Chapter 11

Country and Sovereign Risk

Country risk is the exposure to a loss in . . . cross-border lending caused by events in a particular country which are, at least to some extent, under the control of the government. Country risk is therefore a broader concept than sovereign risk, which is restricted to the risk of lending to the government of a sovereign nation.

—P. J. Nagy1

While the statement “a bank can never be better than the country within which it is located” is not necessarily true in all cases (for example, if a bank has sizeable assets and liabilities beyond the home country’s borders . . .), in general, it is a pretty good rule to follow.

—Robert Morris Associates2

Well before globalization increased the volume of cross-border commercial and financial transactions, banks were exposed to risk associated with the creditworthiness of other countries, either directly or through transactions entered into with banks located in other countries.

Whether the denomination attached to that risk—with country risk and sovereign risk often used interchangeably—it is clear that many banks are exposed to the creditworthiness of sovereigns, as well as to the creditworthiness of financial institutions operating in foreign countries, themselves affected both by the creditworthiness of their government (usually associated with the notion of sovereign risk) and by the risks specific to financial and commercial banking operations in their country (usually associated with the notion of ...

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