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The menu approach to developing country external debt : an analysis of commercial banks'choice behavior

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  • Diwan, Ishac
  • Demirguc-Kunt, Asli

Abstract

This study provides evidence that bank characteristics are significant determinants of commercial-bank choice behavior when confronted with a menu of options. It develops a theoretical model of bank choice behavior and empirically tests its implications using data from the 1988 Brazilian financing package. The empirical results show that bank characteristics are capable of explaining over 80 percent of this choice. One of the main implications of the theoretical model is that under risk-neutrality assumption, financially stronger and more exposed banks prefer to exit. The findings have several important implications for the new debt reduction strategy. (i) First, larger debt reductions operated on a market basis are more costly, per unit of debt reduced. In order to increase debt reduction, weaker banks must be convinced to exit, increasing the needed exit price. (ii) Second, the exit price depends on the strength of the banking industry, and thus, the effectiveness of the present debt strategy is affected by changes in the world economy. In periods of booms, banks become stronger and exit prices are reduced. (iii) Third, regulators can affect the cost of debt reduction by altering the regulatory framework within which the banks operate. (iv) Fourth, LDC debt reductions are beneficial to the deposit insurance agencies of the major creditor nations.

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Bibliographic Info

Paper provided by The World Bank in its series Policy Research Working Paper Series with number 530.

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Date of creation: 30 Nov 1990
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Handle: RePEc:wbk:wbrwps:530

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Related research

Keywords: Financial Intermediation; Economic Theory&Research; Municipal Financial Management; Financial Crisis Management&Restructuring; Banks&Banking Reform;

References

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  1. Jeffrey Sachs & Harry Huizinga, 1987. "U.S. Commercial Banks and the Developing Country Debt Crisis," NBER Working Papers 2455, National Bureau of Economic Research, Inc.
  2. Kareken, John H & Wallace, Neil, 1978. "Deposit Insurance and Bank Regulation: A Partial-Equilibrium Exposition," The Journal of Business, University of Chicago Press, vol. 51(3), pages 413-38, July.
  3. Russell Davidson & James G. MacKinnon, 1982. "Convenient Specification Tests for Logit and Probit Models," Working Papers 514, Queen's University, Department of Economics.
  4. William F. Sharpe, 1977. "Bank Capital Adequacy, Deposit Insurance and Security Values, Part I," NBER Working Papers 0209, National Bureau of Economic Research, Inc.
  5. Amemiya, Takeshi, 1981. "Qualitative Response Models: A Survey," Journal of Economic Literature, American Economic Association, vol. 19(4), pages 1483-1536, December.
  6. Sharpe, William F., 1978. "Bank Capital Adequacy, Deposit Insurance and Security Values," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 13(04), pages 701-718, November.
  7. Kareken, John H, 1986. "Federal Bank Regulatory Policy: A Description and Some Observations," The Journal of Business, University of Chicago Press, vol. 59(1), pages 3-48, January.
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Citations

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Cited by:
  1. Detragiache, Enrica, 1991. "Sensible debt buybacks for highly indebted countries," Policy Research Working Paper Series 621, The World Bank.
  2. Fernandez, Raquel & Ozler, Sule, 1991. "Debt concentration and secondary market prices," Policy Research Working Paper Series 570, The World Bank.
  3. Eaton, Jonathan, 1993. "Sovereign Debt: A Primer," World Bank Economic Review, World Bank Group, vol. 7(2), pages 137-72, May.
  4. Raquel Fernandez & Sule Ozler, 1991. "Debt Concentration and Secondary Markets Prices: A Theoretical and Empirical Analysis," NBER Working Papers 3654, National Bureau of Economic Research, Inc.

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