light of its well-established adjustment performance under a Fund-supported program. In early June 1984, the banks’ advisory committee, in a meeting convened by the Managing Director of the Fund, agreed to begin negotiations for a multiyear restructuring of the Mexican public sector debt. This multiyear approach is seen as facilitating Mexico’s early return to normal market access. For creditors to embark on a multiyear restructuring in other instances, the borrowing country’s commitment to firm adjustment policies is likely to be crucial. In view of the inevitable uncertainty of projections, it seems likely that multiyear arrangements will not be extended to new money packages. A separate point to be borne in mind in establishing a viable medium-term framework is that recent restructurings have shown the importance of the treatment of short-term indebtedness. Restructurings made in conjunction with Fund programs have often covered short-term bank debt by agreements to maintain banks’ exposure, and these generally expire within a few years.

As restructuring and new financing packages move to a more forward-looking basis, new money in the form of trade financing and other lending to the private sector could become more important, provided that maintenance of overall exposure is securely covered by agreements and that requirements for the medium-term financing of the public sector are assured. Over time, trade-related financing is likely to grow in step with countries’ imports, even if other exposure shows little or no real growth in the remainder of the 1980s. Thus, to the extent that short-term financing does begin to grow more naturally, the agreements to maintain exposure would become less onerous. It may also be worth exploring the possibility of providing, in financial packages, more diverse currency options and market-oriented financing possibilities, tailored to the requirements of different lending banks.

While there has been little experience so far with return to spontaneous market access, a number of indications have appeared that may point to the way in which such return to normal market access could occur. Among the first signs of improved creditworthiness is probably the greater willingness of banks to adopt a more forward-looking approach to debt restructurings and to agree to terms more favorable to the borrowing country. This might then be followed by a differentiated resumption of market access according to lending categories and instruments. An early element is likely to be a spontaneous increase in trade- or project-related lending, with relatively less general balance of payments or budgetary financing needed. Indeed, a resumption of lending for general purposes on the scale seen in earlier years would be inappropriate from the point of view of countries’ external debt management, as well as that of prudent banking practice. A next stage might be the arrangement of a limited syndication with a small group of banks, followed at a later stage by wider distributions of loan claims or securities. The return of non-oil developing countries to the international and foreign bond markets is likely to occur at a much slower rate than to the loan market, although, if the incipient trend toward the “securitization” of bank lending continues, the distinction between placements of loans with small groups of banks, syndicated credits, and floating rate notes may become increasingly blurred. Bonds of countries experiencing debt servicing difficulties have generally been serviced promptly, and this should be a factor in favor of the return of some countries to these markets. Indeed, a progressive improvement has been noted in the risk premium on some securities of borrowers that have been engaged in bank debt restructurings and concerted lending. Thus, in the future, some of these countries seem likely to re-enter the bond market, initially through private placements rather than public issues.

Table 5.Debt and Debt Service Ratios for Groups of Developing Countries, 1984, 1987, and 1990
Debt Ratio1Debt Service Ratio 2Interest Payment Ratio3Amortization Ratio 4
Country Group198419871990198419871990198419871990198419871990
Non-oil developing countries
Net oil exporters189178168314030201715112316
Major exporters of manufactures1179784192018129771111
Low-income300298308232422111010121412
Other net oil importers17016116023282614121191615
Major borrowers187165150293430191512101918
Source: International Monetary Fund, World Economic Outlook, Occasional Paper No. 27 (Washington, April 1984).

Ratio of debt to exports.

Ratio of interest and amortization payments to exports.

Ratio of interest payments to exports.

Ratio of amortization payments to exports.

Source: International Monetary Fund, World Economic Outlook, Occasional Paper No. 27 (Washington, April 1984).

Ratio of debt to exports.

Ratio of interest and amortization payments to exports.

Ratio of interest payments to exports.

Ratio of amortization payments to exports.

16Banks with capital denominated in currencies other than the U.S. dollar. A few European banks have affiliates with U.S. dollar capital, through which much of their dollar-denominated lending is channeled.
17However, earnings retained as general reserves can be used as a base for an expansion of lending, whereas specific provisions against loans usually are not available for use in that way.
18“The Chairman of the Board of Governors of the Federal Reserve System … shall encourage governments, central banks, and regulatory authorities of other major banking countries to work toward maintaining and, where appropriate, strengthening the capital bases of banking institutions involved in international lending.”
19The International Lending Supervision Act of 1983 provides that if a bank’s assets have been impaired by protracted inability of public or private obligators to pay, or if no prospects exist for an orderly restoration of debt service, then federal regulators may decide that these assets must be either written off or have special provisions made against them. These special provisions would be made through the establishment of “Allocated Transfer Risk Reserves.”
20The texts of the revised Concordat on the Supervision of Banks’ Foreign Establishments and of the European Community Directive on the Supervision of Credit Institutions on a Consolidated Basis were published in International Capital Markets, Developments and Prospects, 1983, IMF Occasional Paper No. 23 (Washington, July 1983).
21However, the classification of individual countries generally has not been officially disclosed.
22The International Interbank Market: A Descriptive Study, Bank for International Settlements Economic Paper No. 8 (Basle, July 1983).
23In terms of the stock of international bank claims, the U.S. banks maintain very large, but declining, net creditor positions.

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