Debt restructuring
Debt restructuring refers to two types of changes in the terms of debt:
Debt rescheduling changes when payments are due, by pushing the repayments schedule further into the future.The amount of debt is effectively the same, but the borrower has a longer time to pay it off.
Debt reduction lowers the amount of debt.
When a financial crisis hits a country because the country has more debt than it is willing or able to service, resolution of the crisis often requires debt restructuring.By stretching out payments or reducing debt, the borrowing country gains a better chance of meeting a more manageable stream of current and future payments for debt service.A key issue is the process of reaching a restructuring agreement among creditors and borrowers.There is a free-rider problem here.Each individual creditor has the incentive to hold out, hoping that others restructure their lending agreements, but not altering its own.Then the free rider can be repaid faster or fully, while other creditors that agreed to restructuring must wait longer or get less.But if free riding prevents a restructuring deal, then all creditors will probably lose, as the crisis is not resolved.
The debt crisis of 1982 dragged on through the 1980s partly because there was no framework for overcoming the coordination problem among the hundreds of banks that had lent to the crisis countries.In addition to the free-rider problems, legal clauses in many syndicated loan agreements limited debt restructuring.As we saw earlier, the Brady Plan of 1989 finally established a process for debt restructuring.It offered a menu of choices to the creditor banks, as well as coercion when necessary to overcome the free-rider problem.In a typical Brady deal, each creditor bank was offered a choice between partial debt reduction and continuance of its loan agreements along with required new lending to the crisis country.The debt reduction occurred when the bank exchanged its bank loans for a smaller amount of new bonds that were backed by collateral.The borrowing country was able to establish the collateral by borrowing part of the value from the IMF and World Bank.Brady deals succeeded in reducing the debt of 18 crisis countries by $65 billion, about one-third of their total debt.As the Brady deals resolved the lingering crisis, international lending to these countries resumed.
During the crises of the 1990s, restructuring of bank debt went smoother.The limited number of debtors and creditors eased the negotiations.The key issue that arose in the 1990s was the great difficulty in restructuring bonds.There are often hundreds or thousands of bondholders.The legal terms of the typical international bond require that all bondholders agree to the terms of a restructuring.And a small number of bondholders can sue to force immediate full repayment if the issuer defaults on any payment.Since the late 1990s there have been bond restructurings in a few countries, including Pakistan, Ukraine, and Ecuador.In 1999, Ecuador defaulted on its Brady bonds.Although the bondholders resisted, they eventually accepted new bonds that were worth less than the face value of the old bonds but more than the then-current market value of the old bonds.
Given the growing importance of bonds in financial flows to developing countries, there are a number of suggestions to revise the terms of the bonds, to mandate majority voting on restructuring, to share equally any partial payments, and to limit the ability of small numbers of bondholders to force immediate full repayment or take other legal actions concerning the bond.But these suggestions have not yet been adopted, so bond restructuring remains very difficult.