World Bank Document

Box 6.3
The international interbank market
National banking markets are closely linked through the * Some banks attract more deposits than they immediworkings
of the international interbank market. In the ately want to use, while others are unable to exploit lendmid-1970s
only a few hundred banks participated in the ing opportunities because of a shortage of funds. The
interbank market. By the early 1980s, their number had interbank market acts as a clearinghouse, increasing the
grown to well over a thousand banks from more than efficiency of banking services.
fifty countries. The size of the interbank market, that is, * It permits banks to manage the exchange and intertotal
cross-border interbank claims, amounted to some est rate risk that arises from their customer business,
$1,950 billion in rnid-1984. The only entry criterion for a because they can match precisely their assets and liabilibank
is that it must be creditworthy in the eyes of other ties.
participating banks; banks of different creditworthiness Both of these functions serve to increase the stability of
command different credit limits and terms on their busi- the international banking system. In recent years, the
ness.
market itself has been tested by debt difficulties and
The interbank market is informal, is conducted by tele- bank failures. This has forced banks to reevaluate the
phone or telex, and trades mainly in dollars. It is not credit quality of their interbank transactions, and those
independent of other markets. Interbank interest rates from Latin America and Eastern Europe have had to pay
move closely in line with those in domestic money mar- stiffer terms for their interbank borrowing. Inasmuch as
kets, with funds flowing-where exchange controls per- banks are becoming more discriminating, the internamit-between
them. This is because most banks are tional interbank market is becoming a higher quality
active in domestic as well as international markets.
market and hence a more stable one.
The interbank market performs two main functions:
developing countries' debt management in that countries have a potentially wider range of borshifts
in sentiment in one market rebound increas- rowing opportunities because of their greater credingly
on fund availability in another.
itworthiness. But the existence of sovereign risk,
* There has recently been a stagnation of official as Box 6.4 explains, limits this range, particularly
flows and direct foreign investment at a time when in comparison with sovereign borrowers from
banks want to lend less to developing countries. industrial countries. Commercial banks, because
This is a matter of particular concern. Greater of their widely ranging business relationships with
cooperation between official and private lenders developing countries, have a comparative advanhas
been one response to the problem. Banks have tage in sovereign lending. Governments have in
increasingly lent in conjunction with IMF adjust- some instances a degree of political leverage in the
ment programs. The World Bank has also sought provision of official finance, and so have a similar
to increase the financing available to developing advantage. Direct investors are at a distinct disadcountries
through the expansion of its cofinancing vantage in coping with sovereign risk. This is one
program. The official sector is in some instances reason why national schemes for investment
playing the role of catalyst for the private sector; insurance and, more recently, a private insurance
an example is the IFC through its encouragement market have sprung up. Bond investors are also disof
equity investment. There are also several initia- advantaged, and so bond finance has not been a sigtives,
including a proposal for a multilateral invest- nificant form of capital for developing countries.
ment guarantee agency (see Box 9.5 in Chapter 9), As Chapter 5 made clear, for a developing counto
increase direct foreign investment through the try to obtain external finance carrying a suitable
provision of more extensive investment insurance. combination of cost and risk, it may need a mixed
portfolio of liabilities. The broader the mix of liabil-
Assessing the institutional arrangements
ities, the less exposed are developing countries to
interruptions in the supply or increases in the cost
Developing countries have to match their external of any one element. The desired mix may contain
financing needs to the type of capital that is avail- the following.
able. For example, most low-income countries * Equity and debt to reduce commercial risks
have only limited access to commercial finance. and ensure that interest or dividends correlate
They are almost totally dependent on concessional with the borrower's ability to service the external
flows from official sources and on official or offi- capital.
cially guaranteed trade credits. The middle-income * Different currency denominations of loans to
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