Country Risk Management

Risks Associated with International Activities

Under the OCC’s supervision by risk philosophy, risk is the potential that events, expected or unexpected, may have an adverse impact on a bank’s earnings or capital. The OCC has defined nine categories of risk for bank supervision purposes: credit, interest rate, liquidity, price, foreign currency translation, transaction, compliance, strategic, and reputation risk. These nine risks, which are discussed in detail in other booklets of the Comptroller’s Handbook, are not mutually exclusive; any product or service provided either domestically or internationally may expose the bank to multiple risks.

Along with the risks present in their domestic operations, banks engaged in international activities are exposed to “country risk” the risk that economic, social, and political conditions and events in a foreign country will adversely affect an institution’s financial interests. In addition to the adverse effect that deteriorating economic conditions and political and social unrest may have on the rate of default by obligors in a country, country risk includes the possibility of nationalization or expropriation of assets, government repudiation of external indebtedness, exchange controls, [1] and currency depreciation or devaluation.

Country risk has an overarching effect on a bank’s international activities and should explicitly be taken into account in the risk assessment of all exposures (including off-balance-sheet exposures) to all public- and private-sector foreign-domiciled counterparties. The risk associated with even the strongest counterparties in a country will increase if, for example, political or macroeconomic conditions cause the exchange rate to depreciate and the cost of servicing external debt to rise.

Country risk is not necessarily limited to a bank’s exposures to foreign-domiciled counterparties. Although it may not be feasible to incorporate the potential effect of country risk on domestic counterparties into the bank’s formal country risk management process, country risk factors should nevertheless be taken into account, where appropriate, when assessing the creditworthiness of domestic counterparties. Country risk would be pertinent to exposures to U.S.-domiciled counterparties if the creditworthiness of the borrower or of a guarantor (or the value of the collateral) is significantly affected by events in a foreign country. For example, a domestic borrower’s credit risk might increase because of significant export receivables from a foreign country or because of the transfer-pricing of imports from a foreign affiliate. Country risk considerations would also be pertinent when one of the determinants of a transaction’s value is a foreign country’s foreign exchange or interest rate environment, as would be the case in an interest rate swap in which one rate is derived from a foreign country’s yield curve.

Country risk is not limited solely to credit transactions. Investments in foreign subsidiaries, electronic banking agreements, and EDP servicing and other outsourcing arrangements with foreign providers all carry with them the risk that policies or conditions in a foreign country may have adverse consequences for the bank.

1.
Exchange controls are an example of transfer risk, which is a facet of country risk. Transfer risk is the possibility that an asset cannot be serviced in the currency of payment because the obligor’s country lacks the necessary foreign exchange or has put restraints on its availability. The Interagency Country Exposure Review Committee (ICERC) assigns ratings to foreign exposures based on its evaluation of the level of transfer risk associated with a country. See the Guide to the Interagency Country Exposure Review Committee Process, which was issued in November 1999, for a comprehensive discussion of the operations of the ICERC.
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