Loan pushing and triadic relations.

AuthorDeshpande, Ashwini
  1. Introduction

    The process of sovereign lending in the 1970s appears to consist of voluntary and mutually agreeable contracts between the transnational commercial banks and credit-seeking developing countries. The suggestion that there could be in this process an element of aggressiveness on the part of the commercial banks that actively and systematically pushed loans on to developing country borrowers, may at first sight, seem inconceivable. If a borrower voluntarily enters into a loan contract, he is obviously doing so because the contract is beneficial. If such is the case, then would it be correct to characterize the process as one of loan pushing? Also, the commercial banks are supposed to be rational profit maximizers. Thus, the amount of lending cannot be more than optimal. What then is meant by loan pushing? These are a few questions that immediately come to mind.

    It has been argued that international credit can contribute to increasing donor exports. (See, for instance, Winkler 1929; Hyson and Strout 1968; Gwynne 1983; Taylor 1985; Darity and Horn 1988; Basu 1991; Basu and Deshpande 1995.) This is indeed one of the arguments used to explain the phenomenon of loan pushing (however, not the only one). The aim of this paper is to explore the idea of loan pushing a little more deeply by first trying to understand the concept along with a brief review of the literature in the area (section 2). The confessions of a young banker (Gwynne 1983) provide the basis of the theoretical model (section 3), which considers a triadic relationship between a commercial bank in a creditor country, a debtor (nation), and a corporation in the creditor country and the compulsions of loan pushing arising therefrom. Section 4 tries to decipher the new banking philosophy that prevailed during the 1970s which facilitated loan pushing. Section 5 offers some concluding remarks.

  2. What is Loan Pushing?

    There is a small body of literature on loan pushing (Darity 1985; Lombardi 1985; Taylor 1985; Darity and Horn 1988; Devlin 1989; George 1989; Kindleberger 1989; Basu 1991; Vos 1994), where for the most part loan pushing is discussed as one of the many aspects of the international debt crisis(1) and is sometimes used synonymously with large-scale lending. Loan pushing is thus not exclusively (and widely) researched, and most of the discussion is, in fact, descriptive and open ended. Hence, we do not find a commonly accepted definition around which the literature is centered.

    Kindleberger (1989, p. 26), for instance, mentioned the concept of loan pushing by observing that in the early stage of the debt build up, "multinational banks swollen with dollars . . . tumbled over one another in trying to uncover new foreign borrowers and practically forced money on the less developed countries." Darity (1985) traced the idea that banks forced loans on borrowers to the literature exploring financial flows in the 1920s from lenders in the United States to borrowers in Germany and Latin America. He developed his analysis by identifying six major features that, according to him, were common to the 1920s as well as the 1970s.(2) He quotes Max Winkler's work to describe an incredible instance of loan pushing in the 1920s: A Bavarian hamlet was reportedly seeking a loan of $125,000 to improve the town's power station After much persuasion, the mayor of the town was convinced of the desirability of contracting a larger loan. The result was a $3,000,000 issue sold successfully on the American market.

    The available work on the subject highlights several facets of loan pushing, which while revealing, does not provide an unambiguous definition of the term. Basu (1991, p. 24) bases his discussion on the following definition: "loan pushing occurs whenever the lending banks try to supply more credit to borrowing countries than the latter would take at the prevailing interest rate." This definition is predicated upon rigid interest rates, and to that extent, the model in the next section is similar.

    One of the features identified by Darity relates to the promotional-cum-persuasion aspect. The contemporary debt build up offers plenty of instances of loan pushing similar to the one that Winkler described for the 1920s. The most well known is the story told by Gwynne, a young ex-officer in a mid-sized U.S. bank in charge of making a loan to the Construction and Development Corporation of Philippines (CPDP). Although he was aware of the fact that he would be making the loan on shaky grounds, he decided to ignore danger signals and go ahead with the loan, mainly because of internal pressure. One of the bank's best domestic clients was an earthmoving equipment corporation, which was sure that the loan would be used by the CPDP to buy its equipment. Gwynne made the unsound loan, which, as he knew from the outset, would not be repaid. He explained his action as follows: "As a loan officer, you are principally in the business of making loans. It is not your job to worry about large and unwieldy abstractions, such as what you are doing is threatening the stability of the world economy. In that sense, a young banker is like a soldier on the front lines: he is obedient, aggressive and amoral" (Gwynne 1983, p. 24).(3)

    Jain (1986) provides evidence to suggest that the Gwynne story is not an isolated anecdote. His results indicate that the share of U.S. loans was significantly influenced by U.S. share of foreign investment and trade. Thus, "commercial banks of the U.S. seem to follow their domestic customers abroad" (Jain 1986, p. 82). Sales to the Third World were aggressive, as Lord Lever noted: Third World countries were "being sold steel plants and textile factories the same way that a discount store sells refrigerators" (quoted in Lombardi 1985, p. 103). This led to a separation of loan identification and sales from "credit analysis or lending in its proper sense." It has been argued that this separation accounted "for a number of the more spectacular abuses that have occurred in the lending patterns of the major multinational banks" (Lombardi 1985, p. 103).

    The anecdotal accounts bring to the fore various features of loan pushing in different contexts. It is likely that even if one definition of loan pushing for all contexts is not possible, context-specific definitions may be possible. The model in this paper does precisely that: it seeks to formalize one particular cause of loan pushing, namely, credit as an instrument of export promotion. This highlights one of the possible donor motivations in ensuring that a larger loan is contracted than the amount that the borrower initially desired at the given interest rate. (Note that this is the manner in which we defined loan pushing at the outset.) Thus, this is, analytically distinct from, say, Vos' (1994) model, where the market is seen to be demand-constrained, and oligopolistic lenders, in a bid to capture market shares, lend greater amounts at lower interest rates. Having said that, it should be noted that to capture the multifaceted nature of loan pushing, the relationships of the model have to be seen in conjunction with the textual discussion in the rest of the paper that describes the other features of the phenomenon.

    How Were Loans Pushed?

    Most of the major debtors in the 1970s debt crisis have been countries with a previous record of severe indebtedness and default. Thus the essence of loan pushing seems to have been devising a particularly attractive set of incentives, especially to those borrowers who formerly either have been denied access to capital markets or would have been denied such large quantities of funds had their previous record been taken into account.

    Gwin (1984) points out that these bank loans offered borrowers in the developing world more financing with less policy interference than when official lenders were the primary source. Not only was the volume of funds higher, but agreements could be concluded more quickly - in weeks or months rather than years, with lower spreads and higher maturities. The factor conducive to all of this was that, in real terms, interest rates on loans were at or near zero through most of the 1970s and actually were negative in the last years of the decade.

    The need on the part of the borrowers readily complemented the eagerness of the lenders to lend. This need stemmed from several factors, be it for capital imports or meeting balance of payment (BOP) difficulties. How much of this need was genuine and how much of this was inflated to facilitate misuse in order to support the extravagance of the ruling elite in the debtor country is a question that this paper cannot settle, but the fact is that it enabled loan pushing to go through without a hitch.

    Ultimately what resulted was a massive boom in lending, the magnitude of which has been documented in Deshpande (1995). Thus, while the question of whether the amount lent to each country was optimal or not certainly can be debated, the fact that the process resulted in the borrowers taking more loans than the amount that was in their collective self interest is now apparent.

    Splitting the interests of the borrowers so that they act against their collective self interest may also be a form of loan pushing. It could be argued that by doing so, the banks were also acting against their own collective self interest by making themselves vulnerable to default. Here, however, there are several reasons that demonstrate that many of the banks were in a completely secure position of pure gain.

    One of these reasons is the implicit insurance possessed by the banks for their loans through expected support from the International Monetary Fund (IMF). Moreover, lending was being conducted with a new banking philosophy...

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