II Recent Developments in the Markets11
- International Monetary Fund
- Published Date:
- August 1981
In the second half of the 1970s banks expanded their international claims at an annual rate of about 25 per cent. Lending through bond markets was much less buoyant, but taken together, the nominal dollar volume of net market lending in 1979 was more than two and one half times that of 1975 (Chart 1). The rise in oil prices in 1979 suggested a need for continued rapid expansion in capital market activity if the world economy was to avoid too rapid and severe an adjustment. By the beginning of 1980, however, considerable pessimism had developed about the capacity of the markets, in particular the banks, to sustain a large role in channeling financial resources from the surplus to the deficit countries, particularly to the developing countries among them. For a number of reasons (see Section III), the riskiness of international lending appeared to have risen at a time when banks, encouraged by official supervision, were tightening their prudential standards; many observers believed that a slowdown in international bank lending was inevitable.
Chart 1.Net Lending Through International Capital Markets, 1973–80
1 Measured in U.S. dollars; adjusted for valuation effects of exchange rate changes.
2 Net of repayments; does not exclude double counting due to banks’ issuing and holding of bonds.
Nevertheless, there were a number of reasons for thinking that the lending capacity of the markets would not in fact be seriously strained by potential borrower demand in 1980. The prospective increase in current account deficits was mainly concentrated in the large industrial countries; for the non-oil developing countries, in particular, the projected deficit in 1980 relative to the scale of recent international banking flows was considerably smaller than in the period just after the 1973/74 increase in oil prices. A substantial part of the developing countries’ net market borrowing in recent years had facilitated an increase in reserves; their incremental net borrowing requirement would not be large, if they slowed reserve accumulation. Moreover, much of the net market financing they required as a group for 1980 could come from drawing down existing commitments or extending their use of short-term trade finance, which generally was much less constrained by banks’ prudential considerations.
At a more fundamental level, an encouraging fact was that lending spreads were still at historically low levels for most countries. This suggested that prudential considerations had not yet seriously raised the cost of bank intermediation and that, even if they should do so, there was considerable scope for covering the increase through higher spreads. While the system-wide elasticity of loan supply in relation to lending spreads was unknown, there seemed little reason to think that it was so small that the potential for substantial additional funds was greatly limited.
In the event, financing flows through the international capital markets were well maintained in 1980. Total net new bank and bond financing amounted to some $ 183 billion, 21 per cent higher than in 1979 (Table 1). While there were some shifts in the sources, direction, and terms of banking flows, the overall outcome was surprisingly strong, given the pessimistic views expressed by many commentators at the outset of the year.
|International bank lending (net)||40||70||68||90||130||165|
|International bond issues (net)||20||30||31||30||30||28|
|New international bond issues||23||34||36||37||38||38|
|Less redemptions and repurchases||-3||-4||-5||-7||-8||-10|
|Less double counting due to bank purchases of bonds||-2||-4||-5||-8||-9||-10|
International Banking Flows
International bank claims12 are estimated to have expanded by 25 per cent in 1980, about the same rate as in 1979. The amount of the increase in 1980 was $165 billion, which compares with the $130 billion recorded in 1979. An important factor in the response of the banking system to the new demands was the sharp acceleration of international lending by U.S. banks in 198D, after three years of slow growth of their international claims (less than half the rate of increase recorded for other banks in the system). This acceleration was partly in response to the slow growth of the U.S. economy and the consequent slowdown in growth of banks’ domestic assets, but it also reflected a change in their lending strategy. In 1979 one of the factors contributing to a low rate of participation of U.S. banks in syndicated credits had been the unwillingness of many of them to accept low spreads. In 1980, however, larger U.S. banks were highly visible in syndicated loans at spreads well below the ¾ per cent that some of them had previously maintained as a lower limit. Canadian banks also experienced a slowdown in the growth of their domestic assets and increased their international lending operations considerably.
In contrast, after two years of very rapid growth of their longer-term claims, Japanese banks, in consultation with their authorities, sharply slowed their international lending, pending the adoption of new prudential standards by the banks. The slowdown may also have reflected the extent to which Japanese banks were financing Japan’s current account deficit through, among other channels, the use of their foreign currency funding capacity to finance Japanese imports. To a much lesser extent, the banks of many European countries also slowed their international lending, mainly on general prudential grounds. The banks of the Federal Republic of Germany and Switzerland, for example, were affected to some degree by prospective requirements that they consolidate their foreign subsidiaries with their headquarters for purposes of capital requirements.
The direction of sources and uses of capital market flows (Chart 2) broadly reflected current account developments. On the sources side, oil exporting developing countries, as in 1979, accounted for about 30 per cent of the increase in international bank deposits. The growth of their deposits slowed sharply in the second half of the year, however, and for the year as a whole they are estimated to have placed only some 35 per cent of their total cash surplus with banks, less than the 58 per cent in 1979. An increasing proportion of their surplus funds thus has been directly recycled—that is, placed directly with borrowers or in the domestic financial markets of industrial countries, rather than with banks. Both the non-oil developing countries and the centrally planned economies sharply slowed or reversed their accumulation of bank deposits as part of the process of financing their current account deficits.
Chart 2.Sources and Uses of International Bank Funds, 1973–801
1 Banks in the Group of Ten countries and Austria, Denmark, Ireland, and Switzerland; excludes interbank transactions within the reporting area.
2 Excluding Fund member countries.
3 International organizations and unallocated.
With respect to the direction of financing flows, bank net lending to the non-oil developing countries exceeded $50 billion (Table 2 and Chart 3), accounting, as in 1978 and 1979, for almost a third of total lending. Such countries once again were able to obtain net bank financing equivalent to more than half of their combined current account deficits and accumulation of reserves. There was a marked slowdown in their aggregate reserve accumulation, which to some extent may have reflected a tightening in the availability of financing from the markets, but on balance, for those non-oil developing countries which do have access to market finance, the banking system continued to respond flexibly to their increased demands. There is thus little evidence of a crowding out of such borrowers.
|Bank lending (net)1||68||90||130||165|
|Oil exporting countries||9||14||7||6|
|Non-oil developing countries||14||25||41||52|
|Centrally planned economies2||4||7||8||2|
|New medium-term loan commitments||34||74||69||69|
|Oil exporting countries||5||10||7||5|
|Non-oil developing countries||13||27||35||28|
|Centrally planned economies2||3||3||4||2|
|Terms on medium-term loan commitments|
|Average six-month Eurodollar deposit rate (per cent)||6.4||9.4||12.0||14.2|
|Average maturity (years)||6.4||8.2||8.9||7.9|
|Average spread (per cent)||1.2||0.9||0.7||0.7|
|Bond market lending (net)||31||30||30||28|
Increase in bank claims adjusted for valuation effects of exchange rate changes.
Excludes Fund member countries.
Increase in bank claims adjusted for valuation effects of exchange rate changes.
Excludes Fund member countries.
Chart 3.Non-Oil Developing Countries: Financing Through International Capital Markets, 1973–80
1 Net of repayments; does not exclude double counting due to banks’ holding of bonds.
As the major oil exporting countries had large current account surpluses, they needed little market financing and bank claims on them as a group increased only slightly. The growth of claims on centrally planned economies also slowed sharply as a result of growing uneasiness about the risk of lending to a few countries in this group.
Although industrial country borrowers apparently obtained a significant amount of funds directly from the surplus oil exporting countries, they increased their net international borrowing from banks by almost half to $100 billion. That was about 60 per cent of total net international bank lending, the highest proportion in recent years. In contrast to the situation for the non-oil developing countries and some of the smaller industrial countries, a relatively small proportion of market borrowing by the major industrial countries represented direct public sector use of the markets for balance of payments finance. Nevertheless, for some major industrial countries, the growth of bank trade credit associated with the marked increase in the value of their international trade was a major source of capital inflow to finance their current deficits. International bank lending associated with the continuing process of integration of financial markets also may have been enhanced in 1980 by higher interest rates, which increased the cost of maintaining the interest-free reserves required in several market countries, encouraging banks and their customers to shift the booking of loans and deposits offshore. It was in part because of the potential for such shifts that the U.S. authorities in November 1980 began to apply the basic reserve requirements also to net Eurocurrency liabilities of U.S. banks, which are defined to include most credits extended to U.S. residents by U.S. bank branches abroad.
In contrast to the increase in bank claims, commitments of bank funds in the form of publicized medium-term syndicated credits in 1980 remained at about the 1979 level of $69 billion (Chart 4), somewhat below the $74 billion recorded in 1978. (This comparison overstates the stagnation in the volume of new commitments. Many of the new credit commitments in 1978 and 1979 involved refinancing of existing credits on better terms, a process which was largely absent in 1980.) In the early part of 1980 there was to some extent a standoff between the banks, which were persuaded that a significant hardening of lending terms was inevitable, and some of the important developing country borrowers, which were signaling their resistance by limiting their recourse to syndicated credits. During this period many borrowers were able to arrange shorter-term credits and nonpublicized medium-term credits either on a bank-to-bank basis or in small club deals. Later in the year, with some rise in spreads, there was a substantial increase in lending to the non-oil developing countries. For 1980 as a whole, commitments to such countries declined, but large increases in syndicated credit commitments to borrowers in some of the industrial countries served to maintain the aggregate volume of new commitments at the level of 1979.
Chart 4.Medium-Term Publicized Credit Commitments and Total Net International Bank Lending, 1973–80
1 Excludes Fund member countries.
2 Net of redepositing among banks.
In the first months of 1980 there was some shortening of maturities on publicized medium-term credits, and toward the end of the year spreads hardened perceptibly for a few borrowers (Chart 5).13 In general, however, there was no marked hardening of terms on publicized syndicated credit commitments, although lending spreads on nonpublicized credits reportedly have risen in some cases. Given the high and rising levels of the base interest rates relative to which spreads are defined, any additional borrowing cost resulting from higher spreads was of secondary importance.
Chart 5.Terms on International Bank Lending, 1973–80
1 Medium-term publicized international bank credit commitments.
Preliminary information on publicized syndicated credits suggests that medium-term international bank lending was considerably more buoyant in the first half of 1981 than it was a year before. While loan commitments actually signed in the first quarter were not much above the volume of that period in 1980, a large number of new loans reportedly were finalized in the second quarter. For the first six months it appears that the volume of syndicated credits was greater by close to 20 per cent, in comparison with the same period a year ago, and that much of the increase was accounted for by new commitments to non-oil developing countries.
International Bond Market Activity
Issue activity in the various sectors of the international bond market in 1980 continued to be subject to sharp and frequent interruptions associated with fluctuations in interest rates and exchange rates. Total international issues slightly exceeded $38 billion (Chart 6)—little changed from the level of the last few years—and taking into account estimated redemptions, net flows declined slightly. The sharp fluctuations in short-term interest rates in many international money markets during the year—a strong rise in the first four months followed by a rapid decline and then renewed rise—were followed in direction by long-term interest rates, but with more limited oscillations. During the periods of rising short-term interest rates, the willingness of investors to commit funds in longer-term debt instruments declined markedly, and issuing activity accordingly slowed sharply, with a short-term reversal taking place during the brief periods when interest rates declined. These shifts in issuing activity were particularly marked in the fixed-rate dollar sector, where the timing of new bonds is completely left to the decision of the issuing houses and their clients. The flow of new issues was somewhat smoother in the deutsche mark and Swiss franc sectors, where issues are launched according to a calendar.
Chart 6.Developments in International Bond Markets, 1976–80
1 Three-month deposits.
2 Bonds with remaining maturity of 7 to 15 years.
The Eurobond market held up better than the foreign bond markets, in part reflecting the significant expansion of the French franc and sterling sectors, which benefited from the attractiveness of the two currencies to investors wishing to achieve greater currency diversification, but also in part because of the possibilities for issuing floating rate notes in U.S. dollars. The volume of Euro-French franc issues trebled to an equivalent of $1 billion in 1980, while sterling-denominated issues of Eurobonds quadrupled to $1.1 billion. Floating rate notes issued in the U.S. dollar sector, traditionally favored by bank borrowers, became more popular among other private sector entities as well as sovereign entities. Given investors’ interest in dollar-denominated instruments, which paralleled exchange rate developments, and the protection afforded to investors by the provision for floating interest rates, new issues contributed to an increase in aggregate dollar-denominated Eurobond issues. In the Euro-deutsche mark sector, new issue volume remained at a level close to that in 1979. Overall, the total volume of Eurobond issues rose to $22 billion, or a 25 per cent increase in relation to 1979.
With respect to foreign bonds, there was an increase in volume in the Federal Republic of Germany, where long-term interest rates remained well below those on dollar bonds. Foreign issues in Switzerland declined from the peak 1979 level, partly because of a slowdown agreed among the resident issuing houses in the first part of the year, when a rise in interest rates created unstable market conditions. New foreign issues in Japan declined substantially (from $3 billion in 1979 to $1.7 billion in 1980), reflecting the sharp increase in interest rates, weakness of the yen, and balance of payments developments. The leading security houses, after informal consultations early in the year, slowed the pace of public issues and halted new private placements.14 Some recovery in public issuing activity took place in the second half of the year. Subsequently, the limitations on private placements were eased at the outset of 1981.
The overall gross value of new foreign bond issues in 1980 amounted to $16 billion equivalent, compared with $20 billion in 1979. Developments in the segments of the international bond markets in 1980 and 1981 are covered in detail in Appendix II. The question of developing country access to the bond markets is taken up in Section IV below.
The increasingly volatile changes in interest rates and exchange rates have led to creation of funding and lending techniques which have increasingly blurred the distinction between money and capital market instruments. For example, the floating rate note issued in the bond markets has many of the characteristics of a medium-term rollover credit advanced through the banking sector. In the process, enthusiasm of investors and borrowers has shifted among various financial instruments and the currencies in which they were denominated. In these circumstances, there had been some expectation that, particularly after the SDR was simplified, market interest in SDR-denominated instruments would increase. The experience of 1980 and early 1981 seems to support that expectation. While the magnitudes still are relatively small, there has been an increase in the number of banks offering deposit facilities denominated in SDRs, the volume of such deposits, the frequency of bond issues denominated in SDRs, the volume of international banking credits denominated in SDRs, the issuance of SDR-denominated certificates of deposit by banks, and the use of the SDR as the numeraire in contractual arrangements. In short, the markets for SDR-denominated instruments have grown and, although they remain rather thin, the prospects for more widespread use appear favorable.15