I

The 1970s saw a rapid expansion of international bank lending to developing countries, particularly after the first oil shock had led to the ‘petrodollars’ recycling phenomenon. In parallel to the ongoing growth of international and multinational banking since the 1960s, large international banks massively invested in the developing world, because it was considered more profitable than domestic banking and as carrying little risk (James Reference James1996; Cassis Reference Cassis2011). Private lending overtook public lending to developing countries in the early 1970s.Footnote ⁴ After the first oil shock, the Federal Reserve, together with international organisations such as the IMF, the Organisation for Economic Co-operation and Development (OECD) and the BIS, considered international lending as an essential element of the recycling mechanism and therefore encouraged it (James Reference James1996). International lending enjoyed a good reputation, famously illustrated by the chairman of Citicorp Walter Wriston's comment that ‘countries don't go bankrupt’ (James Reference James1996, p. 352). By 1979, aggregate international assets of US banks were five times more important than in 1971, and for some major banks they represented more than half of total assets.Footnote ⁵ According to the BIS data, gross borrowings of ‘non-OPEC LDCs’ (Less Developed Countries) had grown by $14.3 billion on average every year between 1974 and 1977. They grew more sharply at the end of the decade to reach an increase of $39.9 billion in 1981 and a total of $246.9 billion at end 1982. For Eastern European countries there had been annual increases of $5.1 billion every year between 1974 and 1977, reaching a total of $53.3 billion at end 1982 (see Table 1).Footnote ⁶

Table 1. Estimated flows between the BIS reporting banks, non-OPEC LDCs and Eastern Europe, 1974–82 (in billions of US dollars at constant end-of-quarter exchange rates)

Source: BIS 1982–1983 annual report, p. 120.

Developing countries’ banking sectors, particularly in the Mexican case, became more vulnerable as domestic banks heavily relied on the international interbank market to finance their activities (Alvarez Reference Alvarez2015). By the end of the 1970s, these countries were severely affected by the second oil shock, high world interest rates and the world economic recession (Devlin Reference Devlin1989). Turkey, Zaire and Peru were already rescheduling their debts in the second half of the 1970s.Footnote ⁷ Even Mexico had already been through a debt crisis in 1976, which had led to the intervention of the US administration and the IMF (Kershaw Reference Kershaw2018). The situation dramatically worsened with the Polish debt rescheduling in 1981, and the Mexican default in August 1982 triggered a panic among large international banks. In the 1980s, over 50 countries would start a rescheduling procedure (Altamura Reference Altamura2017, p. 196).

International lending had unusual characteristics in the 1970s. The loans to sovereigns increasingly took the form of syndicated loans, where American banks had been particularly instrumental in inviting other banks. For newcomers, in particular Japanese banks, this represented a facilitated entry to a new market such as Latin America, and for American banks, this was a way to diversify risks (Katada Reference Katada, Hirata and Sato2008). Syndicated loans had been around for a long time, but before World War II they mostly existed at the domestic level, whereas in the 1970s they had gone global (Altunbaş et al. Reference Altunbaş, Gadanecz and Kara2006). The market for international syndicated loans first developed in the 1960s with the Eurodollar market, and evolved in the 1970s to focus more on sovereign lending in emerging economies (Altunbaş et al. Reference Altunbaş, Gadanecz and Kara2006; Battilossi Reference Battilossi and Kyrstis2010). Syndication also contributed to lowering banks’ perception of risks, as they thought they had diversified them properly. This was particularly the case for smaller and less informed banks participating in syndicates, an issue frequently mentioned by Basel Committee members.Footnote ⁸

However, country risk exposure was not just an American concern. By the early 1980s, European and Japanese banks had grown to such an extent that they figured among the biggest banks in the world. According to The Banker 1980 ranking of the ten biggest banks, seven were European, two were from the United States, one from Japan, and the Japanese share was rising fast.Footnote ⁹ According to a study of the Bank of France, by 1983 the exposure of Western and Japanese banks’ to indebted countries was distributed as follows: banks from the United States represented 40 per cent of total lending, Japanese banks 25 per cent, United Kingdom banks 15 per cent, French banks 8 per cent, German banks 7 per cent.Footnote ¹⁰ Even though these numbers are to be taken with caution as the lack of accurate data was precisely a key issue of the period, they show that Japanese and European banks were very important actors in international lending. Exposure varied significantly from one bank to another: in France, the Crédit Commercial de France was particularly fragile because its exposure was poorly covered by provisions.Footnote ¹¹ In the United Kingdom, Midland and Lloyds were particularly exposed to Latin America, with respectively 205 and 165 per cent of their capital exposed at end 1984 (Altamura Reference Altamura2017, p. 234).

Regulators had trouble defining country risk precisely, and even more trouble measuring it. The concept of country risk can be set within the context of a broader history of probability and the various ways that have been devised to measure and predict risk by mathematicians, economists and practitioners, but it is also closely intertwined with political power, colonial, post-colonial and Cold War contexts (Toksöz Reference Toksöz2014; see also Krayenbuehl Reference Krayenbuehl1985). If the term country risk was widely discussed in the 1970s, this was not a new phenomenon. Major payment crises had existed for a long time, from the nineteenth-century Latin American debt crises to the Bolshevik debt repudiation in 1918 and various expropriation acts following World War II (Marichal Reference Marichal1989; Dawson Reference Dawson1990; Malik Reference Malik2018). In the 1970s, authorities from the Group of Ten countries (G10) started to worry about the risk of possible default or balance-of-payment issues for individual banks but also, more generally, about the risks of increasing international lending for the financial system as a whole.Footnote ¹² Foreign lending was increasingly considered by authorities as less safe than domestic lending for various reasons, including the absence of any clearly defined lender-of-last-resort responsibilities, but also because of all kinds of events that were possible when banking across borders, such as sociopolitical changes or measures taken in the borrowers’ country (expropriation, exchange controls), natural disasters, world depression or oil price rise. Country risk was primarily a microprudential concern, that is a concern for the individual bank. However, in the context of the 1970s rise in international banking and general indebtedness of developing countries, supervisors could not ignore the risks run by the financial system as whole, and therefore the macroprudential dimension of the problem.

At the same time, the BCBS was emerging as the most important international body specialised in banking supervision. Established in late 1974 by central bank governors from the G10 countries after a series of banking failures in the United Kingdom, the United States and Germany, it met at the BIS in Basel, Switzerland. In its early years, the BCBS was meant to help the G10 central bank governors in their task of preserving the stability of individual banks and of the banking system as a whole. Initially, the Basel Committee was just an expert committee, although an important one, and would gain major regulatory power over time, as it became the global standard-setter for banks’ capital adequacy (Boey Reference Boey2014). The Committee was composed of high-ranking banking supervisors and foreign exchange specialists from the 12 member countries (the G10 plus Luxembourg and Switzerland), all from central banks and supervisory institutions. It thus represented the creditor countries, not the borrowing countries. Its initial remit was balanced between bank supervision and foreign exchange governance.

Banking supervision was an activity with marked national characteristics and different levels of development. In some countries like the United States, banking supervision had existed since the early nineteenth century, while in some others like the United Kingdom, where informal supervision was still widely used, it had only been established in 1974 (Mitchener and Jaremski Reference Mitchener and Jaremski2015; Capie Reference Capie2010, p. 654). Many countries (Belgium, Switzerland, Germany, the United States) had established or extended a formal system of banking supervision in the 1930s in the wake of the financial and economic crisis (Giddey Reference Giddey2012; Feiertag and Drach Reference Feiertag and Drach2018). By the early 1970s, banking supervision still often had limited staff and resources, but was the only profession really focused on the prudential dimension of regulation, that is on protecting depositors and ensuring that individual banks were not taking excessive risks, as opposed to the monetary dimension of regulation, which then formed the primary motive of banking regulation (for the case of France, see Monnet Reference Monnet2018). In all cases, banking supervision focused on the scale of the individual bank, as opposed to the system as a whole, and used tools such as audit and accounting data, or direct discussion with banks’ management, more than macroeconomic statistics, to perform its tasks. This microeconomic focus would have decisive consequences in banking supervisors’ assessment of the international debt situation in the late 1970s.

II

By the mid 1970s, supervisory thinking about country risk at the national level was still very much at the preliminary stage, except in the United States. When the Basel Committee first addressed the topic in March 1976, the chairman (Blunden, Bank of England) stated that he believed that ‘among the members of the Committee the United States had probably done most work in the field of country risks’.Footnote ¹³ The United States was more concerned about country risk because its banks were particularly and increasingly exposed to it. By 1981, US banks’ exposure to the Latin American debt reached 97.3 per cent of their capital and was well above 100 per cent in several individual cases (James Reference James1996, p. 352). American regulators, however, also disagreed among themselves. For example, in March 1976, the Comptroller of the Currency, James Smith, testified before the US Senate Banking Committee that his institution had ‘undertaken in the examination of international banking activities to classify and comment on international lending activity on the basis of sovereign or country risk’ and that it was ‘the only examining agency that so comments on international lending’.Footnote ¹⁴ A month earlier, in February 1976, the Federal Reserve governor Holland had claimed before the same committee that: ‘country risk exposure is too sweeping a label for a useful analysis of risk in international operations … The idea of a country risk concept, I believe frankly, is obsolescent if not obsolete.’Footnote ¹⁵ This hesitant state of mind changed throughout the decade, however, and the United States became much more active in the area of country risk by the end of the decade. In 1979, it set up an Interagency Country Exposure Committee gathering people from the three Federal regulation agencies (the Federal Reserve, the Federal Deposit Insurance Corporation, and the Comptroller of the Currency).Footnote ¹⁶ It was also instrumental in training and providing bank examiners to the IMF, who sent them to regulatory agencies in other countries.Footnote ¹⁷

The political economy of international finance in the second half of the 1970s revolved around the recycling issue. To some extent, the first oil shock had been considered as successfully absorbed by Western and Japanese banks. The financial system had handled the flows properly, which had itself reduced the perceived need for surveillance (James Reference James1996, p. 349). Several commentators spoke of a miracle (Altamura Reference Altamura2017). The IMF, the BIS and Working Party 3 of the OECD, which was focusing on international monetary and financial issues, all brought to the fore the efficiency of the private sector in the recycling mechanism. When the second oil shock arrived, it was hoped that the same approach would work: ‘The IMF, the BIS and WP3 of the OECD never questioned in a credible way the approach adopted to deal with the first oil crisis, and commercial banks in the West continued to expand their operations in the developing world’ (Altamura Reference Altamura2017, p. 196). Because it considered international banks were playing a key role in the recycling mechanism, the BIS was overall opposed to the regulation of international lending, as was the IMF, even though different opinions could coexist within these organisations.

The G10 countries disagreed about what to do in international banking, and particularly concerning the Eurodollar market. In the early 1970s Germany had been a proponent of regulatory measures in this field, in the form of minimum reserve requirements on Eurodollars, because it feared the effects of the Eurodollar on interest rates, unemployment and inflation (Altamura Reference Altamura2017, p. 199). It again submitted proposals for coordinated regulation of the Euromarket in the late 1970s, slightly before the second oil crisis. On the contrary, the United Kingdom was completely opposed to regulation as it feared it would damage the attractiveness of London as a financial centre (Cassis Reference Cassis2006, p. 224). The United States, on the other hand, had changed its position. It was against the regulation of the Eurodollar market in the early 1970s, partly because it considered that Eurodollars were not responsible for macroeconomic disturbances (Altamura Reference Altamura2017, pp. 95–6). However, it adopted a different attitude in the late 1970s, as it considered that the important worldwide demand for dollars facilitated by the Euromarket was pulling the supply of dollars. The American attitude was coherent with the more active position adopted by United States delegates in the Basel Committee regarding the regulation of country risk. Both Germany and the United States proposed to impose minimum reserve requirements similar to those they had at home in 1979, but the second oil crisis made their proposals lose weight, as they were considered difficult to implement. They also faced fierce opposition from the United Kingdom and Switzerland. France had a rather permissive position towards the Eurodollar markets even though it exerted very strict state control at home. It did not want to penalise its own banks in the international competition; rather, it preferred regulation in the form of exchange controls to which most countries were opposed, and it considered that Euromarket regulation was impossible as long as the United Kingdom was not ready to take part.Footnote ¹⁸ Japan was pushing the fast expansion of its banks internationally and did not want to stop their successful growth (Katada Reference Katada, Hirata and Sato2008). At the national level, existing regulations concerned capital ratios, limits to the concentration of risk on a single borrower, or foreign exchange activities, but in the mid to late 1970s, there was no formal limit in the BCBS countries to international lending to specific countries.Footnote ¹⁹

Basel Committee members and banking supervisors in general faced two challenges when discussing country risk: at the micro-level, delineating their responsibilities and those of commercial banks, and at the macro-level, delineating their role, which they conceived as primarily micro-focused, from that of central bankers dealing with macroeconomic problems. These two challenges caused much hesitation about whether or not to deal with country risk, and how. The phrase ‘country risk’ is mentioned for the first time at the March 1976 meeting in the records of the BCBS.Footnote ²⁰ Blunden (Bank of England), the chairman, explained that Lamfalussy, who was not a member of the Basel Committee but was an economic advisor at the BIS, the host institution of the Basel Committee, had suggested that he present a BIS paper on the question of total bank borrowings in various countries. Lamfalussy had just arrived at the BIS in January 1976 as economic advisor (Maes Reference Maes2011, p. 65). He was not a supervisor, but an economist in the Keynesian tradition. He had long worked in the private sector at the Banque de Bruxelles, where he became chairman, until the bank suffered heavy losses in foreign exchange operations in 1974, which made him particularly sensible to risks and financial stability (Maes Reference Maes2011, pp. 62–3). At the BIS, Lamfalussy would become a champion of financial stability concerns. In October 1976, the reaction of the Belgian delegate André, from the National Bank of Belgium, to an initial discussion on the question of country risk was that he was not sure that the topic was part of the Committee's mandate.Footnote ²¹ Within the Basel Committee, different opinions existed on the responsibility of supervisors in the field of country risk supervision.

Several members of the BCBS did not think that they were responsible for either risk assessment by banks or for the macroeconomic regulation discussed by other committees and institutions. However, several groupings within the BIS, such as the Euro-currency Standing Committee (ECSC) and a working group chaired by Lamfalussy, were raising prudential concerns when addressing macroeconomic issues in international bank lending. Therefore, the Committee felt that it could not ignore the question of growing risks in international lending that these other groupings were examining.Footnote ²²

Three related questions emerged in 1978 in the deliberations of the Basel Committee on country risk: (1) should country risk be considered as a simple manifestation of credit risk or as a specific risk requiring detailed regulations? (2) How important were macroeconomic context and macroeconomic data for supervisors? (3) What were the respective responsibilities of bankers and supervisors in country risk assessment? All three questions dealt with the mandate of the Committee, and beyond this, with the role of supervisors. The first question carried important underlying implications. As explained in the 1978 paper by the secretariat of the BCBS, considering country risk as requiring specific regulations meant that:

This option was never seriously considered; however, at the June 1978 meeting, all the delegations supported the first of the two approaches.Footnote ²⁴ Indeed, they all agreed on the fact that banks, and not supervisors, should be responsible for risk assessment.Footnote ²⁵ This position had important regulatory consequences, because it implied that supervisors would not favour strict regulation. However, some countries, and in particular the United States, were more supportive of a few official measures in the field of country risk.Footnote ²⁶

As for the microeconomic versus macroeconomic dilemma, the issues involved proved more challenging to resolve. At the March 1978 meeting, Schneider from the Federal Banking Supervisory Office (Germany) stated that: ‘they should always bear in mind that, as supervisors, they had to deal with micro-economic matters’,Footnote ²⁷ to which a US delegate replied: ‘Mr Dahl [Federal Reserve] felt that it would be short-sighted to over-emphasise the micro-economic approach to country risk at the expense of the macro-economic approach.’ Footnote ²⁸ A delegate from the National Bank of Belgium also considered that ‘it was certainly part of the job of bank supervisors to monitor the degree to which individual banks’ country risk was concentrated’.Footnote ²⁹ American members felt particularly concerned at an earlier stage than other members of the Committee, and were more active in the exercise on country risk. The delegates from the Federal Reserve and from the Federal Reserve Bank of New York stated that they were trying hard to define the problem from a banking supervision perspective and were hoping to circulate a paper to the Committee soon.Footnote ³⁰

The Basel Committee wrote a first report on country risk in 1979 and sent it to the governors in October. It stated the preference of the BCBS for approaching country risk as a type of credit risk, and that supervisors’ responsibility was to ensure banks were monitoring it properly and that they had adequate information.Footnote ³¹ Approved by the governors, it was sent to supervisors worldwide in November 1979.Footnote ³² Stating that country risk had to be considered as a type of credit risk implied that it was a risk that did not require extensive regulations. Its members’ justification was that, as supervisors, they were not concerned with macroeconomic regulations, nor were they responsible for banks’ risk management. The absence of large financial crises since the war, together with the fact that recent failures had been related to foreign exchange issues and not to country risk, contributed to the regulatory blindness to country risk.

III

The articulation between the micro- and the macroeconomic dimensions in the supervisory issues in the area of country risk is well illustrated by the contacts that the Basel Committee had with another G10-based committee, the Euro-currency Standing Committee (ECSC). Most initiatives in the field of the macroeconomic risks of countries’ indebtedness were taken by Lamfalussy, by the ECSC, or by central bank governors (Maes Reference Maes2011). In practice, the BCBS and the ECSC overlapped, and discussions on country risk supervision or regulation dealt with a ‘grey area’ at the crossroads of micro- and macroeconomic phenomena. At the request of the ECSC, the two committees had a joint meeting on 15 November 1978 to discuss the possible use of prudential techniques to limit the growth of international bank lending.Footnote ³³ For some countries, such as Germany and the United States, this joint meeting was an attempt to control the growth of the eurocurrency market (Altamura Reference Altamura2017, p. 199).Footnote ³⁴

The joint meeting with the ECSC triggered a division of regulatory labour between the two committees. As Clement (Reference Clement2010) shows, the first mention of the phrase ‘macro-prudential’ in the records of the BIS dates back to a June 1979 BCBS meeting, when Peter Cooke said that ‘micro-economic problems (which were of concern to the Committee) began to merge into macro-economic problems (which were not) at the point where micro-prudential problems became what could be called macro-prudential ones’.Footnote ³⁵ For Basel supervisors, as for other regulators of the time, macroprudential issues were a new concern and no clear definition or tools were put forward, although one option often considered (and rejected by Basel Committee members) was the establishment of formal limits to international lending.Footnote ³⁶ The ECSC was considered as dealing more with macro-prudential questions, but these questions were only emerging at the time, and it would stay limited to banking regulation until well into the 1990s.Footnote ³⁷

By 1980 it was clear that the international financial system was under severe stress. In April 1980, the committee of the central bank governors of the G10 countries, who were the authority to which the Basel Committee had to report, issued a press communiqué stressing the need to oversee the international situation carefully.Footnote ³⁸ It also made clear that the BCBS had to continue its work on country risk exposure. It was decided that Peter Cooke (chairman of the BCBS, Bank of England) would represent the BCBS at the ECSC's meetings.Footnote ³⁹ The discussions between the two committees revealed conflicting expertise and mindset and were the result of different specialisations in regulatory responsibilities. Lang from the Bundesbank stated at the February 1981 meeting that:

Moral hazard considerations were an important dimension of the banking supervisors’ opinion on international bank lending regulation.Footnote ⁴¹ In February 1981, Cooke considered that ‘indeed, most supervisors would agree that the health of the system sometimes required that the imprudent should pay the penalty for their imprudence’.Footnote ⁴² Basel Committee members, like many supervisors, relied on market mechanisms for ensuring prudence in banking activities, which contibuted to minimising their involvement in country risk. In a speech given in April 1983 about the now ongoing Debt Crisis to the Bankers Association for Foreign Trade, an influential American bankers’ association oriented towards international activities, Cooke reaffirmed this approach:

Even if a diversity of views existed within the Basel Committee, members often stated that market mechanisms, and in particular penalties for imprudent banks, were crucial in helping them carry out their task.

As the possibility of a crisis became clearer, issues of lender of last resort were increasingly discussed at the ECSC, whereas the BCBS had never taken any decision in this area.Footnote ⁴⁴ It had carefully avoided this delicate question when it had agreed on general rules delineating the primary responsibility for the supervision of foreign banks between host and home authorities, in an agreement known as the Concordat (Goodhart Reference Goodhart2011, pp. 96–114). In October 1982, Dealtry (secretary of the BCBS, BIS) explained to his colleagues that an ECSC report on liquidity crises affecting banks’ foreign establishment had been given to the governors in July, and that Richardson (governor of the Bank of England) and Lamfalussy wanted the report to be kept secret.Footnote ⁴⁵ This announcement caused much concern in the BCBS. The Swiss delegate, for instance, suspected the report was about supporting failing banks, for which he had strong reservations. Even if the details of the report were not known, a disagreement on certain points was considered inevitable. The Basel Committee's work on country risk thus sheds light on the diversity of regulatory perspectives and on the difficult combination of macroeconomic and microeconomic approaches at a time when only individual small or medium failures, and no general crises, had occurred for several decades.

IV

The last dimension of the work of the Basel Committee in the field of country risk, and another reason why it did not advocate strict regulation, was the lack of good information. Information was a key issue of the period, because nobody knew enough – neither the banks nor the authorities. When George Blunden (Bank of England), chairman of the Committee, asked in March 1976 if a paper produced by the BIS on total bank borrowings by individual countries would be useful to the Committee, Bürger from the Bundesbank answered very favourably, saying that his institution ‘was making strenuous efforts to discover the degree of indebtedness incurred by German banks in certain foreign countries’.Footnote ⁴⁶

The BIS had been collecting data on international banking activities since the 1960s, but these statistics had focused on tracing the development of the eurocurrency market and provided no country detail outside the G10 area. The changes in international banking during the 1970s had reduced their usefulness. It was now considered important to have information on countries outside the G10, because the geography of indebtedness and risk was changing. In February 1973, the secretary of the OECD van Lennep wrote to the general manager of the BIS at the request of the OECD's Development Assistance Committee, an international forum gathering the most important donor countries for development purposes.Footnote ⁴⁷ Van Lennep suggested that the BIS should collect a full country breakdown of the G10 banks’ external positions. Van Lennep's suggestion was well received by the G10 governors, and the BIS started to collect this new information in 1974. In 1975, it extended coverage to those branches of US banks operating in offshore centres of the Caribbean area (Bahamas, Cayman Islands, Panama) and the Far East (Hong Kong, Singapore).Footnote ⁴⁸ The BIS depended on the goodwill of participating countries to provide the information, but its statistics were considered useful because they were directly based on banks’ activities.

A summarised version of the BIS statistics for international lending to Latin America and Eastern Europe can be found in Table 2. As expected, they revealed large claims on Latin American countries, particularly Brazil and Mexico, as well as on the Soviet Union, Poland, Hungary and the GDR. Oil-exporting countries, on the other hand, were large net suppliers of funds to the reporting banks. At end 1976, total claims of G10 banks on Latin American countries amounted to about $48 billion: on Brazil, $15.8 billion; on Mexico, $14.6 billion; on Argentina, a bit less than $3.2 billion; and on Venezuela, a bit less than $3 billion.Footnote ⁴⁹ Claims on Eastern Europe, including the USSR, amounted to $23.6 billion: on the USSR, $8.3 billion; on Poland, a bit more than $4 billion; on the German Democratic Republic, a bit less than $3 billion; and on Hungary, about $2.5 billion.

Table 2. External position in domestic and foreign currency of banks in Group of Ten countries and Switzerland to the most indebted countries in Latin America and Eastern Europe (amounts in millions of US dollars, end March 1976)

Source: BISA, 1.3a(3) 1976/5, ‘The BIS statistics on international banking’, paper by H. W. Mayer, 24 September 1976.

These statistics were considered useful for both supervisors and the banking community for three reasons: first, they provided supervisors with information on the joint exposure of reporting banks towards individual countries or groups of countries. Second, they gave an idea of the dependence of the reporting banks on suppliers of funds such as oil-exporting countries. Third, they provided guidance to banks themselves for their credit policies, because they gave an idea about countries’ international financial positions, on which little information was otherwise available.Footnote ⁵⁰ However, these statistics had shortcomings: they were not complete, even within the G10 reporting area, and were not homogeneous from one reporting country to another. They did not take into account any possible guarantees and, therefore, did not indicate where the ultimate risk lay. There was no bank versus non-bank breakdown and no maturity breakdown. Finally, obtaining them was a slow process, an issue frequently lamented by the banks, which used them for their credit policy.Footnote ⁵¹

Attempts to invite commercial banks to share their information failed. In 1977, Arthur Burns, chairman of the Federal Reserve, suggested creating a questionnaire asking banks about their claims on foreign countries with a view to compiling the data. It encountered strong opposition by the biggest banks who had no incentive to share their information (Maes Reference Maes2011). Large banks opposed the project because they did not want to take the risk of sharing their information while their competitors refused to do so. Furthermore, they did not want to undermine the informational advantage they had compared to smaller banks, which were more favourable to Burns's project.Footnote ⁵²

In order to glean the best information possible, banks used both informal and official means and relied on both statistics and qualitative information. In early 1981, the BCBS circulated a questionnaire on how banks managed country risk in each country.Footnote ⁵³ A subgroup on country risk exposure chaired by Willey from the Federal Reserve Bank of New York was established in February 1981 to analyse the replies to this questionnaire. German banks were reported as making great use of the press, particularly the Institutional Investor; they used data from the World Bank and the BIS, but they also relied on their own network based on consulates, business associates and correspondent banks.Footnote ⁵⁴ The Swiss answer particularly highlighted the importance of informal networks:

Japanese banks sometimes set up their own research teams to inquire into a specific question, while some large US banks started to hire political consultants, paying increasing attention to political factors.Footnote ⁵⁶ Large US banks also had more formalised and ratio-oriented assessment systems, making use of computers in a few cases, whereas smaller banks relied more on informal networks (for a historical overview of the role of information technology in banking, see Bátiz-Lazo and Wood Reference Bátiz-Lazo and Wood2002; on computers and ATMs more particularly, see Bátiz-Lazo Reference Bátiz-Lazo2018). The Willey subgroup stressed the mix of both types of knowledge in a June 1981 report: ‘The systems which banks use to assess country risk have generally been built up over many years through a blend of territorial expertise and analysis of local and international statistics’, emphasising that even sophisticated assessment systems had no prediction capacity and therefore that ‘there [was] no substitute for knowledge of the country concerned’.Footnote ⁵⁷ Finally, rating agencies played a limited role in forecasting the consequences of international bank lending to emerging countries: according to a study of the FDIC, corporate bond ratings of money centre banks did not reveal any deterioration in their financial position in the years preceding the crisis (FDIC 1997, pp. 201–2). This was primarily due to their good profitability coming from international loans, but also to a lack of information (Sy Reference Sy2003). Either way, the Basel Committee did not address the role of rating agencies in its discussions on country risk.

Within the BCBS, all members agreed on the desirability of having better information. However, they disagreed on what should be done by authorities to improve the situation. The idea of an international central risk office emerged in discussions on country risk, first in March 1979, then more insistently in 1981 and 1982.Footnote ⁵⁸ This idea had already been discussed in the mid 1960s among central bank experts at the BIS, but had been abandoned because of the legal and administrative obstacles such a project raised (Toniolo Reference Toniolo2005, p. 469; Schenk Reference Schenk, Battilossi and Reis2010, p. 159). The rationale of a risk office was to report all credits to authorities so that the overall financial position of clients was identified, in order to help banks to assess their creditworthiness. The BCBS established a working group in June 1981 to examine the question more thoroughly.Footnote ⁵⁹ The proposal was particularly supported by the Germans, who also supported it at the European Economic Community level, but it encountered little enthusiasm otherwise.Footnote ⁶⁰ Most delegates saw the exercise as too ambitious and technically too complicated. In addition, other organisations such as the Euro-currency Standing Committee, the Group of Thirty and the Ditchley Group of Commercial Bankers were trying to improve the data on country risk, and Basel Committee members did not want to engage in another similar exercise.

V

Caught between its refusal to engage with macroeconomic considerations and to take any responsibility for banks’ lending decisions, the BCBS was not in an easy position from which to take significant steps, despite the pressing circumstances. During the years 1980–2, it limited itself to defining and refining the concept of country risk and to making a few proposals for its monitoring, but this limited output was the result of disagreements and absence of a clear solution rather than lack of interest or involvement in the topic. A lengthy discussion on the question in February 1981 showed a renewed interest in country risk.Footnote ⁶¹ Aubanel (Bank of France) said that in France, banks had recently become much more active in this area.Footnote ⁶²

The Polish debt situation had turned into a crisis where French banks and German banks, in particular, were exposed. However, as the International Debt Crisis started, the question was not about whether and how to reduce international lending, but about how to ensure that international lending to developing countries would continue, so as to prevent or limit a default (Bartel Reference Bartel2017). This was a radical turn in which banking supervision had a secondary role. The handling of the crisis was now in the hands of governments, the IMF, the BIS, central banks and commercial bankers, and the coming years would be about persuading bankers to continue to provide ‘new money’ in order to avoid a series of defaults (James Reference James1996, p. 371).

The severely deteriorated situation of borrowing countries triggered a much more active role for supervisors and other regulators at the national level. This was particularly the case at the Bank of England, where several assessments of the consequences of a possible default by a major borrowing country were conducted in 1980 under the rather blunt label ‘Apocalypse Now’.Footnote ⁶³ In May 1980 an important note on the theme was written in preparation for the now regular meetings on exposure to developing countries.Footnote ⁶⁴ Although quite optimistic, as the note was mostly considering a default by one country only, it showed how authorities now expected a crisis and linked international financial stability and banking supervisory considerations to a much greater extent than in the mid 1970s.

Most of the actions taken by the BCBS in 1981 and 1982 focused on the already mentioned initiatives on information and statistics, and on the drafting of two reports, one for the governors, and the other for commercial banks, drafted between June 1981 and March 1982.Footnote ⁶⁵ Both papers were sent to the governors in April 1982 by Peter Cooke (Bank of England), chairman of the BCBS, who indicated in his letter that: ‘[The Governors] may feel it is particularly timely that it should become known in the international banking community that country risk and country exposure questions are under discussion amongst those meeting in Basle.’Footnote ⁶⁶

The 1982 report to banks on country risk was composed of a covering note followed by 12 pages and an appendix clarifying the terminology used.Footnote ⁶⁷ It provided banks with guidance on different elements to take into account when assessing country risk, and on how to determine in which country the real risk lay. In its covering note, the report stressed the particular needs of small banks, whose assessment systems were not as sophisticated as those of the big banks. Overall, the text appeared to be an attempt to spread the principles of prudence within the banking community:

This step taken by the Committee in 1982 through a report to international banks may seem late and modest in retrospect, but it has to be seen in the light of the fact that, by 1982, international lending had reached a political dimension that far exceeded banking supervision capacities and responsibilities. The situation was now handled through diplomatic channels. Internal divisions about how to handle the problem as well as the microeconomic focus of banking supervision led the Committee to formulate only general principles, which recommended that banks follow a prudent line of behaviour. At the end of 1982, the Basel Committee's work focused on the treatment of rescheduled international loans from a supervisory perspective, which included the provisioning and dividend policies, and was linked to capital adequacy issues.Footnote ⁶⁹

The crisis had accelerated in August 1982 after the Mexican finance minister had informed the United States and the IMF that Mexican reserves were exhausted, and that Mexico could no longer service its debt. The BIS and the Federal Reserve acted quickly to contain the crisis, but the longer-term response was provided by the IMF, which established linkages between the financial community, the indebted countries and central banks (James Reference James1996, p. 367). However, if Mexico still appeared as a singular case in August 1982, Argentina and Brazil experienced similar crises a few weeks later, and were followed by many other countries. In the French case, by end 1984 the 35 biggest banks were exposed to the tune of about FF200 billion to 35 to 40 countries whose debt had to be rescheduled, which amounted to 9 per cent of total international bank lending to these countries.Footnote ⁷⁰ The top six countries to which French banks were exposed at end 1984 were, in order of importance: Brazil, Mexico, Venezuela, Argentina, Nigeria, Poland and Ivory Coast.Footnote ⁷¹ The debt situation would weigh on banks’ balance sheets and policy throughout the decade, and would have dramatic social consequences in the indebted countries.

VI

Between 1976 and 1982, the BCBS spent a considerable amount of time discussing country risk in bank lending and related issues. However, it did not want to take responsibility for banks’ risk management. Apart from American delegates, the pressure for really engaging with the topic often came from outside the Committee: in particular, Lamfalussy from the BIS and central bank governors urged the BCBS to work on country risk thoroughly. However, when asked to think about prudential measures to limit international lending growth, the BCBS answered negatively. The microfocus of banking supervision led Basel banking supervisors to place much faith in market mechanisms to stabilise the situation and avoid moral hazard issues at the same time. On a more political level, the hesitant response of the Committee to country risk issues reflected the impossibility of securing an agreement on international bank lending regulation within the G10 authorities. In addition, neither the banks nor the authorities wanted to take any serious steps without clear information, and this information was lacking. All in all, the authorities were poorly equipped to appreciate international banking activities on a global level. Country risk appeared as an impasse for banking supervision, and the Basel Committee, even if it did produce some expertise on the topic, contributed to the general lack of regulatory response to widespread country risk. The risks run by the international financial system were realised well in advance, but regulators could not decide on a course of action to take to improve the situation, mostly because central banks and international organisations relied on commercial banks for the recycling mechanism.

One of the reasons why the BCBS refused to regulate country risk was that supervisors considered that banking supervision should be limited to microeconomic matters. This feature of the supervisory system is essential for two reasons. First, because it was to remain an issue for years to come: it was only around the year 2000 that financial stability and the macroprudential approach really became significant regulatory policies.Footnote ⁷² Second, because microprudential banking supervision continued to grow steadily after the Debt Crisis and became an important part of the political economy of global finance. These characteristics and their implications for financial crises prevention are too often overlooked in the literature on the history of banking regulation.

If it took a long time for macroprudential financial stability to become a major element of the regulatory system, the International Debt Crisis and country risk issues did play a role in the later history of the Basel Committee. Not only did the crisis become central to supervisors’ ordinary practice at the national level as rescheduling operations proliferated in the 1980s, but it also induced a sharp reduction of international lending activities, apart from the flows organised by the IMF to prevent defaults, which pushed banks towards securitisation.Footnote ⁷³ Most importantly, it is considered the indirect origin of the Basel agreement on capital adequacy, as the US Congress pressed American authorities to reinforce supervisory standards after the crisis (see also Wood Reference Wood2005).Footnote ⁷⁴ The famous agreement, known as Basel 1, also incorporated some country risk considerations in its system of risk weighting. However, it did not change the microfocus of banking supervision: instead, the crisis led to a focus on banks’ capital, which became the most crucial regulatory matter of the 1980s and the following decades (Kobrak Reference Kobrak and Troege2015; Drach Reference Drach2019). Studying the years preceding the crisis sheds light on the challenges that such a focus raises for the surveillance of the international financial system as a whole, and why Basel supervisors were against regulation in the late 1970s.