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

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.