During the past two decades various international financial markets have grown very rapidly. This growth was accompanied by changes in the process of international financial intermediation (Bloch, 1989; Courtadon, 1985 ; Miller, 1986). Our purpose here is to survey some of the recent developments in the international credit market. Specifically, we will review some of the regulatory changes that ha d an impact on international financial markets and describe the trend towards securitization.
Deregulation
During the first half of the 1980s several major countries liberalized the way in which their financial markets were regulated. The trend towards deregulation enhanced the integration between the international Euromarket and the national markets of the countries involved (Herring, 1985; McRae, 1985; BIS, 1986). The most noteworthy liberalization measures were undertaken in the USA, but other major countries complemented the trend with their own deregulation. In the early 1980s the UK and Japan abolished restrictions on capital outflows, while West Germany liberalized capital inflows. The integration between the US short-term loan markets and the corresponding euromarkets was aided by US deregulation of domestic interest rate ceilings. A similar effect occurred in France, where banks were permitted to sell foreign currency-denominated CDs.
More recently, many regulations with respect to market participation were liberalized. In Japan the access of non-resident borrowers to the domestic issue market and the euroyen bond markets has been eased. In Germany fore ign-owned banking entities have been allowed to manage euro-DM bond issues. Marketinteg ration was aided by the abolition in the USA, UK, France, and Germany of withholding taxes on interest payments to non-residents. The outcome of these developments has been an increasing convergence between domestic and euromarket rates and a growing internationalization of securities markets. One immediate outcome is to link the capital markets more closely to the foreign exchange markets. One example is bonds with currency conversion options (or with dual-currency features) that offer a combination of a capital-market asset and a foreign exchange option contract. The tendency to deregulate financial institutions also increased the number of participants in international financial markets.
The Securitization of Debt
A major recent trend in the international financial market has been the shift of credit flows from bank lending to marketable debt instruments. According to Walter (1988) and Melnik and Plaut (1991) this “securitization” contributed to the liquidity and marketability of debt instruments. The securitization trend has been fostered by the maturing of the eurobond markets, which became broader and more hom ogeneous, and developed standardized trading practices. It is now common practice to issue bonds through multinational syndicates with well-developed placing power.
The secondary market for eurobonds has grown rapidly. It is relatively free of official regulation and operates through standard clearing mechanisms producing low-cost dealing and delivery. The organization of short-term securities markets is less clearly defined, but the development of new forms of back-up facilities and note issuance facilities (NIFs) is creating access to funds for many new borrowers. The development of both markets was aided by the deregulations that took place in several major countries over the past decade.
In the early 1980s NIFs and euro-commercial paper became an important form of short-term credits, while bonds and floating rate notes (FRNs) accounted for most of the securitized long-term credits. New issue activity rose by close to 400 percent between 1983 and 1993. FRNs range between 12 and 30 percent of new short-term credit volume. The FRNs introduced new types of interest pricing formulas. A number of issues have contained maximum and minimum interest rates (capped and collared FRNs), either over the life of the instrument or beginning two or three years from original issuance. An interesting feature since 1985 has been the issuance of perpetual FRNs by banks and financial institutions, which must be converted into equity in case of solvency problems.
The fixed-rate sector has grown relatively slowly over the past decade. It has made increasing use of special features to compensate for lack of attractiveness. Bonds were issued with warrants, some for further issues of bonds, others for shares. This has been particularly popular for euroyen issues. Convertible bond s have been issued for years in international markets, but recently gained market share. Partly paid-up bonds were also issued, which allowed purchasers to defer the payment of principal for some months.
Market Participants
An important outcome of deregulation is the increasing role of foreign banks in national markets. These banks have become major participants in wholesale money markets. Foreign banks have internationalized domestic financial activity by expanding business abroad. An interesting example is the underwriting of securities by banking subsidiaries whose head offices are prohibited from engaging in such activities in their countries of origin.
The international loan market is extremely large. Over 1,200 banks from fifty countries are active in various areas of the eurocredit mark et. The banks serve three essential economic functions. First, they allocate international funds from surplus units to deficit units. Second, they provide liquidity. Finally, the international credit market provides a hedging device for interest rate and foreign exchange exposures. T he trend towards securitization appears to be a pattern of providing these three functions in a more cost-efficient manner.
Unlike the situation in various domestic markets, direct participation by commercial banks in the international securities markets as issuers , dealers, underwriters, and investors is very common. The blurring of distinctions between banks, securities brokers, and other financial institutions is manifested in the international cr edit market. Banks are able to become dealers in the wholesale paper markets of the world either directly or through international subsidiaries. On the other side, investment bankers have also redirected their activities towards more involvement in the international markets. Since they were initially smaller than the universal banks that dominate in Europe, th ey grew through a series of mergers which led to the disappearance of many institutions, but strengthened the remaining firms.
Securitization of loans by packaging them into marketable instruments has only recently begun to have an impact on the international markets. A few packages of mortgages originating in the USA have recently been funded through eurobond issues. US mortgage-backed securities often include swap components contracted in the euromarket. In the UK specialized institutions have begun to issue mortgage-backed FRNs aimed at the international investor.
Outright sales of loans by banks, not involving packaging into securities, have also expanded rapidly. This eurolending market may be viewed as a supplement to the market for loan syndications. Banks have also attempted to increase the marketability of their international assets. The two main innovations are the trading of claims on sovereign debtors and a more aggressive selling of participations in syndicated loans. Banks have sought to market their claims on problem debtor countries. Most outright loan sales appear to have been concentrated in higher-quality loans.
In recent years the number of participants in international syndicated loans has increased due to the ”repackaging” of loans. The sale of participations, or “subparticipations,” is done through assignment and novation. Assignment is based on the creation of transferable loan instruments. Novation involves the replacement of one obligation by the creation of an entirely new one. Both instruments entail the setting up of a register in which transfers of ownership are recorded. Transferability provides the syndicated credit with some of the attributes of securities together with the flexibil ity and liquidity features of NIFs.
