Ethical Issues in International Lending'

BemardSnoy

ABSTRACT. This article deals with the ethical issues faced by commercial banks, governments and international financial institutions in their international lending activities. Such issues include not only to whom and for what purpose such lending takes place but also the more delicate questions of the relations between sovereign lending and economic management, as well of lending to sovereign countries embroiled in situations of conflict. It leads to the ethical issues raised by the present international debt crisis: coresponsibility, burden-sharing, role of the international organisations. Finally, capital flight out of developing countries is studied as a special case.

I. General ethical issues for lending institutions

Financial institutions are a particular category of enterprises. Whether public or private, national or international, they are financing with the resources of economic actors experiencing a surplus, i.e., spending less than they earn, the needs of economic actors experiencing a deficit, i.e., spending more than they earn. This function of financial intermediation involves an important social responsibility towards the two groups of actors, which may include individuals, domestic and multinational corporations, sovereign states and international organizations.

a. The actors in surplus may expect that their resources will be safeguarded and that their savings will be equitably remunerated; b. When they lend resources to specific debtors rather than to others, financial institutions play an essential role in the expansion of some activities or companies rather than others, and participate indirectly in the investment selection process which determines the future of our society. When they do not finance capital formation, but provide a bridge to economic actors over a period of^ earnings shortfall, they again play a crucial role in the distribution of the burden of adjustment and in the softening of the external shocks provoked by such phenomena as wide fiuctuations in oil prices or crop failures. A financial intermediary is entitled to an equitable remuneration of its services and of the risks it assumes on the assets side of the balance sheet, in view of honouring its commitments on the liabilities side, remunerating its personnel and equity funds and ensuring the development of the institution itself.

n. Specific ethical issues in international lending

In the international sphere, the decisions faced by financial intermediaries, and more specifically commercial bankers, raise some additional ethical issues: a. To whom does one lend? To what extent does the French proverb "on ne prete qu'aux riches" apply in international finance? Retrospectively, one may wonder whether the lending behavior of some of the major international commercial banks over the last 15 years has been wise: eager to make profits in recycling the surplus accumulated by OPEC countries after the two oil shocks, they competed aggres- . sively to lend massive amounts to developing

BemardSnoy bom in BoisSeigneur-Isaac (Belgium) in 1945. Holder of bachelor's degree in philosophy and ofdoctor's degree in law from Catholic University of Louvain and of Ph.D. in economicsfrom Harvard. Has worked for 12 years with the World Bank in Washington and in Paris. Has been teaching at the Catholic University ofLouvain and at the College ofEurope (Bruges). Has been for two years Economic Adviser at the Commission ofthe European Communities. Since May 1988, Bemard Snoy assumed the position of Chief ofthe Minister's Cabinet at the Belgian Ministry ofFinance.

Joumal ofBusiness Ethics 8: 635639, 1989. 1989 Kluwer Academic Publishers. Printed in the Netherlands.

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countries such as Iran, Nigeria and Mexico, which were rich in oil or other natural resources and appeared promised to a brilliant economic future. In doing so, they may have overlooked other important considerations such as the quality of economic management, administrative capabilities and social tensions arising out of a process of rapid and uncontrolled "modernization". The debt crisis, which has erupted since then and the causes of which are both external and internal to the indebted countries, suggests that international lending should be based less on resource endowment than on actual capacity to formulate and implement development programs, to pursue sound economic policies and to adjust in the face of external shocks. Conversely, some countries, less well endowed or less important from a geo-political point of view, have found it difficult to secure the external funds they needed even for economically viable investment projects and sound development programs.
b. For what purpose does one lend? In their interna-

such doubtful projects has been encouraged by practices of corruption. In the debate on this issue, the reaction of many bankers is that if their bank had not financed those doubtful transactions, other banks would have done it and that they would have lost a profitable business opportunity. Competition is obviously a very important consideration in making a judgment on the moral behaviour of bankers and in explaining gregarious attitudes. But competition is a poor justification for deals that ultimately turn sour, and it does not eliminate the margin of freedom of each financial institution and of each decision-maker in these institutions. After all, there are many alternative ways to lend money and in the long run ethics are not necessarily inconsistent with profitability. The fundamental point in banking ethics, as in any field of social ethics, is that individuals guided by their conscience, can make a difference.
c. Does international lending encourage laxist economic

tional loans, banks frequently and legitimately aim at supporting national exports of equipments and engineering services; they are sharing responsibilities in this field with the suppliers themselves and the export credit insurance agencies which are covering the loans against specific commercial or non-commercial risks. This does not exempt the banks from responsibility in assessing whether it is a wise decision on the part of the borrowing country to import these goods or services. A review of what happened in the developing world over the last 15 years shows many so-called "white elephants", i.e., unviable investments, which were actively promoted by suppliers and financiers from industriahzed countries: these investments were often over-sized, poorly adapted to local conditions and particularly to the limited local maintenance and administrative capacities. There are significant differences in the degree of sophistication, institutional and administrative capabilities in the various developing countries but obviously in a number of low-income developing countries, particularly in Africa, suppliers of equipment, financiers and export insurance agencies bear a high responsibility in the costly and unviable projects for which those countries have incurred high debt. Their responsibility is particularly serious when the decision to go ahead with

management! External shocks, such as technological discoveries, wide variations in the price of oil or other commodities and natural catastrophes create situations of surplus or deficit which necessitate the intervention of financial intermediaries. The way in which these intermediaries, whether commercial banks or international financial institutions, intervene determine the conditions under which adjustment takes place. If no financing is forthcoming, adjustment has to be brutal and is accompanied by heavy social costs (e.g., bankruptcies, massive unemployment, migrations). Conversely, if financing can be secured too easily, adjustment is postponed; painful efforts to restructure the economy are eschewed, with the danger of a painful awakening and a much more difficult adjustment a few years later. Over the 1970s, the task of financing balance of payments deficits, which had been traditionally left to international financial institutions, such as the International Monetary Fund and the World Bank, was largely taken over by commercial banks which were recycling the huge OPEC surpluses. Commercial banks were poorly equipped to assess the risks associated with such lending and were not in a position, as international financial institutions, to attach to their loans conditionality concerning macro-economic management. There may have been some irresponsibility on the part of commercial

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banks and on the part of the authorities in industrialized countries which more or less encouraged this process to lend money on such a huge scale to a number of developing countries without due regard to the quality of economic management of those countries; situations, of course, vary considerably from one borrowing country to the other. Not only developing countries but also a number of industrialized countries have resorted to substantial external borrowings to postpone inevitable adjustments. However, for the developing countries which have over-borrowed, the consequences today are probably more serious because the sharp reassessment of risk that has occurred in the aftermath of the Mexican debt crisis of August 1982, has brought about a very sharp curtailment of lending to developing countries, whereas industrialized countries, even highly indebted, continue to be able to mobilize substantial resources in international markets.

ciple interest payments. International organizations such as the International Monetary Fund (IMF) and the World Bank have a crucial role to play in reestablishing confidence between creditors and debtors and in assisting indebted countries in the formulation and implementation of stabilization and growthoriented adjustment programs.

e. Moral responsibilities in situations of conflict. Domestic

d. Co-responsibility and burden sharing in the present debt

crisis. Although situations vary considerably from one country to the other, creditors and debtors are co-responsible of the debt crisis and have in some way to share among themselves the burden of the necessary adjustments. Highly indebted countries have to significantly improve their economic management: this means not only that they have to limit excessive budget deficits, control expansion of the money supply and adopt a correct exchange rate, but more fundamentally, that they have to create the conditions for the resumption of growth; this requires a number of conditions: elimination of the bias against export-oriented activities, better mobilization of domestic savings, improvement in the selection of public investments and in the management of public enterprises and creation of a stimulating environment for private investment. An equitable sharing of the burden of adjustment has to be reached among the various groups in those developing countries so that a disproportionate part of the burden does not fall on the poor. To make this resumption of growth possible, creditors, both official and private, i.e., to a large extent commercial banks, are being asked not only to reschedule capital and interest payments, but also to provide new money or to accept significant reductions in prin-

and international confiicts to which important moral considerations are linked (e.g., confiicts in South Africa, the Middle East, Central America, Afghanistan, Poland) and countries with a bad human rights records oblige bankers to get out of the purely economic and financial logic. Although creditors, commercial banks in particular, are not well equipped to evaluate the degrees in violation of human rights, there are extreme situations in which they may be obliged in conscience to use the power derived from their decision to lend or not to lend. The financing of military expenditures raises particularly delicate moral issues. In these complex matters, the creditors have to exercise their responsibilities with the greatest prudence, particularly in the case of private creditors who have no political mandate. They have also to make a difficult judgment on what sequence of events might unfold further to their decision to lend or not to lend and on which course of action has the highest probability of leading to a desired outcome. Examples can be found in the recent past in which the decision by some commercial banks not to roll-over short term loans to a country have precipitated some political developments; only the future can tell whether, ultimately, such moves will be conducive to an easing of tensions and an improvement of the human rights situation.

f Limits to the social responsibilities of private financial

institutions. In a free market international economy, there are clearly limits to what private financial institutions, including nationalized commercial banks, can be expected to do to channel resources towards priority objectives and to distribute equitably the economic burden of structural adjustment and the financial sacrifices associated with debt renegotiations. Their actions are clearly linked to those of

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other institutions, such as governments, central banks, official export credit agencies and regional or international financial institutions. The central role played by the IMF and the World Bank has been reinforced by the present crisis. The IMF has accumulated a considerable experience in the formulation and the monitoring of stabilization programs, which place emphasis on demand management, i.e., cutting budget deficits, controlling the expansion of the money supply and finding an appropriate external parity for the domestic currency. The World Bank, which extends very long-term loans, specializes in the financing of investment projects and, more recently, in the financing of structural and sectoral adjustment programs which support reforms on the supply side of the economy, particularly concerning the external trade regime, savings mobilization, the selection of public investments and the management of public enterprises. The two institutions are jointly owned by industrialized and developing countries, although industrialized countries detain approximately two thirds of the voting power. The conditionality, which attaches to the financing of the World Bank and the IMF, aims not only at assuring the reimbursement of the loaned funds, but more fundamentally at attaining the objectives of the programs and projects being financed. The content of this conditionality and the way in which agreement on it is reached with developing countries raise obviously a number of important political and ethical issues.
g. Need for concessional credits for poor developing

constitute on the part of the rich countries a rational investment in view of a more politically stable world and the emergence of new creditworthy trade partners. The volume and the distribution of the aid burden among rich countries are moral questions. The efficiency, the management and the adaptation of aid to conditions in each developing country raise problems, not only economic, political and sociological, but also moral (e.g., special concern for the poor, elimination of corrupt practices, respect of local civilizations and of some marginal indigenous groups, etc.).

A special ethical issue: capital flight out of developing countries

One of the most shocking paradoxes in the present debt crisis, particularly in Latin America, is that from a macro-economic point of view, an important part of the increase in the external public debt, particularly over the 19781982 period, has had for counterpart outfiows of private funds, i.e., the accumulation by individuals of financial assets abroad, the income from which is beyond the reach of national authorities which have to service the public external debt. The essential motivations for capital fiight are well known: a. over-valuation of the domestic currency, which makes foreign assets relatively cheap and leads economic agents to anticipate a devaluation; b. rapid and variable infiation, which creates a climate of uncertainty and reduces yields in real terms; c. the imposition of repressive financial policies (e.g., interest rate ceilings or compulsory subscription to low yield government securities) or heavy and progressive taxation on capital income, which brings real interest rates to a negative level, particularly during periods of rapid infiation; and, more generally, d. the absence of confidence in the economic management and the political stability of the country. Protection of accumulated savings against economic mis-management and possible arbitrary political

countries. Because of their limited export potential, unfavorable prospects for commodity prices, institutional weaknesses and the long gestation period of the required investments in infrastructure and education, a number of poor countries, in particular the least developed countries, are not in a position to borrow externally on market conditions. The concessionary external financing necessary for their development may come only from bilateral or multilateral aid agencies, themselves financed from the budget of rich countries, or from non-governmental organizations, financed from private charity. Grants and other concessional financial fiows are. justified not only by a moral imperative of equity and by humanitarian concern for the weaker members of the international community, but may also

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measures is the justification generally given by individuals and enterprises from developing countries when they transfer thair assets abroad. This reasoning, of course, is understandable. However, the protection of savings is not the only moral value at stake. A moral appreciation of capital outflows of individuals has to take into account the level of income and wealth of the concerned individuals. When these individuals are very rich, the question may be raised whether there is or not a moral duty for those individuals in developing countries to invest their savings in priority in the context of their national economy, even if inadequate management of that economy makes it likely that the yield will be lower or even inexistent. Even in a country that is badly managed, it is difficult to accept that wealthy individuals could not fund local or regional initiatives which could improve the welfare of their fellow countrymen. Furthermore, wealthy individuals can be politically influential and one may always wonder why they do not do more to improve the economic management of their own country. Obviously, a clear moral duty exists for the political leaders of developing countries to create an economic policy environment that creates confidence and reduces as much as possible the motivations for capital flight. For the financial authorities of a developing country, it is not only an economic policy mistake but a serious lack of moral responsibility to maintain over prolonged period an overvalued exchange rate, which, in the absence of suitable exchange controls, is bound to provoke serious capital outflows. The heaviest moral responsibility is incurred by those who are at the same time the political, economic and financial decision-makers, and those who directly or indirectly are massively transferring their funds and personally benefitting from the maintenance of exchange rates and convertibility situations, clearly contrary to the interest of their country.

Capital flight raises also an ethical issue for the banks in industrialized countries, which receive these capital outflows or manage funds for individuals and entities from developing countries. Of course, among these outflows it is important to make a distinction between money of criminal or morally reprehensible origins and capital movements wliich are legitimate from a strictly legal point of view, albeit regrettable from an economic standpoint, as we just saw. This issue has been particularly discussed in the context of Switzerland. A gentlemen's agreement (Sorgfaltspflichtvereinbarung) exists

between the Swiss National Bank and the Swiss banks, under which these banks undertook, on the one hand not to actively encourage capital flight from other countries, and on the other hand to employ every conceivable means to establish the true identity of those who deposit funds with them. However, the Swiss National Bank itself admits that control is far from perfect and the recent decision by the Swiss Government to block the assets in Switzerland ofthe former president ofthe Philippines, Mr. Marcos, puts this problem in the limelight. Commercial banks may wish to establish their own moral code of conduct in determining the extent to wliich they wish to accept funds coming from developing countries and, more specifically, funds deposited by the political leaders of those countries.

Note
* This presentation made in November 1987 reflects the views ofthe speaker and does not necessarily represent the views of the Commission. Cabinet ofthe Minister of Finance, 12 rue de la Loi, B-1000 Brussels, Belgium.