This note examines burden sharing among creditors. The introduction of market-based debt reduction programs has made financial relationships between debtor countries and their official and private creditors much more complex. Because official and private creditors typically hold very different types of financial claims on debtor countries, it is difficult to evaluate their respective contributions to a financing package. The main objective of this note is to provide a simple framework that might serve as a useful first step in addressing this important issue.
The need for such a framework is most apparent in cases where the debtor is expected to require additional financing. In this case, the values of the debts owed to creditors are interdependent, and it is natural for a creditor to consider the behavior of other creditors before committing to a financing plan. Suppose, for example, that feasible payments by the debtor are uncertain and that, without new credits, payments are likely to fall below contractual obligations at some point. It is necessary in such cases to be able to distribute partial payments—or, put another way, distribute the residual financing—according to some criterion. Among private creditors the “sharing” of partial payments is typically spelled out in each loan agreement. “Sharing” among official and private creditors, however, is not usually set out in existing contracts explicitly, or if such provisions exist, they may be conflicting.
The lack of a widely accepted analytical framework has led official observers to view the reluctance of commercial banks to provide “new money” as a failure to share the “burden” of financing. At the same time, others have argued that because banks have assumed the “burden” by participating in market-based debt reduction programs where they have often purchased debt at substantial discounts, they cannot be expected to provide additional financing. This note explores the analytical issues raised by such statements.
The framework developed below provides a quantitative measure of the financial consequences of alternative sharing rules for creditors. This measure necessarily fails to consider some important aspects of the problem. The main limitations of the exercise are the strong assumptions about the relative seniority of creditors, about financing arrangements, and about the expectations of the debtor’s ability to repay. Nevertheless, the methodology presented sheds light on how “burden sharing” might be usefully appraised.
The measure proposed is based on the idea that each creditor’s relationship with the debtor is summarized by the rate of return earned on the market value of the creditor’s initial claims on the debtor. In cases where there is no observable market value, the analogous measure would be the expected present value of payments to the creditor. This is necessarily a subjective measure and one that plays an important role in the analysis. The return on the market or expected value of a creditor’s initial stock of claims includes capital gains as well as all payments and receipts undertaken. The latter include debt service payments as well as “new money” lending and buy-backs or swaps. A creditor is said to suffer a burden if this rate of return is less than that available on an alternative safe asset. Creditors earning the same rate of return share the burden, if any, equally.
The figure roughly represents a country for which r = 0.10, s = 0.38, c = 0.3, and P1 = 0.17.