Citicorp, the nation's biggest bank-holding company, surprised competitors and unsettled the stock market last week when it announced that it would put $3 billion of its assets into loan-loss reserves, a move that will result in a $2.5-billion loss this quarter. The decision was painful in the short-term, but it could prove to be a farsighted gamble if it helps solve the debt crisis facing many underdeveloped nations, especially in Latin America.
The difficulty of the decision announced by Citicorp Chairman John S. Reed should not be underestimated. The parent company of New York's Citibank has not reported a loss since the Great Depression. But some analysts argue the Third World debt crisis is the most intractable problem the world banking community has faced since the 1930s. Massive foreign debts have weakened the economies of major nations like Mexico, Brazil and Argentina, forcing them to impose harsh austerity on their people, contributing to political unrest. In their darkest scenarios, analysts warn that if major Latin debtors default on foreign loans, already worth about $350 billion, many U.S. banks will collapse.
It is because they fear such a possibility that responsible political leaders in Latin America and the United States have been urging major banks to take dramatic steps like the Citicorp decision. By increasing its loan-loss reserves, Citicorp has provided a cushion against the shock if a major debtor country does default. It is likely Citicorp was prodded towards the decision by Brazil, which recently suspended interest payments on its debt due to a drop in trade revenues. The country owes foreign banks $68 billion, $4.6 billion of that to Citicorp.
Reed said Citicorp's move was not designed to put pressure on other banks to do the same thing, but it will inevitably have that effect, no doubt to Citicorp's advantage. Following suit would be difficult for major banking companies like BankAmerica and Manufacturers Hanover, both heavily exposed in Latin America but unable to put aside the reserves that Citicorp did.
Reed also said that the move is not a ploy to give Citicorp more leverage in renegotiating its loans with Brazil, a process that is due to start later this year. He must be true to his word, because simply being more hard-nosed with the debtor nations now would be a mistake.
For all their complaining, the major Latin debtors have been liberalizing and modernizing their economies recently, just as their creditor banks and the International Monetary Fund have demanded. And the debt crisis was created not just by irresponsible borrowing, but by irresponsible lending, too. Still, the perception in Latin America is that the debtors have borne all the pain of repayment. Citicorp is the first lender that has shown that it is willing to absorb some pain, too, and it is worth noting that the initial reaction to the bank's decision among political leaders in Brazil and Mexico has been largely positive.
Citicorp's decision was not just courageous, but realistic. Finally a major U.S. bank has accepted the fact that, under present conditions, Latin American and other Third World nations will not be able to pay off their debts.
Now that Citicorp has accepted short-term losses in the hopes of insuring long-term stability, other major lenders must follow along. Being less fearful of short-term losses gives them the freedom to explore other proposed solutions to the debt crisis, like lowering interest rates and extending the time debtors need for repayment, or creating new international funding mechanisms that can provide the capital needed for new investment and growth in Latin America and the rest of the Third World.
No single step, no matter how dramatic it is, will solve a problem as complicated as the Third World debt crisis. But what Citicorp did may at least help end the futile cycle of banks lending new money so their major debtors can pay off old loans, putting themselves further into debt. That road is leading nowhere, so it's time to move in a different direction.