Apr. 2005, Volume 4, No.4 (Serial No.22)
Chinese Business Review, ISSN 1537-1506, USA
Research on the Roles of Commercial Banks and IMF
in the Latin American Debt Crisis
Tongtong Yuan* Tianjin Polytechnic University
Abstract: In the 1980s Latin American countries ran into debt crisis. Heavy debt has been the shade that
cannot be waved all the time. Commercial banks’ expansionist thrust into Latin America made these countries go
deeply into the debt crisis. International Monetary Fund played an indispensable role in resolving the crisis. It
might temporarily steady the financial situation of an area, but it was difficult to stem the enormous economical
loopholes of these countries and couldn’t solve the basic problems of economy, politics and society. It was unable
to make the countries pass the crisis substantially.
Key words: Latin America
debt crisis commercial banks IMF
1. Introduction
In recent years, Latin America’s financial and economic situation has been the most turbulent and most
depressed in the global finance and economy.
As representatives of developing economy, Latin American area was brilliant somewhat, but what is more is
their debt burden even crisis. Since the Mexican government declared that they were unable to repay the external
debt and broke out debt crisis in August of 1982, though the economy of the whole Latin American area has one
period of development, the heavy debt has been the shade that cannot be waved all the time. And that is also the
root of the Latin American crisis originated from Argentina. The stock market slumps; the currency devaluates;
the capital flees and the whole economy even society and politics are all in the turbulence. This paper discusses
the role commercial banks playing in bringing about the Latin American debt crisis in the 1980s and the role IMF
playing in resolving this crisis.
2. The Role Commercial Banks Playing in Bringing about the Latin American Debt
Crisis
2.1 Banks’ Expansionist Thrust into the Third World
The global money market was established to enable western banks to serve their corporate clients on a global
scale. Large numbers of new banks entered the global money game in the early 1970s, however, profit margins on
loans to blue-chip corporations, never enormous, fell dramatically. So banks began to look for new customers to
lend to. For many, the answer was a return to one of the basics of banking-financing governments. In the
nineteenth century, private banks helped countries cope with swings in the trade cycle and made emergency loans
keep governments afloat. However, one of the things bankers disliked about the Bretton Woods Conference was
*
Tongtong Yuan, female, Master of Economics, associate prof. of School of Economics, Tianjin Polytechnic University; Main
research field: International Relations of Economy and Trade; Address: School of Economics, Tianjin Polytechnic University, No.63,
Chenglinzhuang Road, Hedong District, Tianjin, China, Postcode: 300160; Tel: 022-89796610; E-mail: ytt@tjpu.edu.cn.
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Research on the Roles of Commercial Banks and IMF in the Latin American Debt Crisis
that it created a competing public sector institution, International Monetary Fund, to provide short-term loans to
countries experiencing trade and financial difficulties. Despite the creation of IMF, the business of lending to
governments was soon taken over by the banks. By the middle of the decade, the money flowing to the Third
World countries from private banks dwarfed that coming from development agencies like World Bank. With a
global money market in place, money was available to any country on the earth that was perceived to be
creditworthy and could afford market interest rates. It seldom occurred to banks or governments that serious
problems could arise. The massive financial failures of the 1920s and 1930s seemed to be ancient history. For
most of the postwar period, such things as defaults and debt crises were not considered matters of great concern.
The Latin American debt crisis had two fundamental causes. The first was the growing importance of the
Latin American countries in the global banking revolution of the 1960s and 1970s. The second was the series of
economic shocks that hit the world economy in the 1970s. Together, they led to a marriage of convenience
between the global banks and the poor Latin American countries. Basically, the global banks had money to lend
and the Latin American countries needed it to survive in an increasingly hostile world economic climate.
In the early 1970s, with the substantially financing needs of development, countries with ample natural
resources and labor supplies turned increasingly to private banks to finance huge mining and manufacturing
projects. Concurrently, banks’ international activities were growing steadily and so was their appetite for more.
Banks had strong incentive to increase their activities in the Latin American countries. Banks went abroad to keep
up with their corporate clients. When their clients went to Brazil and Mexico, the banks followed. Beyond that,
moving into underdeveloped areas where capital was scarce offered the prospect of much higher returns than that
of capital deployed at home. As for the security of the loans, banks viewed the Latin American countries as
excellent credit risks by virtue of their oil and mineral wealth. In the early 1970s, amid dire predictions of
resource shortages and skyrocketing commodity prices, banks rushed to make loads to corporations and
government agencies exploiting the Latin American resources. They viewed large reserves of natural resources as
impeccable collateral in the event of default. As bankers are fond of saying, although companies may go out of
business, countries never do.
That banks aggressively courted new borrowers and encouraged them to borrow is often ignored in banking
literature. Most bankers tend to view themselves as powerless servants of impersonal market forces, supplying
credit where demand exists. Yet this overlooks the role played by international competition among the banks for
larger loan portfolios, market shares and profit. Richard S. Weinert of the New York investment banking firm
Leslie, Weinert & Co. lists four main factors that he views as responsible for the banks’ expansionist thrusting into
the Latin American countries in the 1970s: serving client needs, defensive expansion to keep clients, earnings
growth, and the opportunities offered by Eurocurrency markets.
Undoubtedly, Third World countries have an insatiable demand for funds. Yet this would mean little to banks
if there is no money in the business and little competition for it. Banks lent to the Latin American countries,
especially the big ones such as Brazil and Mexico, because they had to. The growth in the number of banks
involved in Eurobanking made competition to manage syndicated loans to prized borrowers intense. Moreover, a
country’s bargaining power with the banks tends to expand once it becomes a substantial borrower. If a bank
shows no interest in managing its syndicated loans, Brazil or Mexico can always threaten to take billions in trade
financing, cash management and other valuable business elsewhere. If Citibank won’t do it, Deutschebank will.
The result is that banks compete vigorously to win mandates to manage loan syndications.
2.2 The Third World Countries Went Deeply into the Debt Crisis
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Research on the Roles of Commercial Banks and IMF in the Latin American Debt Crisis
The global banking network was in place before Oil Shock I, but the Latin American addiction to foreign
credit become earnest after 1973. Since then the Latin American countries have been rocked by a series of
economic shocks, which have left them substantially in hock to the Western banking system.
The first economic shock of the 1970s was inflation, which hit double digits in 1973. The second and the
most publicized economic shock of the 1970s was the dramatic increase in oil prices from about $3 in early 1973
to over $30 at the end of decade. The third major shock was the slowdown in world economic growth, highlighted
by the steep recessions of 1974-1975, and 1980-1982.
The fourth economic shock related to indebtedness was soaring interest rates. One of the implications of the
growing importance of private bank lending to the Latin American countries is that the cost of borrowing money
and servicing foreign debts rose substantially. In the aftermath of Oil Shock II, however, interest rates rose and
remained at levels that are unprecedented in modern economic history. Interest rates on Euromarket bank loans
averaged 12 percent in 1979, 14.2 percent in 1980 and 16.6 percent in 1981. For every 1 percent rise in market
interest rates, the Latin American debt-servicing costs increase by about $2 billion. In real terms, considering the
declines in commodity prices, the pain imposed by higher interest rates is much greater.
The interaction of all these developments has given the Latin American countries a Hobson’s choice of going
deeply into debt or facing economic collapse. Even for countries that managed to generate a trade surplus, the
costs of servicing the foreign debts and profits repatriated by the multinationals often plunged the current account
into red.
From a fairly modest deficit of $11 billion in 1973, the oil-importing Third World countries plunged to a $37
billion deficit in 1974 and over $46 billion in 1975. After Oil Shock II, the deficit rose from $37 billion to nearly
$100 billion by 1981.
The meaning of these large and growing deficits is that the Latin American countries have to borrow large
amounts of money just to pay for their bills. The ones that have consistently lived on borrowed money have
become today’s biggest global debtors. Most of what they borrow goes to service old debts. The total long-term
debt of the non-oil Third World countries exploded from less than $100 billion in 1972 to over $500 billion by
1982. The total Third World debt to the private banks is even larger. The debt is so massive that it has laid the
groundwork for a first-rate debt crisis in the international banking system.
The costs of paying the interest and principal on the Third World’s foreign debt have grown enormously in
recent years. The annual cost of debt service payments rose from $15 billion in 1973 to over $100 billion in 1982.
Debt service ratios, the percentage of exports devoted to servicing a nation’s foreign debt, rose from less than 14
percent in 1977 to 22 percent in 1982. Interest payments alone rose from under $5 billion in 1974 to $40 billion in
1982. In the late 1970s, the Latin American countries borrowed heavily from private banks to build up their
foreign currency reserves. Now, however, weak export markets, plus higher interest rates, have forced them to dip
into these reserves to service their debts. The foreign currency reserves of oil-importing the Latin American
countries fell by 15 percent in 1981.
The Latin American countries repay the expired debt principal and interest by every possible means every
year, but the total value of the external debt in arrears still expands sharply as snowballing. So far the external debt
in arrears of Latin American countries has already exceeded $800 billion. The debt burden as a “ghost” ranges in
the Latin America, perplexing the Latin American countries.
3. The Role IMF Playing in Resolving the Crisis
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Research on the Roles of Commercial Banks and IMF in the Latin American Debt Crisis
3.1 IMF Played an Indispensable Role in Resolving the Crisis
The debt crisis made IMF indispensable to the international financial system. While IMF did not have
enough funds to salvage the debt crisis, it did have the authority to grant loads to debtor countries in serious
difficulty and to impose the sort of discipline and intensive care on economics, which would make continued debt
serving possible. These loans also enabled them to continue importing vital commodities and to start the process
of restoring their economies and resolving their balance of payments problems. IMF Stabilization Programs
provided the time needed to enable the private banks to reschedule (increase the time for repayment and the
interest rate) the Third World Debt and avert a major financial meltdown. In time, irrecoverable debts were written
off, some debt was written down and other debt was discounted (sold at a loss to another bank or institution,
which would purse repayment or partial repayment). The international banking system survived without major
crashes but only just.
The global debt crisis gave the International Monetary Fund a new lease on life. Throughout the postwar
period, IMF was gradually edged out of the center of the action in global finance by the private banks. Today IMF
has fewer resources as a percentage of world trade than at any time in its history. As IMF’s influence waned,
senior people left more power and money in the private sector. What changed IMF’s fate was the debt crisis.
Today IMF’s main area of responsibility is mopping up messy global debt problems, mainly in the Third World.
IMF provides a kind of intensive care unit for countries in trouble. IMF’s role is straightforward. When
countries can’t pay for their debts, IMF steps in with a series of recommendations on how it thinks the country can
get back on its feet and regain creditworthiness. Increasingly, private banks look to IMF to discipline debtor
countries so that they can get their money back. Banks normally do not agree to lend to the country in difficulty
unless the government has agreed to do what IMF says it must to set its financial affairs in order.
IMF’s role in resolving the global debt crisis is not primarily its financial contribution. What IMF has to offer
is an experience in dealing with the economic difficulties of individual country. Citibank’s Jack Guenther, who
took his training at IMF, argues that IMF’s experts are actually in a better position to evaluate country trends than
bankers are. Bankers, he says, are frequently “under pressure to lend” to countries the bank deals with and that the
normal tendency “is always to lend more”, which means their reports must be optimistic. He cites as evidence the
rosy reports about the future of Somoza’s Nicaragua written in the mid-1970s by Citibank’s Central American
“experts”. Not long after, Somoza suspended payments on Nicaragua’s foreign debt, and in 1979 a civil war
toppled Somoza.
IMF also has something else that individual banks don’t have, political clout with poor countries, particularly
those with severe financial problems. As a makeshift “lender of last resort”, when countries in trouble can’t
borrow money from anybody else they go to IMF. IMF doesn’t dish out money to good customers as commercial
banks do. Unlike the World Bank, it does not finance specific projects such as steel mills or oil exploration. IMF
lends general-purposed funds but with strings attached. Interest rates are concessional; the real price is what the
country must do to qualify.
In the aftermath of Oil Shock II, IMF’s role in the Latin American debt crisis expanded considerably. During
1980 and 1981, IMF made loan commitments of more than $22 billion to its member countries to support
stabilization programs, more than it had spent in the previous seven years. An unprecedented number of countries
have undertaken stabilization programs under the auspices of IMF. By early 1982, 39 countries had agreed to take
IMF medicine. By the end of the year, so did Mexico, Brail and Argentina.
3.2 IMF Didn’t Make the Latin American Countries Pass the Crisis Substantially
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Research on the Roles of Commercial Banks and IMF in the Latin American Debt Crisis
For a country that falls into the financial crisis, it is essential for it to rely on foreign aid from some
organizations like International Monetary Fund. But because the aid condition of this organization is close to
harsh, or is not suitable for most countries at all, even suspected of infringing the economic sovereignty, so it
always makes people suspect that the real purpose of IMF is to aid or to destroy?
In the Latin American crisis, why IMF took different attitudes to Argentina and Uruguay? Argentina went
into financial crisis and was not able to extricate itself. IMF refused or delayed the loan with every possible reason.
But just there was a symptom of the crisis in Uruguay, IMF set out immediately, constructing it with assistance.
The key reason among them lies in that the City Bank and other banks in U.S.A. have assets of $27.5 billion in
Uruguay, twice the amount in Argentina. Apparently the “boss” behind IMF is U.S.A.
In the history of the economic development of the world, no one can obliterate the function of IMF. But we
have to admit what IMF rescued is the temporary difficulties of the country where crisis has taken place. But at
the same time, it pushes these countries step further into the abyss of the debt crisis.
Because the rescue measure of IMF is only to let Latin American countries borrow new debt to repay the old
debt, or recombine the debt. In this way, how are these countries able to break away from the awful circle of
repaying the debt?
4. Conclusion
The Latin American debt crisis is under the new international economic and financial condition, and an
epitome of serious challenges the new developing market economy countries have faced. In the present time of
economic globalization, economic security has already become the primary condition of national stability and
development. Foreign aid and blood transfusion of International Monetary Fund may temporarily steady the
financial situation of an area, but it is difficult to stem the enormous economical loopholes of these countries and
cannot solve the basic problems of economy, politics and society. While the finance is open and foreign banks are
imported, how to trend towards profit while avoiding being hurt, prevent potential risks, safeguard the economic
and financial sovereignty of one’s own country, guarantee the lasting, steady and healthy development of economy
have already become a serious subject that the new developing economic countries have faced.
References:
1. Jun Ji. Saving Latin America: It’s Time to Get Radical, World Economy and Politics, 2003, Vol.47(4)
2. Changjiu Li. Lesson of Latin American Debt Crisis, Economic Information, 18th September, 2002
3. Hongsheng Liu. Latin American Financial Crisis Is an Awaking Medicament, Study on the World Economy, 2002, Vol.38(11)
4. Michael Moffitt. The Economics and Politics of Global Debt, The World’s Money: International Banking from Bretton
Woods to the Bank of Insolvency, London, Michael Joseph, 1984
5. Jiehua Yan. The Debt—Latin America’s Turbulent Source, Economic Information, 21st August, 2002
6. Guoliang Ye. Focuses on the Latin American Financial Strom: Why the Crisis Won’t Go, Comment on the International
Economy, 2002, Vol.53(9)
(Edited by Joy and Jasy)
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