WEST EUROPEAN BANKS: RISKS TO THE UNITED STATES

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP85T00287R000502120001-3
• Release Decision: RIPPUB
• Original Classification: S
• Document Page Count: 8
• Document Creation Date: December 22, 2016
• Document Release Date: May 11, 2010
• Sequence Number: 1
• Publication Date: October 19, 1983
• Content Type: REPORT

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Memorandum for: RECORD
Assistant to the President and Sensor--
Director of International Economic Affairs,
NSC and Roger Robinson, Director International
Economic Affairs, NSC on 18 Oct. 1983.
for Norman Bailey, Special
The attached was prepared
Distribution:
1 - Norman Bailey, NSC
1 - Roger Robinson, NSC
1 - DD/EURA
2 - EURA Production
4 - IMC CB
1 - EURA
1 - EURA/EI
3 - EURA/EI/EI
DDI/EURA/EI/EI
19 Oct. 83)
EURA
Office of European Analysis
an PA
C- L) IC
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West European Banks: Risks to the United States
The United States has a great deal to be concerned about
regarding Western Europe's banking industry. The-size of the
Euromarket was over $2,000 billion at the end of March this year
and has grown by a staggering 100 percent in the last four years,
and more than six-fold since 1973. Banking.i-s one of Europe's
largest industries comprising well over 12,000 banks which
operate some 130,000 offices. The 30 biggest banks employ about
.one million people. Seven of the top ten banks in the world --
ranked by assets -- are headquartered in Europe, and the ten
largest banks in Western Europe are located in France (4), West
Germany (3) and the UK (3).
The Problem: Information, Standards, and Secrecy
Unfortunately it is difficult to systematically assess the
financial soundness of banks in the euromarket system for a
variety of reasons. Banking regulations are not uniform across
countries and banks themselves as part of the natural course of
doing business and keeping client trust shroud a good part of
their operations in secrecy; not an uncommon practice in many
industries but one that poses a certain risk for the banking
industry and its role as financial intermediary between primary
lenders and borrowers.
Problems with banks and euromarket operations are usually
dealt with on an ad hoc basis, and even a crisis such as Banco
Ambrosiano precipitates only stop-gap measures. The debt crisis
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is starting to change attitudes among central bankers, however,
and has encouraged a greater amount of cooperation. While
necessity and survival of the international financial system have
brought many resources to bear on the current problems, risks to
the system remain large.
Banks in the euromarket system face two kinds of fundamental
risks: (1) liquidity and solvency and (2) confidence. The first.
takes in the bulk of the problems now facing the banks dealing
with the debt crisis. How well these issues are dealth with by
central and commercial bankers affects the second and potentially
more damaging of the two types of risks.
Sources of weakness in the euromarket system which are
wrapped-up in the liquidity/solvency problems and can affect the
United States include:
o The lack of information about bank- and country-exposure
to problem borrowers. The inability to adequately
evaluate the quality of bank assets is the greatest
peril to the international banking system. The lack of
consolidated balance sheet reporting and accounting
differences among countries significantly raises the
economic cost of information.
o High (i.e. weaker than in US banks) asset to capital
ratios in West European banks, particularly the
nationalized banks in France and Austria.
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,) t t,KtT
o
0 Th fund assets.
? The susceptabilit
Y of the interbank market
in, and tiering of to changes
deposits which can a bank's ability t
seriously affect
trends
es.
o The inability of banks to
e
euromarket unregulated
system: these banks
group that formulated are not part of the G-IO
the 1975 concordat and its 1983
reformation which sets out principles
supervision governing the
of banks' foreign establishments by ar
and host authorit? P ent
true for This is particularly
non-syndicated
medium-term borrowing and all
short-term borrowing.
R
ecipe for a Crisis
These structural problems
liquidity crisis
major
liquidity
their way
between
central
countries'
e participation
of Arab banks in th
problems in to deal with
the system and let solvency problems
out through
and
LaKeovers.
liquidit
y and solvency is not
banks
This lack of
central banks
a general
down the
are prepared to do in a
adequately ev
l
a
uate debt
in prospective borrowers
make
the
which - '" 1IItr'oD le to
central could also induce
solvency problems.
b
anks are committed
The
The line
and what the
so
information not clear.
about banks and borr
owers, and what
are prepared to do, are the initi
al
confidence ingredients for
crisis, which
international by its very nature would shut
banking system. A confidence crisis
is
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clearly drawn
crisis is al
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unlikely in that it would probably take a combination of
international` events that would cause investors/depositors to
switch from financial to real assets, leaving the banks with a.
funding problem that could not be solved by central bank
intervention even as lender of last resort. A hypothetical
example might go like this: Argentina fails to service its debt
in a de facto moratorium... Brazil and a few other major debtor
countries reject a weakened IMF's austerity plans...INF
deployment in Western Europe sets off serious riots...the Iran-
Iraqi War heats up, drawing in Saudi Arabia, stopping all oil
shipments from the Middle-East to the Western industrial
countries... and two major banks -- one in the United States and
one in Europe -- close their doors. The chain of events would
shatter confidence in financial assets, and through a domino
effect, paralyze the banking system.
Policy Shifts
West European banks appear to be strengthening their views
that the Latin American debt situation is a US not a European
banking problem. Citing lack of interest on the part of US banks
in the Polish rescheduling, and an obvious desire to reduce
future losses, many European banks are not willing to increase
their exposure in Latin America. Moreover, interbank lines of
credit to banks which are heavily exposed in Latin America have
been reduced. Swiss banks, for example, are not making any new
loans to Latin America and have intensified their flight into
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quality assets, particularly in the US. Commercial banks in the
UK have not always followed the Bank of England's encouragement
on rescheduling issues and has prompted the UK authorities to
become more insistent.
Official policy actions now under consideration in some
developed countries are also causing concern among commercial
bankers. Despite encouragement to commercial banks from Swiss
National Bank President Leutweiler to keep the credit lines open
to problem debtor countries, the Swiss Banking Commission is
considering imposing a 30 percent loan-loss reserve on any new
loans made to problem debtor countries. This requirement would
significantly raise the cost of lending. In another case, the
Japanese Ministry of Finance i's haggling with commercial banks
over making loan-loss reserves a tax writeoff. At the same time,
the US House version of the IMF legislation requires an
unspecified percentage of new loans to problem debtor countries
be set aside in loan-loss reserves. While contacts in other
parts of the US Government have indicated to this Agency that
this will not likely be a part of the final bill, taken with the
considerations in the other countries, it could tend to make
banks even more cautious about lending to LDCs.
The Outlook
The risks posed to West European banks, and all banks for
that matter, are greater in the short-term than in the longer-
run. The present structural weaknesses of the system,,the
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volalitity of interbank lines of credit, divergence of commercial
banks' attitudes toward the debt problem, an IMF under financial
strain, and the perception that government policies may not be
uniform all help to keep the liquidity risk facing the banking
system very high. The economic and political inability of the
LDC's to hit targets outlined in their austerity programs will
.add further stress to the system. Any crisis requiring immediate
action on the part of West European governments and central banks
would by necessity involve the US Government and Federal Reserve.
Bank failures will continue to dot the financial pages in
the press and central bankers will work behind the scenes to
salvage other institutions. So long as problems remain
manageable, many West European banks are in a better position
than their US counterparts to weather loan losses. Both West
German and Swiss banks have hidden reserves which can be used to
absorb bad loans without visibly affecting profits in any one
year; the size of this cushion is unknown, however. Acceptance
banks in the UK have the backing of the Bank of England and
nationalized banks in France and Austria supposedly have the
backing of their respective governments.
In the longer run, time and coordinated action can work to
improve the situation and the structure of the system. Economic
recovery in the industrialized economies will improve earnings
for the LDC's. Work at the OECD and the EC to standardize banks'
balance sheets and expand data collection will improve the flow
6 -
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of information to the market place. Further steps to make
available more information to all participants would.reduce
confusion, permit better risk assessments, and generally correct
the information problem endemic in the financial sector. Full
disclosure by all banks of liability and asset exposure by
various categories would be a self-correcting step to many of the
problems.
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