By Shayan Siddiqui and Erdem Tasbas
The Origins of Sovereign Debt
Lending predates money. Even in the Code of Hammurabi, one of the first legal codes, humans had to contend with the costs of lending: default and bankruptcy.
“A national debt is one of the few economic phenomena without roots in the ancient world” – Earl Hamilton (Hamilton, 1947)
While economic historian Earl Hamilton argues that sovereign debt is a uniquely modern economic concept, ancient history offers a rare exception. In the 4th century BCE, several Greek states defaulted on their loans from the Temple of Delos, a quasi-central bank in ancient Greece (Eichengreen et al, 2018). However, the framework of modern sovereign debt did not emerge until the banking system of medieval Italy.
Italy
Public debt was borne out of war. The kings of medieval Europe relied on domestic earnings to fund their wars and raised armies from their population. In contrast, the merchant-states of Northern Italy relied on taxation and borrowing to fund their mercenary armies.
The Italian city-states raised debt from their own wealthy elites. In 1427, just 2% of the population held 60% of Florence’s debt. These elite families, many of which became prominent bankers, moved beyond lending to their own states and began financing other sovereigns across Europe (Roos, 2020).
This expansion brought far greater risk. Lending locally was relatively secure, as banking families held influence within their own city government. In contrast, foreign sovereigns were harder to discipline. The decline of Siena’s banks illustrates the danger Italian banks faced. They collapsed in large part due to the seizure of loans by Philip the Fair of France and King Edward I of England (Celerier & Guernet, 2026). Simply put, cross-border contracts were challenging to enforce, especially when the borrower was a king.
Amid the risks posed by foreign lending, the first mechanisms for sovereign default and restructuring began to emerge. In Genoa, banking families syndicated and extended numerous large loans to Philip II of Spain to enable his exploration of the Americas and war against rebellion in the Netherlands (Roos, 2020).
The second mechanism resembled the earlier system in Amsterdam in which discipline was imposed by the underwriting banks. Throughout the 19th century, three major intermediary banks underwrote no less than half of all sovereign borrowing at any given time. The most prominent were the Rothschilds; they acted as the gatekeeper to the bond market of London, refusing to underwrite loans for governments that had defaulted and not restructured their debts. Furthermore, to keep their market share, the leading banks wanted to be seen as only arranging loans to reliable countries. This resulted in a system where countries were more receptive to trying to pay or restructure their debts when at risk of default, otherwise they risked having to resort to lenders with higher rates or being shut out of the bond market entirely. This effect was evident during the crisis of 1820, when no Rothschild-backed loan defaulted while only three loans from the rest of the market had not entered non-repayment (Roos, 2020).
Gunboats & the Great Depression
The turn into the 20th century marked a change in how sovereign defaults were enforced. It began in 1902, when, after three years of failed negotiations, British, Italian, and German naval ships blockaded Venezuela. Their warships shelled naval defenses until the Venezuelan government agreed to undergo debt restructuring. This episode began the era of gunboat restructuring (Roos, 2020).
The United States soon sought to manage such disputes within its own sphere of influence. Under the Monroe Doctrine, the US opposed European intervention in the Western Hemisphere. The US took military action or financial control of the Dominican Republic, Cuba, Haiti, Honduras, Mexico, and Nicaragua. Both the US and Britain only applied this tactic within their specific spheres of influence: the Caribbean and Eastern Mediterranean, respectively. No South American country or other European country were subjected to gunboats (Roos, 2020).
However, gunboat restructuring disappeared during the Great Depression. As New York City overtook London as the world’s leading financial centre, traditional enforcement mechanisms failed. When numerous countries defaulted, the US did not intervene. Many countries went through default during the Great Depression, but few restructured. There existed no large underwriters in New York that could control access to capital markets and enforce negotiations. Furthermore, the capital markets themselves could not provide further financing even if a country did restructure their debt, removing a benefit of restructuring (Roos, 2020).
Additionally, coming out of the Great Depression, the defaults of the era were seen as excusable on the side of the borrowers. Bondholders had lent to countries irresponsibly and the US government held the position that bankers had been exploitative in their lending (Roos, 2020). In 1943, Franklin D. Roosevelt apologized to the President of Bolivia for Wall Street bankers lending to Bolivia at an “unconscionable” interest rate (U.S. Department of State, 1943).
IMF, World Bank, and Paris Club
After the Second World War, the international financial system changed significantly. The essential function of private banking families and market intermediaries began to diminish in sovereign lending. They were replaced by international institutions, which took over this central position.
Two of these institutions are the International Monetary Fund (IMF) and the World Bank, which were created in 1944 at Bretton Woods. Their main objective was to act as a stabilizer of the global financial system and to support economic development. When a country encountered a debt crisis, IMF acted as a coordinator between the debtor government and its creditors. In addition to providing emergency financing, the Fund required substantial policy reforms from debtors in order to restore their debt repayment ability.
In parallel to the IMF, another important institution emerged: The Paris Club. It was founded during negotiations with Argentina in 1956 and quickly became the major forum used by major creditors to coordinate debt restructurings (Wikipedia Contributors, 2026). In practice, creditor states met together in Paris to negotiate about restructuring terms rather than each government negotiating separately. This improved the efficiency of the negotiation process.
The Paris Club led to the establishment of many principles that govern the sovereign restructurings today, including collective negotiation of creditors, consensus decision making, and comparable treatment from different creditors (Paris Club, 2026). Practically, this means that if a country restructures its debt with Paris Club members, it is expected that the country seeks similar concessions from private lenders and other governments. In combination, these rules led to greater coordination in a process that was fragmented historically. In summary, the IMF and Paris Club became the central institutions that managed sovereign debt issues in the second half of the 20th century.
1980s Latin America
A key development in sovereign debt restructuring occurred during Latin America’s debt crisis in the 1980s. In the 1970s, many Latin American governments borrowed excessively from various international banks. Low global interest rates and high liquidity from oil rich countries were two key factors encouraging loan creation. The favorable borrowing environment dramatically changed when the US increased interest rates in the early 1980s to tame high inflation. Commodity prices also fell, which made debt repayments increasingly difficult. The first default came from Mexico in 1982, when it announced it couldn’t service its external debt. Brazil, Argentina, and several other Latin American countries defaulted in the following years.
In contrast to earlier crises in the region, this time major creditors were large international banks instead of bondholders. This led to a complex restructuring situation as there was a need for coordination among hundreds of banks with large exposures.
At first, the strategy to restructure was to extend maturities and provide new loans to allow debtors to continue servicing their debts. Unfortunately, these efforts proved insufficient. By the late 1980s, policymakers realized that many countries were not in a position to repay their loans in full. The solution finally came in 1989 via the Brady Plan, which converted bank loans into tradable bonds, reducing principal and interest payments (Cline, 1995). This was a foundational development in sovereign bonds and restructuring as the Brady plan introduced conversion of loans into bonds and debt reduction as opposed to simple rescheduling.
1990s Russia
The collapse of the Soviet Union in 1991 created one of the most complex sovereign debt situations of the 1990s. Russia inherited a large portion of Soviet external debt. Simultaneously, the Russian economy was experiencing a difficult transition from a centrally planned system to a market economy. Fiscal instability and declining output made debt sustainability increasingly uncertain.
The situation deteriorated rapidly in 1998 when a combination of falling oil prices and capital flight resulted in severe pressure on Russia’s finances. In August, the government defaulted on its domestic debt and announced a moratorium on some foreign obligations.
The Russian debt crisis was important as it occurred in an economic environment dominated by bond markets and global investors. It resulted in extensive financial instability and contributed to the collapse of the infamous hedge fund Long Term Capital Management. As discussed in Roger Lowenstein’s book ‘When Genius Failed’, the Russian crisis led to a domino effect in the global bond market that resulted in several once in a lifetime event in a single month (Lowenstein, 2000).
Restructuring negotiations involved both private creditors and official institutions like the IMF and the Paris Club. Eventually, Russia reached agreements to restructure Soviet-era obligations with official creditors and continued renegotiating private debt. These events highlighted the growing complexity of sovereign debt crises in a globalized financial system.
Greece, 2013
The European sovereign debt crisis was another major turning point in sovereign restructuring history. After the 2008 financial crisis, many eurozone countries experienced substantial financial stress. Greece was the most severe case; when economic growth slowed, its vulnerability increased due to large budget deficits and rising public debt.
By 2010, Greece effectively lost access to private capital markets. Accordingly, the country received large rescue packages from the European Union, the European Central Bank, and the IMF. However, these loans were insufficient to restore debt sustainability. In 2012, Greece undertook what became the largest sovereign debt restructuring in history. Private investors agreed to exchange their bonds for new securities with lower face value and longer maturities. This reduced the value of privately held Greek debt by more than 50% (International Monetary Fund, n.d.).
Use of collective action clauses was also instrumental, as they enabled a supermajority of bondholders to approve the restructuring terms. This made them binding for all investors and prevented holdout creditors from blocking the agreement.
Greece’s crisis exemplified the scale that modern sovereign restructurings can reach, and the importance of contractual mechanisms in coordinating thousands of bondholders was again emphasized.
The Rise of China as a Creditor
In recent years, the structure of sovereign debt environment changed in a meaningful way once again. The key development was the rise of China as a major creditor to the world. Through initiatives such as the Belt and Road Initiative, Chinese policy banks extended large amounts of credit to emerging markets. Many of these loans financed infrastructure projects such as ports, railways, and energy systems. This new lending structure complicated debt restructurings further. As opposed to traditional creditor countries, Chinese lenders are not part of the Paris Club framework, making debt restructuring among different creditors more difficult.
In response, G20 introduced the Common Framework for Debt Treatments in 2020 (G20 Italian Presidency, n.d.). The framework aimed to bring together Paris Club members, China, and private creditors to allow for more coordinated restructuring negotiations for heavily indebted countries.
However, implementation has been slow. Differences in lending practices, transparency, and restructuring approaches have made negotiations more complex. Furthermore, the emergence of ‘no Paris clause’ provisions in Chinese loans further complicates restructuring of sovereign debt between various creditor groups (Gelpern et al, 2021). The growing diversity of creditors suggests that sovereign debt restructurings will continue to evolve in the coming decades.
Conclusion
Sovereign debt restructuring continually evolved along with the structure of international financial markets. In the medieval period, restructurings were negotiated between a small number of banking families. In the 19th century, the number of investors involved in sovereign debt was expanded by the capital markets of Amsterdam and London. The 20th century introduced international institutions to coordinate negotiations, namely the IMF and Paris Club.
More recently, the complexity of the process has been increased by the rise of global bond markets and new creditor countries. Mechanisms such as collective action clauses and coordinated creditor forums have improved sovereign debt restructuring. However, even today, no formal global bankruptcy system exists for sovereign states. In conclusion, as global lending continues to evolve, the institutions and mechanisms to manage sovereign debt crises evolve with them.
References
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