FINANCIAL INSTABILITY AND THE INTERNATIONAL DEBT PROBLEM

FINANCIAL INSTABILITY AND THE INTERNATIONAL DEBT PROBLEM

Financiallnstability and the International Debt Problem George McKenzie Direetor Centre/or International Eeonomies, University 0/ Southampton and Stephen Thomas Leeturer Department 0/ Aeeounting and Management Scienee, University 0/ Southampton Palgrave Macmillan

ISBN 978-1-349-21732-8 ISBN 978-1-349-21730-4 (ebook) DOI 10.1007/978-1-349-21730-4 George MeKenzie and Stephen Thomas, 1992 Softcover reprint of the hardcover Ist edition 1992 All rights reserved. For information, write: Seholarly and Referenee Division, St. Martin's Press, Ine., 175 Fifth Avenue, New York, N.Y. 10010 First published in the United States of Ameriea in 1992 ISBN 978-0-312-07197-4 Library of Congress Cataloging-in-Publieation Data MeKenzie, George W. Financial instability and the international debt problem / George MeKenzie and Stephen Thomas. p. em. Includes bibliographical referenees (p. ) and index. ISBN 978-0-312-07197-4 1. International finanee. 2. Intermediation (Finanee) 3. Debts, ExternaJ. I. Thomas, Stephen (Stephen H.) 11. University of Southampton. Centre for International Economics. III. Title. HG3823.M39 1992 336.3'435~e20 91-27767 CIP

Contents List 01 Tables List 01 Figures Acknowledgements PART ONE: Understanding the Behaviour of Financial Intermediaries 1 The Fundamentals 2 Objective Risk Assessment 3 A Behavioural Approach to Financial Institutions' Behaviour vi vili ix 3 19 35 PART TWO: The Evolving Debt Crisis 4 International Debt: The Anatomy of a Financial Crisis, 1973-83 57 5 The Maturing Crisis: 1983-87 109 PART THREE: Responses to the Debt Crisis 6 The Market's Response: Debt Swaps 135 7 The Regulator's Response: The BIS Capital Adequacy Proposals 163 Appendices 1 Annexes to BIS, International Convergence 01 Capital Measurement and Capital Standards, Basle, July 1988 193 2 A Model of Bank Behaviour 205 Bibliography 207 Index 209 v

List of Tables 1.1 New international bank lending: bonds and bank credits 4 1.2 Externa1 debt service ratios for developing countries 4 2.1 Prob ability information 20 4.1 Summary of payments balances on current account, 1973-83 59 4.2 Non-oil developing countries: merchandise exports and imports, 1968-82 63 4.3 Developing countries: changes in output, 1968-83 64 4.4 Estimated Eurocurrency market size 70 4.5 Oil-exporting countries: estimated disposition of current account surplus, 1974-82 73 4.6 Non-oil developing countries: long-term and short-term external debt relative to exports, 1973-83 77 4.7 Non-oil developing countries: debt service payments on short-term and long-term external debt, 1973-83 78 4.8 OECD member countries' policies regarding the establishment of foreign bank agencies or branches and subsidiaries 85 4.9 Externallending and deposit-taking of banks in the BIS reporting area, 1978-82 90 4.10 Share of claims on developing countries and centrally planned economies in banks' net international claims, 1973-82 92 4.11 Sovereign loans as proportion of syndicated internationallending, 1976-81 100 4.12 Countries reviewed, ranked by debt to banks at end of December 1982 105 5.1 Long-term bank debt restructured, 1983-7 (third quarter) 111 5.2 External financing requirements, capital importing countries, 1980-8 113 5.3 Debt service ratios, 1979-88 114 5.4 Long- and short-term external debt relative to exports, 1979-88 115 VI

List 0/ Tables vii 5.5 Developing countries: external debt 117 5.6 Terms of long-term bank credit commitments, 1981 to third quarter 1987 119 5.7 Financing instruments and options in new money packages and restructurings of bank debt of selected developing countries, 1983-7 122 5.8 Assets and capital of US banks, 1977 to first half 1987 130 6.1 Volume of debt conversion: face value of debt retired 137 6.2 Market prices for developing country debt 143 6.3 Mexico: debt-equity conversion programme, 1986 148 7.1 Japanese city banks' assets and reserves 172 7.2 Bank of England matrix of debt recoverability 178 7.3 Difference in risk measurements 186 7.4 J.P. Morgan: effect of Basle capital proposals 188 Al.1 Transitional arrangements 201

List of Figures 2.1 Probability distribution 20 2.2 Continuous probability distributions 22 2.3 Indifference curves for a risk averter 26 2.4 Inconsistent indifference curves 27 2.5 Indifference curves for a risk lover 29 2.6 The optimal portfolio 30 2.7 The optimal portfolio: (a) risk averter; (b) risk lover 31 2.8 Effect of incorrect assessment of opportunity locus 33 3.1 Summary of behavioural theories of profit-seeking organisations 47 4.1 Terms on international bank lending, 1973-82 83 4.2 OPEC exporter deposits $100 million directly with US banking system 87 4.3 OPEC exporter purchases $100 million US securities from US dealers 87 4.4 Developing country purchases $100 million in goods and services from the USA 88 6.1 A typical debt-equity swap 139 7.1 Banking operation with a leverage of five 165 7.2 Maximising profits relative to capital 167 7.3 Relaxing assumptions 167 7.4 Imposing the assetlcapital ratio 169 7.5 Aspects of the double-ieveraging of bank equity 179 viii

Acknowledgements This volume began life as a research report prepared for the United Nations Conference on Trade and Development in 1983. We wish to thank Shahen Abrahamian for his encouragement and helpful comments upon this early work which now forms the basis for Part Two of this volume. Since then we have undertaken many additions and revisions, a reflection of the dynamic nature of the international banking problem. We would like to thank the Department of Economics and the University of Southampton for providing the secretarial support. In particular, thanks are due to Sarah Rollason, Carol Willison and Christine Blanc for their tireless efforts. GEORGE MCKENZIE STEPHEN THOMAS ix