Three Booms, Three Ways Risk Travels

The subject here is how international credit-supply expansions became vulnerable in three different historical settings: Latin American sovereign lending, the Asian financial boom, and the Great Financial Crisis. The focus is not to declare that these crises had identical causes, but to compare who supplied the credit, how it was funded, where the exposure accumulated, and what turned expansion into retreat. That comparison lets readers use the cases as mechanism-based warnings without mistaking historical resemblance for a deterministic forecast.

When abundant funding met eager borrowers

The Latin American debt crisis began with a long expansion in international bank credit, not with the default that made the danger unmistakable. By the late 1960s, competition had compressed margins on cross-border lending to advanced economies. Banks seeking higher returns moved toward emerging-market borrowers, especially sovereigns. US banks were dominant in the early 1970s, while Japanese and European banks gained ground later in the decade. The lending capacity of banks outside the United States was further supported after the 1973 oil-price rise, when deposits from oil-producing states eased their funding conditions.

Borrowers in Latin America initially sought funds for industrialization and imports. Later, some borrowed to meet the cost of servicing their growing debts. That change in use matters, but the BIS account emphasizes the lending environment as well: banks competed to meet demand, considered sovereign borrowers relatively safe, and eased lending terms while volumes were high. The expansion was measurable. Cross-border claims on Latin America rose from $43 billion at the end of 1974 to $197 billion in the middle of 1982, more than quadrupling in less than eight years.

At the time, each component could be given a reasonable local explanation. A government needed development finance. A bank had access to new deposits and a borrower willing to pay. A syndicated loan could distribute an individual exposure across many lenders. But a system-wide expansion changes the meaning of those decisions. When many banks make similar foreign-currency loans to borrowers whose revenues and public finances are exposed to the same external conditions, diversification across institutions may not diversify the underlying shock.

Mexico’s announcement in August 1982 that it could not meet its foreign-currency debt obligations exposed that common vulnerability. Interest-rate and exchange-rate risks had initially been transferred to borrowers through the design of the loans. Once the borrower could not absorb those risks, they emerged as credit risk on international banks’ balance sheets. The default was the trigger; the preceding lending surge had determined how much correlated exposure the banking system had to absorb.

The Asian case followed a different route into a related problem. In the 1980s, low capital costs enabled Japanese banks to increase leverage and expand internationally. Their expansion was particularly strong in interbank lending during the second half of the decade. Concerns that Japanese banks were undercapitalized were one impetus for the first Basel capital accord in 1988, an early sign that the international banking boom was affecting the design of supervisory standards as well as the allocation of credit.

After Japan’s asset-price bubble began to burst in 1990, Japanese banks retrenched in some areas but continued to expand their claims on emerging Asia. Those claims doubled from $60 billion at the end of 1990 to $124 billion in the middle of 1997.