International bank lending in perspective International lending by commercial banks has risen very rapidly more slowly and with less disruption of since 1971. The authors of this article examine the implications of their economies. this growth for international inflation and for the conduct of Nevertheless, many questions about the monetary policy in the major industrial countries. ultimate macroeconomic implications of the expansion of international bank credit still await a satisfactory answer. In particular Andrew Crockett and Malcolm Knight there is the question whether the growth of Eurocredit leads to uncontrolled liquid- The past few years have witnessed a spec- countries in 1972-73, the large current ac- ity expansion. Do commercial banks, tacular growth in international credit mar- count deficits of the non oil-countries after through their international borrowing and kets. Total international bank claims on 1973, and the depressed level of domestic lending activities, act as an independent nonbanks rose from $61 billion at the end loan demand in the industrialized coun- cause of inflation in the sense that they can of 1970 to $405 billion in December 1977 tries which has persisted since late in 1974. increase world liquidity independently of (see the table). The average annual rate of It seems clear that the commercial bank- domestic money supply growth in the ma- increase during the seven-year period was ing system has played a most important jor industrial countries? To answer this, it just over 31 per cent, although the growth role in recycling surplus funds from mem- is necessary to understand the factors which rate was far from constant from year to bers of the Organization of Petroleum Ex- lead to growth in Eurocredit markets. year. porting Countries (OPEC) and several in- The major factors which contributed to dustrial countries to non-oil exporting Factors affecting growth the expansion were the relative ease of countries. This has financed a substantial International banking encompasses two domestic monetary policies in the major segment of balance of payments deficits distinct types of activity. The first occurs industrial countries during the early 1970s, and has permitted the subsequent adjust- when a bank in a particular country en- the overoptimistic projections for the ments in the borrowing countries' domes- gages in domestic currency borrowing or growth prospects of primary producing tic output and absorption to take place lending vis-a-vis nonresidents. The second Estimated total external bank claims on nonbanks as reported for major financial markets, 1970-77 (In billions of U.S. dollars) 1970 1971 1972 1973 1974 1975 1976 1?ZZ Dec. Dec. Dec. Dec. Dec. Dec. Dec. March June Sept. Dec. U.S. banks 24 33 41 56 83 98 123 123 129 134 142 Head offices1 12 14 16 20 32 38 48 45 47 49 52 Branches2 12 19 25 36 51 60 75 78 82 85 90 Of which: In the United Kingdom (7) (9) (11) (15) (19) (17) (18) (19) (19) (20) (22) In the Bahamas and Caymans (2) (4) (5) (9) (14) (19) (29) (30) (33) (33) (32) Banks3 in Western Europe,4 Canada, and Japan 37 44 60 98 137 162 207 217 231 241 263 Total 61 77 101 154 220 260 330 340 360 375 405 U.S. banks'share of total (39) (43) (41) (36) (38) (38) (37) (35) Source: Bank for International Settlements, U.S. Federal Reserve, and Exchange and Trade Relations Department, IMF. ' Short-term and long-term external claims excluding claims on banks and their branches, as measured by the latter s liabilities to parent banks. 2 Claims on foreign (non-U.S.) official institutions and nonbanks. 3 Excluding branches of U.S. banks. ' Belgium-Luxembourg, the Federal Republic of Germany, France, Italy, the Netherlands, Sweden, Switzerland, and the United Kingdom. Finance b Development I December, 197S 45 ©International Monetary Fund. Not for Redistribution involves a Eurocurrency (foreign currency) these deposits have an expansionary im- and thereby induce a "leakage" of part of transaction, when a bank in one country pact on Euromarket aggregates. If a coun- the original inflow. But the Eurocurrency issues liabilities or purchases assets which try which holds its official foreign ex- markets are so vast that domestic interest are denominated in the currency of some change reserves in the United States has a rates and financial conditions, even in the other country. Thus, a dollar-denominated deficit with another country which keeps United States, cannot be taken as given loan made to Brazil by a New York bank is its reserves in the Euromarket, official and may be altered by deposit transfers classified as a foreign credit, while a similar monetary movements between the two will vis-a-vis Eurobanks. This fact severely lim- loan granted by a bank in London would inject reserves into the Euromarket, per- its the usefulness of the deposit multiplier be regarded as a Eurodollar credit. For some mitting an expansion of deposits and loans. concept as a method for mechanically pre- purposes, it is important to distinguish Given this pattern of initial inflows, how dicting the growth of Eurocurrency aggre- these transactions clearly: in most coun- is the expansion of the market determined? gates. tries, for example, foreign lending and bor- The ultimate increase in Euromarket ag- These limitations of the multiplier ap- rowing in domestic currency are subject to gregates will not be identical to initial de- proach have led to an alternative view of stricter banking regulation than are Euro- posit inflows because there are always international credit expansion: that, since currency transactions. As our concern is subsequent flows induced by interest Eurobanking is largely unregulated, there with the overall growth of international differentials and portfolio adjustments. is no limit to the potential expansion of the bank lending, however, we will include This, together with the fact that Eurobanks market as long as creditworthy borrowers both types of activity under Euromarkets hold only a very small proportion of their are willing to use it. At first glance this or off-shore markets. assets in the form of prudential reserves, view that Eurocredit is demand deter- Eurocurrency deposits and loans expand has encouraged some economists to at- mined may seem appealing. But it is tena- whenever funds flow into the Eurobanking tempt to analyze the behavior of the mar- ble only if it is assumed that central banks system, as deposits with Eurobanks, either ket by using money multiplier concepts. in the major industrial countries always from private sources or from central banks. The concept most commonly used—the pursue an accommodating credit policy that For example, in the case of Eurodollar de- initial deposit multiplier—attempts to cal- allows the Eurobanks to obtain all the de- posits, which make up the largest part of culate the ultimate increase in Eurocur- posits they want at constant cost (that is, at the market, there are three types of trans- rency aggregates on the basis of a given in- stable money interest rates). Although in actions causing such flows: (1) transfers of flow of deposits. With given initial levels of the 1960s central banks often had a policy funds to the Eurodollar market by banks or U.S. and foreign interest rates, this multi- of stabilizing nominal interest rates, it is other private residents of the United States; plier is obviously less than 1, since a $100 now generally recognized that such a pol- (2) transfers by private residents (banks or initial deposit inflow will encourage Euro- icy would quickly lead to inflation, even in nonbanks) of other countries; and (3) cen- dollar rates to fall relative to foreign rates a world without Eurocurrencies. As a re- tral bank placements of reserve accruals in sult, monetary authorities in the major in- the Euromarket, either directly or via the dustrial countries have shifted the focus of intermediation of the Bank for Interna- Andrew D. Crockett their policies from nominal interest rates to tional Settlements. The first type of flow, monetary growth targets. Because Euro- which is the result of the portfolio behavior banks can attract additional funds only by of private U.S. residents, can be caused by bidding them away from domestic finan- one or more of the following factors: (1) a cial institutions, such deposit transfers must fall in U.S. interest rates relative to Euro- a citizen of the United act to tighten credit conditions in national dollar rates; (2) an increased desire for as- Kingdom, is a graduate of money markets, thus tending to slow down set diversification; (3) a fall in the covered Cambridge University the shift of funds to the Euromarkets. yield on foreign assets or (4) an expected (U.K.) and Yale University As explanations of the growth in inter- appreciation of the U.S. dollar. (U.S.A.). He was a national bank lending, both the multiplier Eurodollar inflows initiated by banks or member of the staff of the and demand-determined approaches are nonbanks outside the United States in- Bank of England from 1966 until 1972, when he unconvincing. In our judgment, a more joined the Fund staff. He is presently Advisor, volve a portfolio shift out of domestic cur- balanced view may be derived from the ar- , Middle Eastern Department. rency assets and into dollars. These shifts guments which lead us to reject them. occur for reasons comparable to those listed While weak domestic loan demand in the above. If central banks are intervening to Malcolm Knight industrial countries and the appearance of prevent their exchange rates from depre- the OPEC surplus have been important ciating by buying domestic currency with contributing factors, it is not possible to dollars, there will be a fall in their official pinpoint a single cause for the rapid growth dollar reserves.