Sovereign Risk
Research Question: Country/Sovereign and Risk Assessments have evolved to become an integral part of international lending. Explain the factors to consider in determining the overall Sovereign/Country risk and why these factors are critical. What is the Bahamas' experience in its Risk Assessments?
Financial institutions increasingly conduct business abroad in order to diversify and expand their sources of revenue and profitability. This strategy of international lending exposes the bank to country risk and raises the potential for financial loss. Country risk is a collection of risks which are associated with investing in a foreign country. These risks include political risk, exchange rate risk, economic risk, and sovereign risk (as well as transfer risk). It varies from one country to the next. Some countries have a high enough risk to discourage foreign investment. The United States is generally considered the benchmark for low country risk and most nations can have their risk measured as compared to the U.S. One of the main subsets of country risk is sovereign risk. This is the risk that a foreign central bank will alter its foreign-exchange regulations, thereby significantly reducing the value of foreign exchange contracts. It is the potential loss of the assets that a bank loaned internationally in foreign currency (Khambata, 1996). The existence of such risk means that creditors should take a two-stage decision process when deciding to lend to a firm based in a foreign country. Firstly one should consider the sovereign risk quality of the country and then consider the firm's credit quality (Cooper, 1998). According to the International Monetary Fund (IMF), the term transfer risk, which is also known as direct sovereign intervention risk, is usually only used in a foreign currency context. It refers to the probability that a government with foreign debt servicing difficulties imposes foreign exchange payment restrictions on otherwise solvent companies and
Financial institutions increasingly conduct business abroad in order to diversify and expand their sources of revenue and profitability. This strategy of international lending exposes the bank to country risk and raises the potential for financial loss. Country risk is a collection of risks which are associated with investing in a foreign country. These risks include political risk, exchange rate risk, economic risk, and sovereign risk (as well as transfer risk). It varies from one country to the next. Some countries have a high enough risk to discourage foreign investment. The United States is generally considered the benchmark for low country risk and most nations can have their risk measured as compared to the U.S. One of the main subsets of country risk is sovereign risk. This is the risk that a foreign central bank will alter its foreign-exchange regulations, thereby significantly reducing the value of foreign exchange contracts. It is the potential loss of the assets that a bank loaned internationally in foreign currency (Khambata, 1996). The existence of such risk means that creditors should take a two-stage decision process when deciding to lend to a firm based in a foreign country. Firstly one should consider the sovereign risk quality of the country and then consider the firm's credit quality (Cooper, 1998). According to the International Monetary Fund (IMF), the term transfer risk, which is also known as direct sovereign intervention risk, is usually only used in a foreign currency context. It refers to the probability that a government with foreign debt servicing difficulties imposes foreign exchange payment restrictions on otherwise solvent companies and