The Debt Problem

Banks are inherently a risky business. They handle large amounts of money that is mostly not their own. Additionally, they create money and make loans far in excess of their net worth. While they may take adequate precautions, the banks know that some loans will turn bad. Therefore a certain amount is set aside as loan reserves to cover bad debts. But if an unusual number of loans turn sour, those reserves will not be sufficient to cover the large loan losses, or a run on the bank. “The more equity that’s at risk because of bad loans, the weaker the bank gets financially,” states New York magazine. “Bankruptcy (or failure) occurs when all the bank equity is used up.”

More and more banks today are finding themselves in just that position​—too many of their loans are turning sour, and there is insufficient capital to back them up. The reasons given are legion: the oil crisis, trade restrictions and deficits, downturns in the economy, unstable interest rates, capital flight, inflation, disinflation, recessions, overly aggressive lending policies, corporate bankruptcies, fierce competition, deregulation​—even ignorance and stupidity.

But there are ways to stay alive​—on paper. Rescheduling the loans, stretching the debt over a longer period, is one means used and reused. Another is to list the loans at full value, though there may be little hope of having the principal paid in full. An oft used tactic is to lend the borrowers more money so that they can make their interest payments.

All these methods are currently being used by banks in regard to Third World debt, considered by many to be the greatest threat to the stability of the international banking system. According to a World Bank survey, the external debt of over a hundred developing nations reached a combined total of some $950 billion at the end of 1985, an increase of 4.6 percent over the previous year. Although already too large, it is expected to reach $1.01 trillion by the end of 1986. Why? Because many of those nations simply cannot repay and are pressing for more time and money. Taking into account the enormity of their loans, the banks have complied. As one person puts it: “If I owe you a dollar, I am in your power; but if I owe you a million, you are in my power.”

Always looming ahead is the possibility that some deeply indebted nations, tiring of the hardships of austerity programs, may just decide not to pay at all. The banks cannot force sovereign states to pay. “For banks, the meaning of the global debt crisis is simple,” states Savvy magazine. “They earn most of their profits by making loans, and if countries cannot repay their huge loans, banks’ profits, capital bases, and stock prices could fall precipitously. . . . Significant Third World defaults could stretch the financial system to the breaking point, possibly resulting in the collapse of major banks.”

A default by just four nations​—Mexico, Brazil, Argentina, and Venezuela—​could bring about the collapse of the nine largest U.S. banks, experts warn. “That actual defaults have not taken place is remarkable,” states The New York Times Magazine. “One could, of course, attribute it to semantics. Just as wars are no longer ‘declared,’ no one is now declared ‘legally’ in default.”

“Is My Bank Safe?”

Can one tell if a bank is strong and solvent? “For most depositors it’s difficult or impossible to find out what shape a bank” is in, states the magazine Changing Times. Adds The New York Times: “Recent experience has shown that it is extremely difficult for outsiders to judge the soundness of a bank. Practically every large bank that collapsed in recent years, or nearly collapsed, had been highly touted by bank-stock analysts. . . . Even bank regulators and auditors were unable to detect serious troubles until it was far too late.”

Usually the most a customer does is examine the bank cosmetically: the types of services offered, the friendliness and speed with which he is served. In fact, where banks advertise, it is usually those things that they emphasize​—the friendly banker, the quick loan, special accounts or services, convenience. Sometimes gifts are offered to lure in new depositors. But little is said about the financial standing of the bank. Of course, a bank’s services are important. Also to be noted is the interest given and how it is compounded, as yields will vary. Of utmost importance to the depositor is the safety of his money.

Here, deposit insurance is the key. “Because of deposit insurance, unless there is an utter collapse of the banking system these are the problems of bankers and bank stockholders, not depositors,” says The Atlantic Monthly. “It is extremely unlikely that bank failures today could bring thirties-style losses of life’s savings to individuals.”

So it is good to check if accounts are insured and by whom. Government insurance, of course, is best. An example of this is the Federal Deposit Insurance Corporation in the United States. Some who were told that their accounts were insured later found that it was by a private agency with insufficient funds to repay all depositors when the bank failed. Check also the amount insured. If your account exceeds that limit, consider opening accounts in other banks so that all your money will be covered.

What Lies Ahead?

Individual bank failures are expected to continue and the number may even rise. Yet, what is of utmost importance to the banking system is that confidence in it be maintained. “A crisis would occur only if depositors interpreted these financial lurches as a reason to withdraw their money from the affected banks,” states Fortune magazine. Therefore, all-out efforts are being made to strengthen the system and keep that confidence strong.

Plans are also in motion to reduce the debt of Third World countries to manageable levels and aid them to meet their obligations. “In the final analysis, the enormous financial deficit will be absorbed by the taxpayers worldwide,” states Albin Chalandon, former French Minister of Industrial Planning.

How safe, then, are the banks? One bank official put it this way: “The banks are as safe as the governments that back them up.”

[Box on page 9]

The Banking Situation​—What Others Say

● “It is no overstatement to say that the governments of dozens of debt-ridden nations, the International Monetary Fund, the Federal Reserve Board, and hundreds of American and foreign banks together face the severest and broadest financial crisis since the 1930s.”​—New York magazine.

● “Present policies provide only a most precarious protection. The world’s financial safety is balanced on a knife-edge. The debt crisis threatens not only development in developing countries but also the stability of the banking system of industrial countries.”​—Report by a Commonwealth group of experts, The Guardian of London.

● “The immense debt owed to the banks of the United States by third-world nations is poised like a potential avalanche above the American banking system.”​—The New York Times Magazine.

● “The total global debt is so massive that it has laid the groundwork for a first-rate debt crisis in the international banking system.” “The supreme irony of the global debt crisis is that the banks are in so deep they can’t get out without bringing down the whole house of cards.”​—Savvy magazine.

● “The situation today is more critical and more dangerous than it was in the 1930s.”​—West German economist Kurt Richebächer, U.S.News & World Report.