Legislative and Administrative Obstacles to Writedowns and Swapping of Less Developed Country Debt

Gao ID: T-NSIAD-87-29 April 2, 1987

GAO discussed practices U.S. banks use to reduce their risk in lending to less-developed countries (LDC), focusing on legislative and administrative obstacles to: (1) writedowns, which involve the reduction of the book value of an asset to the level of its present or appraised value; and (2) swapping loans between banks to reduce their exposure in specific LDC. GAO noted that: (1) LDC debt to U.S. banks totals about $950 billion, with most debt concentrated in major banks; and (2) many U.S. banks have shifted their LDC loan holdings from private commercial loans to lower-risk foreign government loans. GAO also noted that: (1) while the federal bank regulatory agencies can mandate writedowns of devalued loans, the banking industry perceives several disincentives to voluntary writedowns; (2) writedowns have no effect on the debt burden of LDC, since they are done for financial reporting purposes; (3) U.S. banks tend to maintain lower LDC loss reserves than foreign banks, but foreign banks usually operate in more stringent regulatory environments than U.S. banks; (4) lending institutions perceive a disincentive in an accounting requirement that they value swapped loans at current fair value, which is difficult to assess and is often less than book value; (5) another accounting requirement could force institutions to devalue comparable assets when they devalue swapped loans; and (6) the Internal Revenue Service might disallow deductions for voluntarily devalued loans in the absence of similar collective bank actions for the same LDC. In addition, GAO noted that: (1) many U.S. banks overstate the real value of their LDC loans; (2) bank regulatory agencies do not require banks to provide certain information on how the LDC debt crisis affects banks' financial positions; and (3) economic sectors other than the financial industry have borne most of the cost of the LDC debt crisis, which has indirectly affected the U.S. trade deficit by causing economic problems in LDC.

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