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fl v FDId NEW S R ELEA S E F E D E R A L D EPO S IT I N S U R A N C E C O R P O R A T I O N PR-13-83 (2-17-83) for immed: FEB 2 4 1983 tf f ì l f FEDERAL DEPOSIT INSURANCE CORPORATION O STATEMENT ON INTERNATIONAL AND DOMESTIC IMPLICATIONS OF U.S. COMMERCIAL'LENDING TO FOREIGN GOVERNMENTS AND CORPORATIONS PRESENTED TO i; h < i SUBCOMMITTEE ON INTERNATIONAL FINANCE AND MONETARY POLICY th COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS . UNI-TED STATES SENATE M K. BY WILLIAM M. ISAAC, CHAIRMAN FEDERAL DEPOSIT INSURANCE CORPORATION 9/30 a.m. Thursday, February 17, 1983 , Room SD-538, Dirksen Senate O ffice Building F E D E R A L DEPOSIT INSURANCE CO RPO RATIO N, 55 0Seventeenth St. N.W., Washington, D.C. 20429 202-389-4221 Mr. Chairman, I welcome th is opportunity to present our views on the international fin a n c ia l situ a tio n . I w ill outline very b r ie fly the nature of the global fin a n cia l problems and th e ir causes and then focus most of my remarks on remedial measures. The Problem Many developing countries have accumulated substantial indebtedness to the w orld's commercial banks. A number of those countries are having serious d if f ic u lt ie s meeting repayment schedules. In many countries, public and private indebtedness to foreign banks has been or is in the process of being rescheduled. A substantial portion of the indebtedness is owed to U.S. banks. The most recent figures indicate in excess of 35 percent of the developing countries' debt to commercial banks is held by U.S. banks, with the major share (over 20 percent) held by the large, m ultinational banks. For the larger borrowers, foreign debt and servicing requirements are very high re la tiv e to gross domestic product and export income. For example, the 1983 debt-servicing obligations of the four largest Latin American borrowers (Mexico, B ra z il, Venezuela and Argentina) amount to about 120 percent of th e ir projected export earnings. By any c r it e r ia , the situ a tio n is of concern. In spite of the seriousness of the current global fin a n cia l situ a tio n , we do not believe extreme pessimism is warranted. point of both the domestic and international We may well be at the low recession. An expanding world economy may cast many of today's world debt problems in a better lig h t a few years from now. Moreover, the problems are now well recognized, and a dialogue among banks, cre d ito r and debtor nations, and the international organizations has begun. The Causes While a number of factors are important in explaining how the current situ a tio n developed, they can be summarized as follows: - Overly stim ulative fis c a l p o lic ie s and accommodative monetary p o lic ie s produced in fla t io n in the U.S. and world economies over a sustained period and fueled the expectation of a continued rise in p rices, p a rtic u la rly of commodities. The large o il p rice increases by OPEC exacerbated the situ a tio n for many nations. - Banks saw opportunities for what appeared to be very p rofitab le lending. Most cre d its were originated at a premium over LIBOR, overhead costs were low, and the default risk of lending to foreign governments and large foreign business firms was perceived by many banks to be minimal. Moreover, information concerning the fin an cial condition of, and financing a c t iv it ie s by, various nations was d e fic ie n t, so banks were not always aware of ju s t how much borrowing was occurring u n til after the fact. - Banks were encouraged by many in th e ir role as "recyclers" of OPEC surpluses to countries incurring payments d e fic it s due to the large increases in o il p rices. As a consequence, however, banks developed a s ig n ific a n t cre d it exposure to the non-oil-producing developing countries. - Bank regulators were in s u ffic ie n tly sensitive to the develop ing problems in foreign lending and fa ile d to take firm steps to lim it c re d it concentrations and the leveraging of bank c a p ita l. - 2 - These factors having set the stage, a combination of elements converted the potential problem into a r e a lit y . Depressed economic con d itio n s throughout the world lim ited the growth in world trade and resulted in f a llin g prices for primary products (the main exports of developing countries) instead of the continued rise upon which many lending decisions had been predicated. Oil-exporting developing nations, in p a rticu la r, were placed in a precarious position rela tiv e to debt-servicing demands due to the decline in o il p rices, a development that favorably affected o i l importing nations. Record high interest rates had an immediate, painful impact on borrowers because a large share of L X lending was on a flo a tin g rate basis. F in a lly , appreciation of the d o lla r raised the debt-servicing burden of countries with dollar-denominated debt. It is d if f i c u l t , and not p a rtic u la rly useful, to "blame" any group for the current international fin a n cia l problems. There is plenty of blame to go around and the U.S. government must accept it s share of i t . In our judgment, however, i t is far more important that we focus our attention on the steps that must be taken to relieve the present strains in the system and to decrease the p o s s ib ility that sim ila r problems w ill arise again. In our opinion, the basic ingredient missing during the past decade has been " d is c ip lin e ." Governments throughout the world have not exercised d is c ip lin e in the management of th e ir fin ancial a ffa ir s . Some banks may not have had much more d is c ip lin e , but i t would be d if f i c u l t to make the case that they have had su b sta n tia lly less. - 3 - Possible Remedies Short Term The International Monetary Fund (IMF) can play an important role in s t a b iliz in g the present situ a tio n . The IMF is in a position to keep private and public lenders in lin e , to provide orderly expansion of c re d it where that seems appropriate and to in s is t upon the appropriate b elt-tightening and other p o licy adjustments needed by debtor countries. It is extremely d if f i c u l t , under the present circumstances, for private lenders to impose such d is c ip lin e . Making additional resources available to the IMF, including ra isin g the U.S. quota, would increase it s a b ilit y to provide emergency funding to help bridge liq u id it y problems and to avert p o te n tia lly serious international fin a n c ia l problems. Making additional funds available to IMF would not bail out or replace private debt; in the aggregate, the la t t e r w ill increase. Banks w ill be required to stay in and be part of the solution. We support the proposal to increase the resources of the IMF because we believe i t is a reasonable, balanced approach to resolving some d if f i c u l t , immediate problems in the worldwide financial system. We are convinced, however, that th is is only a short-term response and that more fundamental changes must also be made. Longer Term Some experts have questioned whether lending to foreign governments should be the re s p o n s ib ility of the private banking system. Others have suggested a statutory lending lim it on loans to foreign countries. While i t is understandable, under the circumstances, that these kinds of questions and solutions would be raised, we believe better long-term so lu tions are availab le. There is nothing inherently wrong with U.S. or other banks making loans to foreign countries. They do involve special risks which argue for even more caution and prudence than one would find necessary with respect to domestic lending. However, i f the loans are for the purpose of supporting economically-sound endeavors and are lik e ly to be repaid as agreed at market rates, they can be highly beneficial to the U.S. and world economies and should not be discouraged. The question is: sound? how do we insure that the loans w ill be economical ly - We believe the answer is to allow the market system to function with as l i t t l e government interference as possible. We are firm ly committed to the preservation of a strong, privately-owned banking system. The free-enterprise system cannot function properly unless there is d is c ip lin e , and we cannot achieve or maintain d is c ip lin e unless we permit market forces to operate — to reward the successful and penalize the unsuccessful. Unfortunately, the present system of bank regulation and insurance unwisely in h ib its the operation of the market and creates the wrong kinds of incentives. We currently have the worst of two worlds. During the 1930s, we crafted a tig h tly -c o n tro lle d regulatory environ ment to protect banks from competition. Product, p rice and geographic competition were highly regulated through in terest-rate co n tro ls, entry re s tric tio n s , lim ita tio n s on permissible a c t iv itie s and branching re stra in ts. Bank regulators were assigned the re s p o n s ib ility of preventing bank fa ilu re s , almost at any cost. A deposit insurance system was developed to help restore confidence and s t a b ilit y and to protect despositors in the event of fa ilu r e . 5 Although the deposit insurance system was o r ig in a lly designed to provide protection to only smaller, unsophisticated depositors, i t has evolved into a system which is perceived by most people as providing f u l l protection for a ll depositors and other creditors of our larger banks. Larger banks are perceived by most sophisticated creditors as being " fa ilp r o o f," at le a st in terms of depositors su ffe rin g a loss in the event of trouble. They believe we simply cannot and w ill not pay o f f the deposits of a large bank. They believe we w ill either prop up the bank with new capital or, at worst, merge i t into another i n s t i tu tio n . In eith e r case a ll depositors, insured and uninsured, would be made whole both as to princip al and in terest. As a practical matter, the potential problems involved in paying o ff insured depositors in a large bank would be enormous. The adm inistrative and lo g is tic a l problems that would be involved in the FDIC1s assuming control of a large bank, preparing checks for insured depositors and liq u id a tin g the bank's assets are d i f f i c u l t to even contemplate. Moreover, the uninsured deposits would be extremely large and would be tie d up in a receivership for years, thereby causing substantial disruption throughout the economy. F in a lly , the franchise value of the in s titu tio n would be lo s t , s ig n ific a n tly increasing the cost of the fa ilu re to the FDIC. For these reasons, a merger of a fa ile d bank is o rd in a rily far superior to a deposit payoff. The problem is that under current law a merger cannot be accomplished without making a ll depositors and other general creditors whole. The Congress has recognized the importance of th is issue, p a rtic u la rly in a deregulated environment, and has requested the FDIC to present it s recommendations for reform by A pril 15 of th is year. - 6 - I cannot t e ll you at th is time precisely what our recommendations w ill be, but I can say that we w ill almost c e rta in ly recommend that we be given the authority to arrange for the merger of a fa ile d bank on a basis that does not make a ll general cred itors whole. This may be the sin gle most important reform that could be made to restore d is c ip lin e in our banking system and insure that i t w ill remain strong under private ownership. We are not so naive as to place a ll of our fa ith in the market. During our f i r s t 150 years as a nation, we had a s ig n ific a n t amount of unfavorable experience w ith an unregulated, uninsured banking system. We believe in deposit insurance, and we believe regulation and bank examinations are v it a lly important. We are convinced, however, that p a rtic u la rly as in terest rate controls and other re s tric tio n s on competition are eliminated, we must find new ways to control destructive competition and excessive risk-taking . We could attempt to achieve that objective by h irin g thousands of additional bank examiners and adopting countless new regulations. Such a system would be expensive, would s t i f l e innovation and undermine many of the benefits we hope to gain from deregulation, and, u ltim ately, would probably not be e ffe ctiv e in c o n tro llin g the level of risk in the system. We would lik e to supplement our supervisory system by bringing market forces in to play to a greater degree. We must gradually, and in a non- disruptive fashion, move away from the notion that a ll large-bank l i a b i l i t i e s have a federal guarantee behind them. Disclosure I f the marketplace is to function e ffe c tiv e ly in co n tro llin g bank ris k , i t must be given s u ffic ie n t information about the nature of that risk to make an informed decision. The banking agencies have adopted new c a ll report schedules to provide information on non-performing loans, in te re st-ra te s e n s itiv ity and a s s e t/ 1 ia b ility maturity structures, and we w ill make th is information p ublic th is year beginning with the June 30 report. That is a step in the rig h t d ire c tio n , but more needs to be done. The Securities and Exchange Commission recently broadened disclosure requirements for bank holding companies with respect to loans outstanding in countries experiencing liq u id it y d if f ic u lt ie s . It may be desirable to to require banks to routinely report th e ir loan exposures on a country-by country basis, whether or not liq u id it y problems e x ist. Special Reserves I f disclosu re is to be e ffe c tiv e , i t must properly re fle c t conditions in the bank. I f losses e x is t, they ought to be reflected . Many banks have acted responsibly and provided s p e c ific reserves to re fle c t foreign loans at a r e a lis t ic carrying value. Others have not. We believe that when severe and protracted problems warrant, banks should s p e c ific a lly reserve against certain loans. By requiring banks to reserve against these assets, earnings statements and capital accounts w ill be more r e a lis t ic and dividend p o lic ie s more d is cip lin e d . In th is same vein, we are also reviewing the accounting treatment of fees paid to banks at the time a loan is rescheduled. In some cases i t appears these fees are being taken into earnings immediately. A more r e a lis t ic approach would have the fees taken into income over the l i f e of the restructured cre d it or perhaps even charged d ire c tly against p rin c ip a l. The agencies are cu rrently reviewing th is issue. - 8 - Conclusion In conclusion, we believe the problems in the worldwide fin an cial system, which have been developing over the past decade or so, are serious but manageable i f the countries and bankers involved act responsibly. We believe th is is occurring, as evidenced by the IMF proposal which we support. In our judgment, i t would be unfair and a serious mistake to attempt to assess the en tire re s p o n sib ility for the current situ a tio n against the banking industry. Bankers have been overly aggressive in some instances and mistakes have been made. They are by no means alone. The basic climate in which they were operating was created by government p o lic ie s throughout the world. We cannot expect to maintain the banking system on a sound basis in d e fin ite ly unless we pursue sound economic p o licie s throughout the major nations of the world. The financial system is undergoing a v irtu a l revolution. On the in te r national side, banks have been operating for more than a decade on a major scale in a fast-paced, deregulated clim ate. Deregulation is rap id ly becoming a fact of l i f e on the domestic side as w ell. Our regulatory and insurance systems were not designed to deal with the fin a n cia l system as we know i t today. In our judgment, the regulatory and insurance systems are not consistent w ith a deregulated banking environment and no amount of tinkering w ill make i t so; they are in need of a major overhaul and the sooner they receive i t the better. I appreciate th is opportunity to present our views and w ill be pleased to respond to any questions. 9