II Assessment of the Attitude of Commercial Banks Toward Individual Countries
Author: Mr. Paul Mentré1
  • 1 0000000404811396https://isni.org/isni/0000000404811396International Monetary Fund
Language:
English
Keywords:
OP; lending; bank; debt; crisis; commercial bank; consortium bank; BIS bank; bank claim; bank supervisor; net position vis-à-vis bank; Foreign banks; Bank credit; Commercial banks; Multilateral development institutions; Eastern Europe
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Abstract

During the 20 years from 1960 to 1980, gross external claims of banks in the BIS reporting area4 (including cross-border interbank claims) grew at an average annual rate of about 25 percent. As of December 31, 1983, they amounted to $2,024 billion ($1,085 billion excluding redepositing among reporting banks). Banks located in the United States, the United Kingdom, and offshore centers play a leading role in the expansion of gross external assets, and the U.S. dollar remains the predominant currency, representing almost three fourths of total claims (Table 1).

Background

During the 20 years from 1960 to 1980, gross external claims of banks in the BIS reporting area4 (including cross-border interbank claims) grew at an average annual rate of about 25 percent. As of December 31, 1983, they amounted to $2,024 billion ($1,085 billion excluding redepositing among reporting banks). Banks located in the United States, the United Kingdom, and offshore centers play a leading role in the expansion of gross external assets, and the U.S. dollar remains the predominant currency, representing almost three fourths of total claims (Table 1).

Table 1.

Gross External Claims of Banks in the BIS Reporting Area,1 December 31, 1983

(In billions of U.S. dollars)

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Sources: Bank for International Settlements (BIS), Monetary and Economic Department, “International Banking Developments—Fourth Quarter 1983” (Basle, April 1984).

The Group of Ten countries, Luxembourg, Switzerland, Austria, Denmark, Ireland, and branches of U.S. banks in offshore centers (see footnote 2).

In the Bahamas, the Cayman Islands, Hong Kong, Panama, and Singapore.

Other banks in the offshore centers listed in footnote 2 plus bank claims in two other offshore centers: Bahrain and the Netherlands Antilles.

The breakdown of continental European banks’ claims is as follows:

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Estimates for nonreporting banks in offshore centers mentioned in footnote 2 and all banks located in Bahrain, Lebanon, and the Netherlands Antilles. For Hong Kong, banks’ liabilities exclude those vis-à-vis the nonbank sector.

Excluding position in foreign currencies vis-à-vis residents: $439 billion, of which $333 billion in U.S. dollars and $106 billion in other foreign currencies. U.S. dollar claims represent also 73 percent of total claims in foreign currencies ($1,070 billion out of $1,458 billion).

The other currencies playing a significant role in the foreign currency positions of reporting banks are the deutsche mark (12 percent), the Swiss franc (6 percent), the Japanese yen (2 percent), the pound sterling, the French franc, and the Netherlands guilder (about 1 percent each).

The international banking system plays a fundamental role in the functioning of the international monetary system, extending credits to deficit countries and taking deposits of countries whose surpluses mirror the deficits financed by bank credits5 (see Table 2).

Table 2.

External Positions of Banks in the BIS Reporting Area1 vis-à-vis Individual Groups of Countries, December 31, 1983

(In billions of U.S. dollars)

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Source: Bank for International Settlements (BIS), Monetary and Economic Department, “International Banking Developments—Fourth Quarter, 1983” (Basle, April 1984).

The Group of Ten countries, Luxembourg, Switzerland, Austria, Denmark, Ireland, and branches of U.S. banks in offshore centers (the Bahamas, the Cayman Islands, Hong Kong, Panama, and Singapore).

The Bahamas, Bermuda, the Cayman Islands, Hong Kong, Lebanon, Liberia, the Netherlands Antilles, Panama, Singapore, Vanuatu, and other British West Indies.

Includes, in addition, Bahrain, Brunei, Oman, and Trinidad and Tobago.

Including those countries in the Caribbean area which are not classified as offshore banking centers.

Including international institutions other than the BIS.

Basically, in terms of outstanding net positions, the system channels funds from member countries of the Organization for Economic Cooperation and Development (OECD) and from Middle Eastern and other countries of the Organization of Petroleum Exporting Countries (OPEC) to the other industrial, East European, and non-oil developing countries, notably Latin American countries.6 But the pattern of net financing has evolved over the years. In terms of flows, OPEC countries were net suppliers in 1979 and 1980 but have been net borrowers since 1981, and the United States turned round in the last three quarters of 1983 from being a substantial net supplier of new funds to the rest of the world to being a net borrower of such funds.

Table 3.

Euromarket Positions, December 31, 1982

(In billions of U.S. dollars)

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Source: Bank for International Settlements (BIS), Monetary and Economic Department, “International Banking Developments—Fourth Quarter 1982” (Basle, April 20, 1983), Table 8 (Estimated Sources and Uses of Eurocurrency Funds of Banks of Reporting European Countries (narrowly defined Euromarket)).

Excluding positions of banks located in the Federal Republic of Germany vis-à-vis the German Democratic Republic.

The Bahamas, Barbados, Bermuda, the Cayman Islands, Hone Kong, Lebanon, Liberia, Netherlands Antilles, Panama, Singapore, Vanuatu, and other British West Indies.

Includes, in addition, Bahrain, Brunei, Oman, and Trinidad and Tobago.

Including positions vis-à-vis international institutions other than the BIS.

As in Table 2 but with figures on December 31, 1982 and signs reversed.

Commercial bank loans have played a fundamental and growing role in the financing of current account deficits of non-oil developing countries, notably in middle-income countries (Table 4). International bank lending represents more than 50 percent of international capital flows and more than 50 percent of the total long-term external debt of developing countries. Claims with a maturity of more than one year now represent about 50 percent of total bank claims,7 thus contributing to the medium-term financing of current account deficits. The development of medium-term international bank credits through publicized syndicated loans and direct transactions has been one of the most striking features of these financing patterns. The Fund, in its overall assessment of the international financial and monetary situation and of individual member countries’ external positions, had therefore to pay increasing attention to international bank lending and to the changing characteristics of the Eurodollar market.

Table 4.

Oil Importing Developing Countries: Current Account Deficit and Finance Sources, 1970–80

(In billions of 1978 U.S. dollars)

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Source: International Bank for Reconstruction and Development, World Development Report, 1981 (Washington, August 1981), p. 49.

Excludes net official transfers (grants), which are included in capital flows.

A minus sign (–) indicates an increase in reserves.

The international bank credit market may be characterized by the existence of three circles.

(1) The inner circle, which consists of about 25 large banks based in OECD countries. These banks are able to use their deposit base for transborder domestic currency lending, notably dollar-denominated loans for the big U.S. banks and their subsidiaries or branches in London and in offshore centers and deutsche-mark-denominated loans for the major German banks and their subsidiaries in Luxembourg. In addition, they have a sufficiently strong capital base, a sufficiently diversified portfolio, and a sufficiently large international network to attract deposits from the main international depositors (central banks of countries other than those of the Group of Ten, OPEC countries, and multinational corporations shifting their assets from domestic assets to Eurodollar assets or to other Eurocurrency assets) and from the other banks for which they act as correspondents. They normally have the capacity to be simultaneously the main participants in credits to final borrowers and the main suppliers of funds, through interbank placements or deposits, to other banks in the market.

(2) The intermediate circle, which consists of about 3,000 banks all over the world and includes three main categories:

(i) regional banks from industrial countries which use either their domestic deposits, notably for regional U.S. banks,8 or interbank credits to fund their participation in syndicated credits or bilateral transactions with final borrowers;

(ii) consortium banks that associate banks of similar characteristics (a group of industrial country banks, a group of OPEC or Arab banks) or associate one or two industrial country banks and developing country banks; and

(iii) commercial banks from developing countries or centrally planned economies which, in addition to some direct deposits, use interbank borrowing, either directly or through their branches or subsidiaries abroad, to fund loans to their own countries or to participate in credits to third countries, notably in connection with their own countries’ exports.

The intermediate circle is thus heterogeneous, and the distinction between participants somewhat blurred. The large Arab consortium banks have a capital and deposit base, which is gradually bringing them into the “inner circle.” The central banks of member countries of the Council for Mutual Economic Assistance (CMEA), and their network of associated banks in Moscow (International Bank for Economic Cooperation), London, and Paris, act both as intermediaries and as final borrowers. Basically, this intermediate circle is a channel through which large deposits collected by the inner circle and not used directly by the leading banks are re-lent to final borrowers.

(3) The external circle, which consists of final borrowers. It includes private enterprises in industrial countries borrowing in foreign currencies from their domestic banks or from international banks or borrowing in their domestic currency from international banks (Eurodollar borrowings by large multinational U.S. corporations with a growing substitutability between domestic dollar borrowings and Eurodollar borrowings); public entities and sovereign states among the industrial countries; private enterprises in developing countries borrowing in foreign currencies from their domestic banks or from international banks in addition to direct borrowings from their commercial suppliers or, for subsidiaries, from their parent companies; and public entities and sovereign states among the developing countries and centrally planned economies.9 While the characteristics of these final borrowers are quite diversified, there is a tendency to group them according to the locus of the final sovereign risk, after reallocation of guaranteed loans, under a general country risk assessment.

The stability of the market thus depends on the quality of final risks (i.e., the quality of country risks), which is in turn related to the adequacy of economic policies; the attitude of the large banks, which are the key participants in the market; and the stability of the intermediate circle and of the interbank market. Even if final risks are sound and large banks are cautious on country risks, the instability of the intermediate circle could well affect the overall structure.

At the beginning of 1983, and after 20 years of rapid expansion, the market was characterized by10

—the leading role played by 25 banks11 representing 60 percent of total lead management; about 20 banks with international assets greater than $20 billion account for about 50 percent of total international bank lending, while about 70 banks with international assets greater than $10 billion account for about 85 percent of total international bank lending;

—the fundamental role played by interbank transactions, which give “breadth and depth to the market”12 approximately 2,000 banks participate in the market; the largest banks redeposit about 60 percent of their deposits; interbank transactions represent about 40 percent of total international bank lending (60 percent if transactions within BIS countries are included; see Table 5);

—the growing involvement of second-tier banks: small banks from industrial countries, notably for loans to neighboring countries (for Mexico, U.S. banks and for Eastern Europe, German banks); banks from developing countries (the share of nonindustrial country banks in the list of banks included in the first ten participants of all publicized Eurocredits has grown from 5 percent in 1973 to about 10 percent in 1980 (27 out of 332).13 In all, about 65 new participants entered the international syndicated loan market every year during 1973–80;14

—the shifting pattern of funding in the market, depending on the magnitude of OPEC surpluses and the effects of relative current account positions, of national monetary policies, or specific regulations affecting international lending in various industrial countries;

—the concentration of sovereign risks in a limited number of countries; transborder claims on BIS countries represent about 50 percent of total transborder claims of BIS banks (compared with 30 percent for non-BIS countries, 15 percent for offshore centers, and 5 percent unallocated); among claims on non-BIS countries, 20 debtors account for about 70 percent of total claims (Table 6).

Table 5.

International Lending and Outstanding External Claims of Banks in the BIS Reporting Area,1 1981–83

(In billions of U.S. dollars)

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Source: Bank for International Settlements (BIS), Monetary and Economic Department, “International Banking Developments—Fourth Quarter 1983” (Basle, April 1984).

The Group of Ten countries, Luxembourg, Switzerland, Austria, Denmark, Ireland, and branches of U.S. banks in offshore centers (the Bahamas, the Cayman Islands, Hong Kong, Panama, and Singapore).

Cross-border claims between branches of the same bank are included in these figures. The trend toward a 24-hour market operating on a world basis, in spite of time zones, fuels the expansion of such intra-network transfers of positions.

Calculated as the difference between total domestic assets in foreign currency and domestic assets in foreign currency vis-à-vis nonbanks.

A BIS estimate of net lending excluding double counting resulting from the redepositing of funds between the reporting banks themselves.

Table 6.

Twenty Principal Non-BIS Borrowers, December 1980, June 1982, and December 19831

(In billions of U.S. dollars)

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Source: Bank for International Settlements (BIS), Monetary and Economic Department, “International Banking Developments—Fourth Quarter, 1983” (Basle, April 1984).

Other non-BIS borrowers with bank debts greater than $4 billion were Hungary, Malaysia, Algeria, Colombia, Israel, Egypt, the Taiwan Province of China, Peru, and Ecuador (plus Romania at the end of December 1980 and June 1982).

The Group of Ten countries, Luxembourg, Switzerland, Austria, Denmark, Ireland, and branches of U.S. banks in offshore centers (the Bahamas, the Cayman Islands, Hong Kong, Panama, and Singapore).

These evolving patterns have shaped the attitudes of commercial banks. The banks have tried to improve their assessment of country risk, especially for the largest borrowers, which explains the growing sophistication of assessment procedures. They are now trying to improve their knowledge of the interbank market and their assessment of risks attached to the individual banks that are participants in the market. This reappraisal is reflected in recent developments.

Country Risk Assessment

With their growing involvement in international lending, commercial banks have felt the need to develop more sophisticated techniques for country risk analysis. This entails an analysis of sovereign or of transfer risks, which are the risks of default by all borrowers from the same country, when, owing to the external situation, the monetary authorities are not in a position to supply individual borrowers with the foreign exchange needed to meet their external debt obligations.

With few exceptions, banks engaged in international lending set limits for overall risks in a given country and reappraise their limits quarterly, or at least once a year, with interim revisions for specific countries. These country limits are based on an overall perception of the risks attached to a given country. The methods for country risk assessment vary across banks but basically belong to three main categories:15 (a) the unstructured approach in which a series of ad hoc decisions are taken on the basis of individual country reports without any codified format; (b) the fully quantitative approach in which countries are automatically classified in different categories according to the results of a model based on a set of economic indicators; and (c) the qualitative/structured approach in which decisions are based on standardized reports including a homogenous list of relevant indicators.

There is a tendency, as international bank lending develops, to move from (a) to (b) or (c), with a majority of major banks using (c). Hence, the set of indicators used by individual banks will have some built-in effect on their lending attitudes and policies.

In assessing country risk, the banks consider three categories of economic variables: the domestic economy (gross national product (GNP), inflation rate, exchange rate), the balance of payments (reserves, trade balance, current account balance, capital flows), and the external debt (absolute amount, debt ratio to gross national product, debt service ratio); and also the political situation (internal stability, attitude of various groups and parties on economic issues, external threats).

Some assessment systems are more comprehensive than others (with particular reference to resources, including energy), some are more forward looking, and some are based more on year-to-year comparisons than on absolute amounts, but they have many characteristics in common. In particular, they all stress debt service capacity as the key variable in assessing potential transfer risks. In some cases, models have been developed that try to derive a list of potential problem countries from a set of selected indicators. Clearly, the quality and the timeliness of the information injected into the system is crucial. For that reason, all commercial banks stress the need to improve the disclosure of information by borrowing countries, either in their own statistical publications or in the Fund’s International Financial Statistics. A specific concern is the shortcomings in external debt data. There are delays in the production of data on banks’ claims,16 inadequate coverage of short-term debt to nonbanks, inadequate coverage of military debt, and undue delays in the collection of statistics on long-term public debt and on export credits.

In addition to better information gathering, efforts under way in banks to improve their country risk assessment systems show three main trends: computerization, with a large use of data banks; inclusion of a judgment on potential political developments, through the hiring of political specialists; and a greater weight being given to vulnerability to random events—the capacity, through an adequate liquidity situation, to cope with unexpected adverse developments or contagion effects.

In spite of recent improvements in country risk assessment systems, the translation of country risk assessment into actual country limits remains ambiguous. Whether country risk assessment through a formalized set of data is an integral part of the country limit-setting process (as done in some U.S. banks) or whether its results are synthesized in a rating of the country or its classification in one of five or six groups (most other large banks), other elements have an important bearing on the end result.

External judgments are introduced into the system either in the rating or in the setting of limits: rating by external consultants or by specialized publications; experience of the bank’s industrial customers in the country, with a tendency, notably among Japanese banks, to pay growing attention to delays in or modifications of financing patterns of suppliers (and trading companies) as early indicators of coming difficulties; attitudes of official agencies, such as governments, export credit agencies, supervisors, and central banks (see below); and the judgment of the Fund or of the International Bank for Reconstruction and Development (World Bank) as determined by policy actions (stand-by arrangements in the Fund; structural adjustment loans in the World Bank) or through informal contacts.

Market conditions also play a major role, notably in ad hoc revisions of credit ceilings. Higher spreads improve the closely watched “rate of return on total assets” and send a signal of adjustment to borrowing countries, while lower spreads bear testimony to the quality of the signature as perceived by the market.17

Overall country limits are based largely on past experience adjusted according to market trends (share of the bank in overall BIS claims or, for a U.S. bank, in all U.S. banks or in its peer group), and the results of the country risk assessment are continuously balanced against commercial considerations, notably relations with exporters. In addition, the monitoring of credit limits is not always adequate. Credit limits might be set within the international department, which might lead to undue weight being given to commercial aspects; interbank placements which are not transborder claims might be excluded from country limits; a distinction is introduced between medium- and long-term claims (more than one year) and short-term claims, with a tendency to be less strict on the latter category.

In all of these aspects, improvements are under way. Efforts are being made by individual banks to computerize all interbank relations in which the bank network is involved and to establish an “objective” definition of country limits through formulas based on GNP, total BIS claims, and total national claims as a starting point to which country risk assessment and commercial opportunities apply. Further efforts involve the setting up of a portfolio target in which the weights given to individual countries and regions take into account their relative importance and the potential medium-term risks resulting from individual countries policies or from regional contagion effects, with a view to moving gradually in the direction of the portfolio target in actual decisions regarding country limits.

Above all, the functioning of the market itself leads to a “herd” effect. If other banks are involved in a country, the risk of an isolated error is limited. If other banks begin to reduce their credit lines, one bank’s maintenance of its exposure would in fact mean that it would have to bail out the other banks. Small banks in all countries are reportedly the more likely to shift abruptly from a position of open lending to a position of rapid reduction of exposure, facilitated by the predominance of short-term claims, but such behavior is rapidly spreading.

In view of the growing share of external claims in the overall assets of individual banks, bank supervisors and central bank officials are paying increasing attention to the quality of commercial banks’ external portfolios. Under the aegis of the Basle Committee on Banking Regulations and Supervisory Practices set up in 1974 (first, the Blunden Committee and, since 1978, the Cooke Committee), major efforts have been made to pay greater attention to country risks by individual supervisors and to achieve greater uniformity of supervisory practices.

First, there is an agreement to require worldwide consolidated data from individual banks to get a clear picture of their overall situation. Unfortunately, the agreement has not yet been fully implemented in some major countries. Second, there is a movement toward greater uniformity of capital adequacy requirements where large differences still exist and, possibly, toward a greater similarity in provisioning policies. Third, there is a growing tendency among supervisors to look at the adequacy of country risk assessment systems used by individual banks and even to check the results against those of an independent system managed by the supervisor. This type of assessment began in 1977 with the Interagency Review Group of U.S. regulators (Federal Reserve System, Comptroller of the Currency, Federal Deposit Insurance Corporation) through a screening process operated by the Federal Reserve Bank of New York that groups countries according to potential risks and provides a comparison for an individual bank within its peer group. In addition, the classification of loans as performing or nonperforming assets has a direct effect on the lending attitude of U.S. banks.

Some central banks rely more on qualitative or semiquantitative techniques and on informal discussions with bankers. Also, supervisors and central bankers consider that they do not have to pass judgment on individual countries and that they should not replace the commercial banks in the assessment of final risks. Within the Basle Committee on Banking Regulations and Supervisory Practices, an agreement has been reached on country risk analysis and country exposure measurement and control that stresses the need for banks to have a system of country limits, to separate the selling function, and to relate the country exposure limits to the banks’ capital and reserves.

While playing a positive role in pressing individual banks to improve their systems of country risk assessment, this growing supervisory involvement might reinforce the “herd” effect if all banks reporting to the same supervisor or all supervisors adopted the same attitude toward a given country. There might be, in addition, a contradiction between the attitude of central banks stressing the need for commercial banks to maintain an adequate flow of international lending and the attitude of supervisors, a danger underlined by the Chairman of the Board of Governors of the U.S. Federal Reserve System when proposing in 1982 that, in assessing loans, supervisors should take into account the adjustment efforts of problem countries under Fund programs.18

Through its overall approach to adjustment policies, stressing the importance of domestic imbalances as the source of future external imbalances, and its close contact with member countries through the consultation process, the Fund has already played a major role in the overall trend toward a better working of the country risk assessment process. Further progress could be contemplated in three areas.

Statistics. Comprehensive, timely, and accurate statistics are central to an adequate country risk assessment process. The Fund could, therefore, in its consultation reports describe more extensively the attitude of member countries to the release of information on domestic and external developments and, if necessary, insist in its programs on additional commitments to that effect. In addition, the Fund should continue to contribute to a better knowledge of the external debt situation of member countries, through a breakdown of debt by categories and a reconciliation of data between creditor and debtor countries.

Country risk assessment models. The Fund has always stressed the specificity of individual member countries and the need to take into account a diversified and interrelated set of unique economic, social, political, and external variables before passing any judgment on the viability of any country’s balance of payments and on its ability to service its external debt. Any temptation to move toward a purely mechanistic approach based on a computerized model or to rely, as with an early warning system, on a set of predetermined and uniform indicators would thus run counter to Fund philosophy. To be sure, in terms of staff months, the input of the Fund in the economic analysis of any given country is probably several times the input of any of the largest banks. The reliance on rating systems or on early warning systems, while improving the intercomparability of country risk assessments, would be an unjustified mutilation of this comprehensive approach.

Nevertheless, there are some arguments in favor of having the Fund experiment with a country risk assessment model. The rationale for this can be found in the contribution it could bring to the Fund’s ability to assess the likely attitudes of banks toward an individual country. These attitudes are not predetermined by numbers. The “herd” effect, marketing opportunities, and rates of return play a fundamental role in the banks’ assessment, and the translation of country risk assessment into country limits remains the weak point in the present process. But a synthesis of individual country risk assessment systems could provide a base for more sophisticated projections of private financial flows, with possible satellite models on regional contagion. The setting up of such a model would involve an in-depth study of industrial country risk assessment systems used by leading banks in the United States, Japan, Canada, the United Kingdom, the Federal Republic of Germany, France, Switzerland, and one or two other European countries (about 25 banks representing about 50 percent of total international bank lending) for which some information is already available. This study could provide the base for a statistical country risk assessment model that would reflect a kind of weighted average of leading indicators as used by banks. The model could be used, together with direct market indicators (spreads and maturities) as an early warning system of banks’ attitudes toward a given country. As a by-product, it could give, at the Fund management level, an additional degree of intercomparability between member countries’ external situations. But obviously it would have to remain a purely analytical and internal instrument, since Fund policies and programs would continue to be based on a comprehensive overall approach and since country risk assessment by individual banks should remain a decentralized process.

Cooperation with supervisors. There is a tendency toward a growing involvement of supervisors in country risk assessment, either through the treatment of certain categories of loans or through the checking of a particular bank’s exposure in a given country against the average exposure of all banks. The coordination of national efforts in this field, under the aegis of the Basle Committee is a complex undertaking, since the independence of judgment of national regulators and the full responsibility of individual commercial banks in assessing risks have to be fully protected to achieve the overall aim of a sound international banking system. The Fund could contribute to this coordinating process. Through the Berne Union, export credit agencies are aware of the views of the Fund on the results of adjustment policies under way in countries engaged in a program with the Fund, a process which helps to ensure a more rapid adaptation of export credit agencies’ attitudes toward countries successfully entering a recovery phase. Adequate contacts between the Fund and the Basle Committee of regulators could, in a similar way, contribute to a better mutual understanding of the views of all interested parties while fully respecting the independence of each participant.

Recent Developments in International Banking

The international banking system has been profoundly affected by the conjunction of a series of events during the past two years.

(1) High real interest rates (on average in 1982 the London interbank offered rate—LIBOR—exceeded the U.S. rate of inflation by about 8 percent) initiated a series of adverse developments for borrowers until then accustomed to debt relief through inflation. Some large corporations (International Harvester, AEG, AM International, Dome Petroleum, GHR Company) had major financial difficulties, most associated with losses in international lending. There were failures of banks or of financial intermediaries (Drysdale Securities, Penn Square Bank of Oklahoma, Banco Ambrosiano) owing to large exposures to borrowers running into difficulties or to managerial errors in the assessment of collateral when energy prices were falling, or in the adaptation to a greater volatility of interest rates. Payments arrears or interruptions of payments occurred in developing countries that were affected by a slowdown of their exports after a period when most of them, confronted with an increasing oil burden, had delayed adjustment and had rapidly accumulated external debt, thus building up a highly vulnerable debt and liquidity situation.

(2) A series of political developments had an impact on international bank lending. Heightened East-West tensions and the imposition of martial law in Poland in December 1981 intensified in 1982 the trend toward an abrupt suspension of new credits to Eastern European countries and a rapid reduction of existing exposure. This trend began in 1981 when the first Polish debt rescheduling made it clear that not only was there no CMEA umbrella but that other CMEA countries were suffering from a contagion effect (“reverse umbrella theory”). The possibility of a formal default by Poland and the occurrence of debt arrears by Romania, followed by a suspension by the Fund of its program with the country, shattered the confidence of bankers and led to associated crises or near crises in Hungary, Yugoslavia, and, to some extent, the German Democratic Republic.

The South Atlantic crisis highlighted the vulnerability of the external financial situation of Argentina and, together with other factors, contributed to a “Latin American syndrome,” similar to the East European syndrome, in which all major Latin American borrowers (Brazil, Chile, Mexico, and Venezuela) were included.

The freeze on Argentine assets by U.K. authorities (with a reciprocal freeze of U.K. assets by Argentina) demonstrated that, in addition to political risks attached to the use of a given national currency (e.g., the U.S. action in 1979 which sought to freeze all Iranian assets denominated in U.S. dollars), there were, in interbank transactions, political risks attached to the location of activities (the freeze in 1982 was applied to all Argentine assets in London, whatever their currency denomination).

(3) The new funding patterns in the Euromarkets induced a more cautious attitude by continental European bankers. The disappearance of OPEC surpluses because of the new energy situation and the conflict between Iraq and Iran ($3 billion of an identified deployed net cash surplus in the first half of 1982 against $54 billion for 1981 as a whole and an overall decline in 1982 of OPEC deposits as reported by the BIS of about $22 billion)19 implied a greater reliance in the Euromarket on funding by the U.S. banks using their domestic dollar base. Thus, the U.S. net position in the Eurodollar market (the difference between sources and uses of Eurocurrency funds of banks of BIS reporting European countries), which was $33 billion at the end of 1981, rose to $51 billion at the end of June 1982 and $61 billion at the end of December 1982.20 This reliance on the U.S. domestic market was underlined by the growing proportion of credits including two tranches, or dual pricing—one based on LIBOR and one based on the U.S. prime rate.21

The setting up, starting in late 1981, of international banking facilities located mainly in New York also contributed to new funding patterns. Initially, deposits with these facilities represented largely a repatriation of bookkeeping operations of U.S. branches in the Caribbean area, but in the wake of the South Atlantic crisis there was some additional shift, later partially reversed, from the London Eurodollar market to the New York market. More recently, there has been some shift from the Hong Kong/Singapore Asia-dollar market to the New York market. Japanese banks have contributed to this trend, but that might be reversed by the setting up of an international banking facility in Tokyo. Overall, the growth of the international banking facilities has been more rapid than initially contemplated, with claims rising from $63 billion at the end of December 1981 to $119 billion at the end of June 1982 and $144 billion at the end of December 1982.22 The growing perception of the risks attached to interbank funding led European banks to protect their medium-term funding through the issuance of floating rate notes, notwithstanding the additional cost.23 It also led them to reduce maturity mismatching, which, if they had been obliged through tiering to pay a premium on their resources, could have caused heavy losses.

These adverse developments came to a head in July and August 1982. The handling of the Ambrosiano crisis, and especially the debate among the Italian, Luxembourg, and Swiss authorities on their relative responsibilities, added to the overall uncertainty among Euromarket participants. The losses incurred by some large U.S. banks in connection with the Penn Square failure cast doubts on their managements and led to a massive shift, notably by money market funds, from bank certificates of deposit to treasury bills and to the emergence of a tiering among U.S. banks themselves. The most serious blow came in August 1982 when Mexico, the largest single borrower (BIS banks’ claims at the end of June 1982 were $62 billion), asked for a 120-day moratorium, later extended by 90 days, on its debt repayment obligations to banks. As had happened in the wake of the Herstatt crisis in 1974, sizable tiering reappeared on the interbank market, starting with a “Latin American premium” but spreading to other banks as well. It has been reported in specialized publications that the tiering scale, taking prime U.S. banks as the base level, was as follows: 116 percent for prime U.K. banks and some large continental European banks, ⅛ percent for other large continental European banks and Japanese banks, 316 percent for many smaller banks, ¼ percent for Latin American and Third World banks, and ½ percent for Eastern European banks.24 Since some banks were not ready to pay additional premiums, there was a net contraction of the London interbank market, which could have been the forerunner of a cumulative reduction of international lending and even of a worldwide banking crisis.

Central bankers and international organizations perceived the danger thus looming and took a series of measures that helped to reassure the market. A shift in the U.S. monetary policy by the abandonment of strict reserve growth targeting led to a rapid decline in short-term U.S. dollar interest rates (for LIBOR, from 15 percent in July 1982 to 9-10 percent at the end of 1982). The Bank of England monitored banks’ attitudes on the London interbank market, notably on transactions with London branches of Latin American banks. The most acute debt cases were handled through joint action by the Fund, the BIS central banks, and commercial banks:

Hungary—a commercial bank loan ($260 million), a Fund program ($500 million over three years, plus an $80 million compensatory financing facility loan), and a BIS bridging operation ($510 million) combined to avoid a liquidity crisis.

Yugoslavia—a commercial bank loan ($600 million plus refinancing of medium-term maturities and rollover of short-term debt), new commitments by foreign governments ($1.3 billion), a Fund program ($600 million in 1983, under a three-year stand-by arrangement), and a BIS bridging operation ($500 million) combined to avoid a debt crisis in 1983.

Mexico—the announcement of a $1.85 billion bridging loan by BIS banks (the first of its type for a non-BIS central bank) and the adoption of a Fund program ($4 billion) paved the way for an agreement on a standstill by bankers and for an agreement on joint credits involving net new lending by commercial banks of about $1.5 billion in 1982 and about $5 billion in 1983.

Argentina—the BIS granted a $500 million credit facility while the Fund approved the use of Fund resources totaling $2.2 billion, including $1.6 billion under a stand-by arrangement; at the same time the central bank proposed to take over about $5 billion of private debts to be repaid after four or five years.

Brazil—a $1.45 billion bridging loan from the BIS and use of Fund resources amounting to $5.4 billion, including $4.6 billion under the extended Fund facility, were combined with new short-term credits by banks in 1982 ($1.2 billion) and a combination in 1983 of refinancing of maturities falling due, extension of short-term credit, reconstitution of interbank positions, and new money from commercial banks amounting to about $6 billion.

Later in 1982 and in 1983, agreements were reached with the Fund and commercial banks (but without direct BIS involvement) by other large debtors such as Chile, Ecuador, Peru, and Uruguay. Also, discussions on rescheduling were begun in 1983 by Nigeria, the Philippines, and Venezuela.

“Involuntary lending,” which means an agreement with banks by which each individual bank agrees to increase its exposure by a given percentage, in the framework of an overall agreement including the Fund, thus became a frequent feature of international bank lending.25 Individual actions by borrowing countries to adjust their economies, improve their debt profile, and come to terms with their bankers on rescheduling agreements also contributed to some restoration of confidence in the marketplace.

The joint action on Mexico was considered a turning point by many bankers. The contraction in the London interbank market in the second quarter of 1982 was offset by a resumption of growth in the third quarter. Also, the widespread fear that this contraction would lead to a marked contraction in international bank lending proved to be unfounded. Nevertheless, it appears that lending by banks in the BIS reporting area was at the end of 1982 no more than 10 percent higher than at the end of 1981, a notable slowdown from previous trends (about 20–25 percent a year until 1980 and 17 percent in 1981).26

There was also a sharp reduction in syndicated medium-term loans to non-oil developing countries in 1982. This was not reflected by an increase in the proportion of short-term debt in individual countries’ external debt, which amounted to 46.7 percent at the end of 1982 against 47.1 percent at the end of 1981, but by a decline in banks’ total undisbursed credit commitments from $103 billion at the end of 1981 (21 percent of outstanding claims) to $91 billion at the end of 1982 (17.2 percent of outstanding claims), adding to the vulnerability of the system. At the same time, there was a tendency to stress trade-related credit operations which, in the years to come, might adversely affect the availability of funds through syndicated Euroloans.

During 1983 there was again, in the second quarter, a temporary contraction in the interbank market, partly of a seasonal nature, and, for the year as a whole, a further slowdown in the expansion of total claims and in net international bank lending (see Table 5). Cross-border interbank claims within the BIS reporting area decreased by $3 billion in the second quarter. This was reversed in the third and fourth quarters, and for 1983 as a whole, cross-border interbank claims increased by $64 billion, but this figure is to be compared with a figure of $108 billion in 1982. Total external assets (cross-border claims) increased by $108 billion (of which $28 billion vis-à-vis outside BIS area). International bank lending, net of redepositing, increased by $85 billion in 1983 ($10 billion, $15 billion, $20 billion, and $40 billion in the four successive quarters) against $95 billion in 1982 ($20 billion, $30 billion, $25 billion, and $20 billion in the four successive quarters). The slowdown in the increase in BIS reporting banks’ claims affected all areas, with the exception of OPEC countries:

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As noted by the BIS in its review of international banking developments in the fourth quarter of 1983, there has been, since mid-1982, a much slower growth of total new lending to outside area countries ($41 billion during the 18 months from end-June 1982 to end-1983, against $92 billion during the 18 months from end-1980 to end-June 1982), in particular for Latin America ($9 billion against $42 billion), as exemplified by the evolution of claims on the 20 principal non-BIS borrowers (see Table 6).

The consequences of this slowdown were evidenced by the sluggishness of new syndicated Eurocurrency credits to developing countries (Fund definition), which reached $33 billion in 1983 (including $27 billion to non-oil developing countries)27 against $46 billion (including $37 billion to non-oil developing countries) in 1982. This sharp contraction in medium-term credits took place in spite of a substantial amount of medium-term funds ($14 billion) granted by commercial banks within the framework of restructuring packages. According to the OECD, spontaneous credits to developing countries amounted to about $19 billion (including about $13 billion to non-oil developing countries) in 1983 against $27 billion (including $18 billion to non-oil developing countries) in 1982. The banks’ reluctance to increase exposure in developing countries was also reflected in markedly higher contractual spreads. The differential between the average spread on new loans to OECD borrowers and to non-oil developing countries widened from some 42 basis points in the first half of 1982 to about 120 basis points on average during January-October 1983.28

Eurobond issues have approached in 1983 the volume of $46 billion reached in 1982, as borrowing by banks increased (23 percent of total issues in the first ten months, mainly in the form of fixed rate issues to be swapped into floating rate loans) and major borrowers, such as the European Community and Sweden, turned to the floating rate notes as a substitute for the syndicated bank loan market. But access in 1983 to Eurobond markets continued in practice to be limited to OECD borrowers.

On the whole, developments in 1983 confirmed the feeling in the market that the rate of expansion in international bank lending might be reduced by more than one half and stay well below 10 percent in future years. This would have a marked impact on the financing of middle-income countries, which would have to adjust their economies accordingly. It is, therefore, of the utmost importance that international organizations, and particularly the Fund, have adequate resources to implement the appropriate mix of adjustment and financing. At the same time, in the present circumstances, the Fund should continue through its dialogue with commercial banks to help convince them to remain active participants in efforts under way to restore viable balance of payments prospects for borrowing countries. As mentioned by the Managing Director: “The Fund as the agent of adjustment and the banks as the major source of international financing have a vital and common interest in supporting efforts on the part of deficit countries to tackle their balance of payments problems.”29 In the months to come, the Fund should pay additional attention to the funding side of the market. The BIS study on the interbank market30 could be supplemented by a Fund study on non-BIS banks. Also, there have been in major industrial countries important changes in legal, informal, or supervisory requirements applied to banks, and the Fund could try to assess their impact on international bank lending. These analyses and a more direct perception of the banks’ attitudes on the lending side would help the Fund to assess the attitude of commercial banks in the years to come and develop means to assist member countries in their debt management, to build constructive relations with commercial banks, and to handle potential crises in the system.

Within Same Series

Other IMF Content

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Cover The Fund, Commercial Banks, and Member Countries
The Fund, Commercial Banks, and Member Countries
Author: Mr. Paul Mentré
ISBN:
9781557750679
ISSN:
0251-6365
Publication Date:
06 Apr 1984
Publisher:
International Monetary Fund
DOI:
https://doi.org/10.5089/9781557750679.084
Pages:
46

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