Copyright © 2000 by Harcourt, Inc. All rights reserved. 22-1 Chapter 22 Global Financial Crises and International Management Issues

Copyright © 2000 by Harcourt, Inc. All rights reserved.

22-1

Chapter 22Global Financial Crises and International

Management Issues


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International lending is confined to large banks for several reasons.

Gaining access to international markets is difficult and requires special facilities.

Lenders bear added regulatory burdens because of separate provisions applying to international loans.

The additional international risk that accompanies these loans acts as a deterrent.


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How do banks gain access to international markets?

Loan participations International banking facilities (IBFs)

• IBFs are located in the U.S. but serve international customers exclusively.

Edge Act subsidiaries…

• are branches of the parent institution serving international customers.

• operate as full-service branches and are subject to regulation.


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Shell branches…

• are offices overseas that permit banks to participate in Eurocurrency markets in terms of Eurodollar Liabilities or issuing foreign loans.

Offshore offices Full-service foreign branches Export trading companies

• Bank holding companies are allowed to invest and participate and lend to export trading companies.


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Factors Affecting Loans to Less Developed Countries

Changes in world economic conditions Changes in the price level of energy

products Changes in the price level of other products

that LDC countries may depend on for foreign exports


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What factors contributed to the 1982 LDC crisis?

Overaggressive lending efforts by U.S. banks seeking international business to counteract declining loan demand at home.

Rising interest rates affecting the cash flows of borrowing nations.

Poor use of borrowed funds resulting in inadequate returns on invested capital to service debt.


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Congress Responded to the LDC Crisis: The International Lending Supervision Act of 1983

ILSA established special examination procedures for international loan portfolios.

ILSA granted power to supervisory agencies to set minimum capital guidelines to ensure adequate support in the case of loan losses.

ILSA required a special allocation to loan loss reserves by institutions engaged in foreign lending.


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ILSA required that income from loan origination fees be amortized over the life of the loan rather than recognized as income in the year negotiated.


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Techniques for Managing LDC Debt Exposure

Secondary markets for LDC loans Securitization of international debt as bonds Debt for equity swaps


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Brady Bonds • Banks swap nonperforming loans in LDC

countries for those countries’ long-term bonds.• The bonds are collateralized by the LDC’s

holdings of U.S. Treasury securities.• The principal in the bonds is default-free but

interest payments are at risk.• Brady bonds were first used with Brazil and

Argentina.


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Risk Analysis in International Lending

Foreign exchange risk (discussed in Chapters 14 and 17)

Sovereign or country risk…

• arises from any political, economic, social, cultural or legal circumstance in the home country of the borrower that prevents the timely fulfillment of debt obligations.


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Measuring Sovereign Risk

ILSA requires special procedures for rating the country risk of a bank’s portfolio.• Ratings are ex post assessments.• Finding reliable signals for ex ante risk is difficult.

Available proxies for sovereign risk.• Moody’s and Standard and Poor’s sovereign ratings

for bonds.• Euromoney and Institutional Investor country risk

rankings.• Internal country risk measurement systems of

multinational banks.


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July 1997 Collapse of the Thai currency, the baht.

August 1997 The IMF provides a rescue package for Thailand. Indonesia floats its currency. South Korea institutes emergency measures to prevent a banking system collapse.

November 1997 IMF approves package for Indonesia. South Korea requests IMF assistance. Japan’s fourth largest security firm fails.

December 1997 IMF provides package to South Korea. Korea lets its currency float. International financial institutions are convinced to roll over credit lines to Korea’s financial institutions in return for Korean-government guarantees of debt.

January 1998 Indonesia consents to radical economic reforms to gain IMF support.

March 1998 The Thai baht and the Korean won stabilize, and investor confidence returns.

May 1998 Riots plague Indonesia, President Suharto resigns after 32 years in power.

SUMMARY OF MAJOR EVENTS FOR THE GLOBAL FINANCE CRISIS OF 1997-1999


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August 1998 Speculators bet against the Russian ruble. The IMF proposes a package, but reforms cannot be pushed through Russia’s lower house of parliament. Russia devalues its ruble, restructures short-term public debt and sets a moratorium on private-sector payments of foreign debt. The IMF cuts Russia off after $4.8b disbursed. The ruble continues to fall, and contagion effects occur for Brazil based on its large budget deficit.

September 1998 Investors express risk-aversion for risky debt in response to Russia’s turmoil, and fears of a U.S. credit crunch, with risk premiums on debt rising for U.S. corporate debt and emerging market debt. Stock market and currency exchange rates plunge in Brazil and other Latin American countries. Long-Term Capital, a hedge fund, is bailed out at the Fed’s request by a group of large financial institutions with large stakes in the fund.

October 1998 U.S. Congress provides $18b for the IMF in return for minor reforms in the way the IMF operates. Other countries contribute $72b.

November 1998 U.S. joins rescue effort for Brazil, fearing contagion in other Latin American countries and potential losses for major U.S. banks with large LDC holdings. Signs of recovery occur in Thailand and South Korea.


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December 1998 A third of the world’s economies are in recessions or experience very slow growth.

January 1999 State governor of Brazil sets off a run on the real by declaring a moratorium on the state’s debt. Brazil devalues the real and allows it to float. Brazil negotiates with the IMF for a second installment.

February 1999 G-7 ministers meet to discuss the crisis. Reports show Asian country economies are on the mend, and the U.S. economy to grow at a very fast 6.1% annual rate in the fourth quarter of 1998.

March-April 1999 U.S. economy continues to show strength. Signs of recovery in Asia continues. Economic uncertainties exist in Japan, Europe, and some developing countries. Russia and the IMF negotiate a new loan agreement. Brazil arranges a new loan agreement with the IMF. The real stabilizes and interest rates fall. Confidence improves, and Brazil successfully issues $2b in bonds underwritten by U.S. investment banks. The G-7 meets and designs reforms to help prevent future crises.

Source: Michael M. Phillips, “One by One: A Look at How the Global Finance Crisis Began - And How it Spread”,

The Wall Street Journal, Special Section on Global Investing, April 26, 1999, R4 and R7


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Warning Signs for the Asian Crisis

A high and growing ratio of short-term debt to short-term assets.

Increased foreign bank lending in the five countries later experiencing a crisis.

Much of the expanded credit was invested in real estate markets rather than in improving a country’s production capacity.


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Depressed world demand for semiconductors in 1996.

Contraction in monetary policy in the U.S. and Japan in the Spring of 1997.


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Attempts to Try to Help Nations Avert Financial Crises

G-7 nations were more coordinated in their rate-cutting activities in 1998 and 1999.

The IMF has approved plans to develop a Contingent Credit Line Facility (CCLF).• Countries will be allowed to draw on a pre-approved

basis from the IMF if their economies are in fairly good shape and their policies meet various criteria.

• To discourage unnecessary borrowing, the interest cost will be set at 3% points above the interest rate prevailing on normal IMF borrowing.


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U.S Secretary of the Treasury Robert Rubin’s plan to ward off a financial crisis includes:

• forcing lenders to pay a greater share of the cost of bailing out nations;

• discouraging most countries from using fixed exchange rates;

• encouraging nations to rely more on long-term borrowing and less on short-term;

• disclosing more information about outstanding debt; and

• protecting the poor and middle class during crises.

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Copyright © 2000 by Harcourt, Inc. All rights reserved. 22-1 Chapter 22 Global Financial Crises and International Management Issues