Domestic Creditors Research Articles

Sovereign debt markets in turbulent times: Creditor discrimination and crowding-out effects

In 2007, countries in the euro zone periphery were enjoying stable growth, low deficits, and low spreads. Then the financial crisis erupted and pushed them into deep recessions, raising their deficits and debt levels. By 2010, they were facing severe debt problems. Spreads increased and, surprisingly, so did the share of the debt held by domestic creditors. Credit was reallocated from the private sector to the public sector, reducing investment and deepening the recessions even further. To account for these facts, we propose a simple model of sovereign risk in which debt can be traded in secondary markets. The model has two key ingredients: creditor discrimination and crowding-out effects. Creditor discrimination arises because, in turbulent times, sovereign debt offers a higher expected return to domestic creditors than to foreign ones. This provides incentives for domestic purchases of debt. Crowding-out effects arise because private borrowing is limited by financial frictions. This implies that domestic debt purchases displace productive investment. The model shows that these purchases reduce growth and welfare, and may lead to self-fulfilling crises. It also shows how crowding-out effects can be transmitted to other countries in the euro zone, and how they may be addressed by policies at the European level.

Sovereign Debt Markets in Turbulent Times: Creditor Discrimination and Crowding-Out Effects

In 2007, countries in the Euro periphery were enjoying stable growth, low deficits, and low spreads. Then the financial crisis erupted and pushed them into deep recessions, raising their deficits and debt levels. By 2010,they were facing severe debt problems. Spreads increased and, surprisingly, so did the share of the debt held by domestic creditors. Credit was reallocated from the private to the public sectors, reducing investment and deepening the recessions even further. To account for these facts, we propose a simple model of sovereign risk in which debt can be traded in secondary markets. The model has two key ingredients: credit or discrimination and crowding-out effects. Creditor discrimination arises because, in turbulent times, sovereign debt offers a higher expected return to domestic creditors than to foreign ones. This provides incentives for domestic purchases of debt. Crowding-out effects arise because private borrowing is limited by financial frictions. This implies that domestic debt purchases displace productive investment. The model shows that these purchases reduce growth and welfare, and may lead to self-fulfilling crises. It also shows how crowding-out effects can be transmitted to other countries in the Eurozone, and how they may be addressed by policies at the European level.

The Cross-Border Contagion and Competition Effects of Bank Bailouts Announced in October 2008

The paper studies the domestic and cross-border effects of government bailouts in October 2008 on the CDS spreads and stock prices of 63 banks in eight countries. The study examines the variation across domestic banks receiving similar support, as well as the cross-border effects versus foreign rivals. Bailouts benefit both domestic bank creditors targeted by the support and foreign rivals, with CDS spreads narrowing. Government recapitalizations generate idiosyncratic stock price reactions, benefiting or hurting some banks relative to their domestic peers with share prices diverging. The reactions are stronger for banks that compete directly. Globally, US banks outperform banks in other countries, particularly UK banks. The evidence suggests bailouts are associated with contagion events for bank creditors but competition effects for banks shareholders.

Sovereign Debt Markets in Turbulent Times: Creditor Discrimination and Crowding-Out

In 2007, countries in the Euro periphery were enjoying stable growth, low deficits, and low spreads. Then the financial crisis erupted and pushed them into deep recessions, raising their deficits and debt levels. By 2010, they were facing severe debt problems. Spreads increased and, surprisingly, so did the share of the debt held by domestic creditors. Credit was reallocated from the private to the public sectors, reducing investment and deepening the recessions even further. To account for these facts, we propose a simple model of sovereign risk in which debt can be traded in secondary markets. The model has two key ingredients: creditor discrimination and crowding-out effects. Creditor discrimination arises because, in turbulent times, sovereign debt offers a higher expected return to domestic creditors than to foreign ones. This provides incentives for domestic purchases of debt. Crowding-out effects arise because private borrowing is limited by financial frictions. This implies that domestic debt purchases displace productive investment. The model shows that these purchases reduce growth and welfare, and may lead to self-fulfilling crises. It also shows how crowding-out effects can be transmitted to other countries in the Eurozone, and how they may be addressed by policies at the European level.

Public debt and shifting of the debt burden from one generation to the next. Further considerations: do outright monetary transactions (OMT) comply with the EU Treaty?

In connection with the immensely increasing public debt both within the European Union and in other leading industrial countries of the world, reproaches are made again and again that this constitutes also an increasing burden for the future generations of the population of these countries. Such generalizations are wrong, however. Objective treatment of this problem requires differentiated consideration. We should keep public debt owed to domestic creditors (internal public debt) strictly separate from that owed to foreign creditors (international public debt) in these countries regardless of whether the creditors are natural or legal persons. Where does monetary policy end and fiscal policy begin? These issues are currently subjects of heated disputes and controversies. There is no general answer for them and also courts cannot decide them. Answers can in principle be found only in a specific situation and by taking into account specific macroeconomic framework conditions.

Seven Ways to Deal with a Financial Crisis: Cross‐Country Experience and Policy Implications1

This article presents a taxonomy of financial restructuring strategies that have been used by national policy makers to manage financial crises in the past. The goals of financial restructuring are to preserve or, if necessary, restore the debtor‐creditor relationships on which the economy depends for efficient allocation of capital, and to do so at minimal cost. Costs include not only the direct costs to taxpayers of financial assistance, but also—and likely more important—the indirect costs to the economy that stem from misallocations of capital and incentive problems resulting from the restructuring.Countries typically apply a combination of tools, including decentralized, market‐based mechanisms as well as government‐managed programs. Market‐based strategies generally aim to strengthen the capital base of financial institutions and borrowers using some mix of debt forgiveness and capital infusions. Government‐led restructuring strategies include the establishment of entities to which non‐performing loans are transferred as well as government‐assisted sales of domestic financial institutions, often to foreign entrants.Market‐based mechanisms can provide low‐cost ways of resolving the coordination problems faced by countries in the wake of massive debtor and creditor insolvency, particularly when those mechanisms are effective in achieving the desirable objective of selectivity—that is, devoting taxpayer resources only to those borrowers and banks that, with temporary assistance, will be capable of sustaining themselves in the future.But limiting their range of application mainly to developed economies, such market‐based mechanisms also depend on an efficient judicial system, a credible supervisory framework and authority with sufficient enforcement capacity, and lack of corruption in implementation. Although government‐managed programs may not seem to depend as heavily on well‐functioning legal and regulatory institutions, such approaches—especially the transfer of assets to government‐owned asset management companies—also rely to some extent on such institutions. Asset management companies are less likely to achieve their goal of resolving the overhang of debt at reasonable cost when legal and political institutions are weak and ownership of domestic creditors and debtors is highly concentrated. Especially in such cases, complexity and failure to consider incentive problems when designing specific rules governing financial assistance can aggravate moral hazard problems, unnecessarily raising the costs of resolution. Resolution mechanisms tend to be most successful when—like across‐the‐board debt forgiveness programs implemented through redenominations of debt—they are simple in design and afford quick resolution of outstanding debts, offering little discretion to governments while providing incentives for the private sector to work down the remaining debt overhang.

The Impact of Information Asymmetry, Moral Hazard and the Structure of Funding on Corporate U.S. Dollars Loan Pricing: The Empirical Study in Indonesia the Period 1990-1997

This study aims to answer the question: 'What factors that influence the price of corporate loans in Indonesia?' and 'Are there some differences in loan pricing between several types of creditors?'. Furthermore, this research is to develop and test the loan pricing model that was developed in America and Europe to the context or setting in Asia, especially Indonesia. Different conditions and settings of the financial system between America/Europe and Asia, especially Indonesia, causing the loan pricing model that was developed in America/Europe can not be fully implemented for Indonesia.Key issues in this study consisted of: information asymmetry, moral hazard and funding structure. The first issue, information asymmetry consists of the type of creditors, foreign and domestic ownership, public and non-public ownership. The second issue, moral hazard problem consists of variables governmental and non-government ownership, and the special relationship between creditors and debtors. The last issue, creditors’ structure of funding is proxied by the ratio of CD/ML. In addition, this study also adobt the loan pricing models that are developed in America/Europe as control variables. This study also examines the argument of Strahan (1999) whether the loan fees also reflected the condition of the loan as well as loan spreads.The OLS regression (Ordinary Least Squares) with white correction method (White heteroskedasticity correction) for heteroscedasticity problem is conducted to test the model. Various samples and sub samples are prepared to answer various research questions and hypotheses. Testing between regression coefficients are conducted to examine differences in loan pricing between different types of creditors for each variable in the model.The test results generally show that only two new variables suggested by the study, namely: ownership and structure of funding have a significant contribution to the loan pricing model. For variable type of institution consisting of investment banks and commercial banks indicate that generally there is no difference in loan pricing between the two, only in some models of these variables are not significant with signs consistent. Ownership variable show results consistent with the hypothesis and significant effect on loan prices. While the variable special relationship between creditors and debtors have no effect on loan prices, it is due to inter-group loans made by conglomerates. For the case of capital costs of the creditor shows that the variable has a positive effect on lending rates set by creditors. Testing different regression coefficients lead to the conclusion that domestic creditors succeeded in detecting an increased risk of the debtor before the economic crisis of 1997 compared with foreign creditors.

A model law framework for the resolution of G-SIFIs

Global systemically important financial institutions (G-SIFIs) operate thousands of entities on many continents and engage in various business activities such as banking, investment banking, insurance, proprietary trading and commercial activities. These fragile enterprises have financial structures that can deteriorate very quickly because they operate with significant leverage, rely on uninsured short-term debt and engage in maturity transformation. This necessitates swift action to prevent increasing losses and to limit the systemic consequences when a G-SIFI fails. International cooperation is necessary to reach an optimal solution; however, national considerations often trump international cooperation. When a G-SIFI nears insolvency, national authorities come under immense political pressure to take actions to protect their constituents at the expense of stakeholders in other jurisdictions.1 Domestic creditors want to limit their losses, and taxpayers want to avoid a bailout. The taboo word bailout is controversial and some national authorities will want to avoid a bailout...

Home Bias in Interbank Lending and Banks’ Resolution Regimes

In recent years, banks have become increasingly aware of the credit risk borne in lending in the interbank market and they select their counter-parties accordingly. They may also fear that if they come across a bad borrower, rescue plans will be skewed towards domestic creditors; moreover, lenders may prefer to defend their rights in their own regulatory and legal jurisdiction. Using 2004-09 data, this paper argues that these elements, the “resolution edge” of the domestic creditor, contributed to the increase in the home bias of interbank lending by euro-area banks from mid-2007 on, while a more consistent downward pattern emerges in the home bias of banks from five non-euro-area countries (including the US and the UK). The intuition is that when the crisis broke out, euro-area banks reckoned that within-the-area cross-border interbank loans carried a distinct risk compared with domestic loans. By contrast, a large Swiss bank, for example, did not need to wait until 2007 to gauge that its business in New York was a very different matter from a deal in Zurich.

Interdependent bank runs under a collapsing fixed exchange rate regime

This paper provides a framework for simultaneous multiple bank runs in a country experiencing a currency crisis. The correlation of bank runs increases as the proportion of debts from foreign creditors (indexed to the dollar) to domestic creditors (indexed to the domestic currency) increases. Moreover, when the share of dollar debt is sufficiently high, this interlinkage is perfect; that is, runs occur in all banks or not at all. Consequently, a situation exists where even a solvent bank cannot borrow in the interbank market. These findings imply that as the domestic banking sector becomes increasingly dependent on dollar debt, there is a heightened requirement for dollar reserves and a lender-of-last-resort facility.

DEBT, DEMOCRACY AND REPRESENTATION IN SOUTH AFRICA

Contrary to most newly independent colonies which borrowed extensively in order to fuel economic growth and development, the post‐apartheid South African government pursued a different path. With the advent of democracy in 1994 they chose to stabilize the economy and reduce public debt via the adoption of an austere fiscal programme. We argue that the choice was made in order to gain greater policy independence from creditors and portray an image of sound fiscal management to potential international investors. The consequences of the decision were, however, quite the opposite. The South African government’s austere and prudent response to debt made its bonds more attractive. It has therefore become more, not less, dependent on the constraints of creditors, albeit international creditors, and so more subject to investor scrutiny and sentiment. And, yet, as a result of the fact that in South Africa the interests of domestic creditors do not enjoy formal, political representation, South Africa still lacks creditworthiness and remains a relatively risky place in which to invest.

Alexander Hamilton's market-based debt reduction plan a comment

As noted by Garber, the debate over the payment of the domestic debt was long and complex. In fact, the arrangement reached by Hamilton and accepted by the Congress was a compromise, and the outcome for creditors could have been far worse. Many people at the time wanted to pay less to the domestic creditors. The motivation for these plans was the fact that much of the debt was not held by t’he original recipient. The popular outcry against the “speculators” who had purchased the securities was substantial. As one writer put it, “It is wished to sacrifice the mnny to a few...to make noblemen and nabobs of a few New York gentlemen, at the expense of all the farmers in the United States” (quoted in Ferguson, 1961, p. 301, italics in the original). It is likely that Hamilton was wrong in his claim that only a third of the debt was held by alienees (Garber, p. 90). For the states of Massachusetts, Maryland, Pennsylvania, a.nd R.hode Isla.nd, data are available on the fraction of the federal debt held in state which had been transferred before the federal loan of 1790. For these states the average fraction held by the original creditors was less than 30% (Ferguson, 1961, pp. 273-83). In Virginia, 65% of the debts had been tra.nsferred by 17S6-only two years after many of the securities had been issued (Ferguson, 1961, pp. 254-5).

Legal Treatment of Foreign and Domestic Creditors

will always be found in every State a large mass of politicians, who will deem it more safe to consult their own temporary interests and popularity, by a narrow system of preferences, than to enlarge the boundaries, so as to give to distant creditors a fair share of the fortune of a ruined debtor. International trade has learned through cosdy experience the truth of this statement of Story.1 Differentiation in the treatment of the resident and the distant creditor is an old ill. There are few countries in which there have not been tendencies at some time to favor the local creditor. Differentiation is still practiced in various countries. The fear of its consequences, as well as the security measures adopted in protection, hamper international trade. The local creditor obtains preference in different ways. They are not always easy to recognize and not generally known. Insufficient documentation has been a major handicap in dealing with the subject of discrimination. A presentation of some types of existing inequalities in the treatment of the foreign and the domestic creditor may be helpful in efforts to overcome differentiation.

Foreign and Domestic Creditors in Bankruptcy Proceedings. Remnants of Discrimination?

One of the resolutions adopted by the First Conference of the Inter-American Bar Association 1 dealt with the protection of foreign investments. The academies, institutes, and associations of lawyers, particularly those which are members of the Inter-American Bar Association, were urged to exert influence in their respective countries in behalf of uniformity in matters relating to foreign investments. It was asked that, in such uniform legislation, principles be included which, while assuring the integrity and economic and commercial progress of each country, shall at the same time afford the foreign investor sufficient protection to encourage such investments.2 Any law relating to the exercise of creditor rights and which differentiates between domestic and foreign creditors by granting priority rights to the former, is, in fact, in opposition to this resolution. If foreign creditors are to be paid only after payment of domestic creditors, they are not sufficiently protected. It is a wide-spread belief that, in some countries, such discrimination between foreign and domestic creditors still exists. If this is true, a change will not be effected merely by passing resolutions of a general character. Cases of alleged discrimination must be cited to insure clarification, and to provoke modification in the domestic legislation, if necessary. Foreign criticism of domestic legislation is often resented, especially if the questions involve fairness to other countries.3 In a world