Last tango in Basel: a Gaucho’s guide to avoiding the repayment of debt

Most voters would never have heard of the Basel-based Bank for International Settlements (BIS).

However, the BIS performs a crucial role as the central banks' banker. In establishing rules on capital adequacy requirements (the Basel Rules), it influences how much banks can lend to business and individuals. The BIS also has a distinguished record in warning about the credit boom and securitisation in 2008. Yet its own internal governance is in need of urgent reform.

The Bank’s reputation is being sullied by abuse on a major scale. A clutch of nations have spotted that the BIS enjoys  full  legal immunity from unpaid creditors of outstanding bonds issued by countries that have fallen into default. The biggest abuser is also the largest defaulter of all times, namely Argentina, which defaulted on US$81 bn of government loans when it also unpegged the national currency – the peso – from the US Dollar in January 2002. In terms of value, the peso fell by 70 per cent after it was allowed to float. With bank accounts frozen, the country’s reputation fell through the floor.

It turns out that Argentina demonstrates a great deal of form in this regard. The Paris Club of creditor nations, founded in 1956, was established when Argentina defaulted on a stack of government debt.

In recent years, Argentina has made some attempts to hammer out a deal on the accumulated debts it reneged on back in January 2002. In February 2005, three- quarters of the country’s creditors agreed to a deal which repaid 27 per cent of the face value of the bonds they held. Last year a further tranche of bondholders agreed to a deal which repaid 75 per cent of the outstanding debt. But there remain a considerable number of bondholders who still hold unpaid Argentine bonds valued at $15 bn.

Over the last decade Argentina has managed to rebuild its economy and accumulated considerable reserves of foreign currency. In order to evade its creditors, Argentina has  chosen to stash 86 per cent of its foreign currency reserves at the BIS in Basel. Figure 1 shows the way in which Argentina has chosen to funnel the vast majority of its foreign reserves into two international institutions – the IMF and the BIS – both of which afford it protection from its unpaid creditors.

Figure 1: Where Argentina puts its foreign cash (source: Calculated from IMF data)

The proportion of foreign currency reserves held at the BIS by Argentina is out of all proportion to international norms. Figure 2 charts the proportion of foreign currency and gold reserves held by a range of developed and developing countries at the BIS, IMF and other central banks in May 2011. It turns out that a clutch of controversial regimes have also chosen the BIS as a safe haven for their accumulated cash. Nicaragua, for example, where corruption is perceived as pervasive1, holds no less than 61.5 per cent of its foreign currency reserves in Basel while Iceland, hit hard by the banking crisis, has just over half (50.4 per cent) of all its reserves deposited at the BIS. 

Excluding Argentina, the weighted average holding for 48 countries analysed in our research is just over six per cent. The UK holds one per cent and Chile, Argentina’s neighbour, deposits only 0.1 per cent. The European Central Bank, on behalf of the eurozone, deposits a mere 1.4 per cent of its reserves at the BIS. Compared with the interest rates paid by commercial banks, the BIS offers relatively lower returns. But its crucial attraction is that it provides legal immunity from unpaid creditors.

Figure 2:  Sovereign Nations’ Deposits of Foreign Currency deposited at the BIS in May 2011 as a Proportion of Their Total Official Reserves ( source: based on IMF data)

Countries such as the UK and Chile are adopting an economically rational course with regard to their foreign currency deposits at the BIS. Since the interest rates offered compare poorly with rates elsewhere, these countries deposit only modest sums in order to meet calls generated from global trading activities.

Hence, Argentina is exploiting the legal loophole afforded by the archaic Hague Convention that established the BIS in 1930. Such manipulation stains the BIS’s reputation. It is also short sighted. Until Argentina negotiates a final settlement with outstanding bondholders, it will be unable to raise funds in the world’s capital markets.

Senior European figures have begun to speak out about the BIS as an “unwitting accomplice” in Argentina’s non-payment to its creditors.  For example, Frits Bolkestein, a former EU Commissioner recently contributed an article2 in the Wall Street Journal Europe calling for the BIS to “demonstrate its commitment to a sound global financial system, by tackling what looks very much like the corruption of its own regulations”. Clearly, it is now time for the BIS Board of Governors to implement a root and branch reform of the Bank’s international legal position with a view to preventing governments using it as a safe haven for most of their foreign currency reserves.

There is an opportunity here for the United Kingdom – as one of the original six signatories3 to the Hague Convention – to take the lead in reforming the way in which it deals with defaulting nations. Given the current risk of default in so many countries worldwide, there should be no encouragement of a situation in which the bankers’ bank in Basel becomes the favoured home for foreign currency reserves in need of an international bolt-hole. The Governor of the Bank of England, Sir Mervyn King, should accordingly spearhead a move to carry out a thorough reform of the legal immunities relating to the BIS. This would deter abuse and restore faith in this long standing pillar of the international financial system.

1 As quoted in the 2011 Index of Economic Freedom, published by the Wall Street Journal & Heritage Foundation. Nicaragua ranked at the worst end of the Corruption Perception Index - 127th out of 180 countries - in Transparency International’s 2010 league table.

2 Wall Street Journal Europe, Frits Bolkestein, “Where Buenos Aires Hides its Cash; The Bank for International Settlements must tackle what looks very much like the corruption of its own regulations,” 22 July 2011

3 The other five are Italy, France, Belgium, Germany and the USA.

The BIS or World Domination Club as it is often known is far more interested in advancing the single global government agenda than balancing the books.

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