Deck 17: International Banking: Reserves, Debt, and Risk

Question 1

A nation's need for international reserves is similar to an individual's desire to hold cash balances. Explain.

Answer 1

An individual desires to hold cash balances to have the ability to fund the discrepancy that arises between his monetary receipts and payments. People purchase goods and services more frequently than they receive paychecks or in other terms, the occurrence of payments exceed receipts. In order fund these expenses before the arrival of paychecks; people need to have cash on-hand. Similarly, a nation's need for international reserves is like an individual's desire to hold cash balances. Nations can use their international reserves to finance disequilibrium in their balance of payments. Suppose a nation currently has a deficit because it is importing more goods and services than it is exporting. It can use its international reserves to temporarily sustain the balance-of-payments deficit until the nation can adjust to correct the disequilibrium (by promoting increases in exports through monetary/fiscal policies).

Question 2

What are the major factors that determine a nation's demand for international reserves?

Answer 2

The major factors that determine a nation's demand for international reserves include the degree of exchange-rate flexibility and the size and duration of the disequilibrium in the nation's balance of payments.
Flexibility in the exchange rate is important because it determines the efficiency of adjustments to the balance of payments. In addition, the size and duration of the disequilibrium determine the urgency for international reserves because such reserves allow the nation to temporarily sustain a balance-of-payments deficit until it can adjust to correct the disequilibrium.

Question 3

The total supply of international reserves consists of two categories: (a) owned reserves and (b) borrowed reserves. What do these categories include?

Answer 3

A nation's total supply of international reserves can be either owned or borrowed.
The category of owned reserves for a nation includes assets such as monetary gold stocks, foreign currencies, and special drawing rights (SDRs).
Borrowed reserves include IMF drawing positions, swap arrangements, and the General Arrangements to Borrow.

Question 4

In terms of volume, which component of world reserves is currently most important? Which is currently least important?

Question 5

What is meant by a reserve currency? Historically, which currencies have assumed this role?

Question 6

What is the current role of gold in the international monetary system?

Question 7

What advantages does a gold exchange standard have over a pure gold standard?

Question 8

What are special drawing rights? Why were they created? How is their value determined?

Question 9

What facilities exist for trading nations that wish to borrow international reserves?

Question 10

What caused the international debt problem of the developing nations in the 1980s? Why did this debt problem threaten the stability of the international banking system?

Question 11

What is a eurodollar? How did the eurodollar market develop?

Question 12

What risks do bankers assume when making loans to foreign borrowers?

Question 13

Distinguish between debt-to-export ratio and debt service/export ratio.

Question 14

What options are available to a nation experiencing debt-servicing difficulties? What limitations apply to each option?

Question 15

What methods do banks use to reduce their exposure to developing-nation debt?

Question 16

How can debt/equity swaps help banks reduce losses on developing-nation loans?