Pre ClassPPT 2

8/11/2019 Pre ClassPPT 2

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Country Risk

OBJECTIVE

To comprehend:

Country Risk Concentration Risk

Counter Party Risk

Settlement Risk


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Country Risk

Definition: Country risk refers to the risk of

investing in a country, dependent on changes

in business environment.

Country risk is also referred to as Political Risk.

Factors affecting Country risk:

Currency controls

Devaluation

Stability factors (Mass riots, civil war etc)


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Country Risk

For rating countries, Political risk analysts useQualitative methods focusing on political analysis.

Credit rating agencies use quantitative models andfocus on financial analysis.

Controlling Country Risk:

Central banks fix exposure limits to differentcountries.

Also individual banks fix country wise exposurelimits.


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Concentration Risk

Definition :Denotes overall spreads of banks

outstanding accounts over the number or

variety of debtors to whom the bank has lent

money.

Concentration ratio: Percentage of

outstanding accounts to each bank loan.

5 loans of equal value CR will be 0.2

3 loans of equal value - CR will be 0.333


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Concentration Risk

A bank with 10 loans valued at 10 dollars a

piece would have a CR of 0.10.

But if 9 of the loans were for 1 dollar and the

last was for 50, the CR would be considerably

higher.

1/59 = 0.0169

50/59 = 0.847


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Concentration Risk

Therefore loans weighted towards a specificeconomic sector would create a higher ratio thana set of evenly distributed loans because evenlyspread loans would serve to offset the risk. This is

called Risk of Default. Two types of Concentration Risk:

Uneven distribution of exposures to its borrowersis called Concentration Risk

Uneven distribution of exposures to particularsectors, regions, industries or products is calledSectorial Concentration Risk.


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Counterparty Risks

Counterparty is a party with which a transactionis done. If A sells something to B, then B is acounter party from As point of view and vice-

versa. Definition:. The risk that a counterparty will fail to

fulfill their obligations either by failing to pay orby failing to deliver securities is called

counterparty risk Tracking and managingcounterparty risk in much

the same way as any credit risk.


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Counterparty risk

The counterparty risk from securities tradingare either simple credit risk (other party willnot pay) or a combination of credit risk with

the risk of a position in a derivative (otherparty will not deliver securities).

A large financial institution will be acounterparty to many others, and thereforethe knock-on-effects of its failure pose asystemic risk.


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COUNTER PARTY RISK

Ways of controlling counterparty risk:

a. DVP (Delivery versus payment)

A securities industry procedure in which the

buyer's payment for securities is due at the time ofdelivery. Security delivery and payment aresimultaneous.

b. Central counterparty

The central counterparty guarantees theperformance of the underlying transaction byacting as a matching seller to the buyer and amatching buyer to the seller.


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Settlement Risk/Cross Country

Settlement Risk

Definition: The risk that one party fails todeliver the terms of the contract with anotherparty at the time of settlement.

Settlement Risk is some times called HerstattRisk.

Settlement risk is foreign exchange settlement

risk or cross-currency settlement risk. Settlement Risk is possibility your counter

party will never pay you.


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Settlement Risk

Settlement risk was a problem in foreign

market until creation of Continuously Linked

Settlement (CLS) which was facilitated by CLS

Bank International which eliminates time

difference.

Settlement risk comprises both credit and

liquidity risk.


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HERSTATT RISK

Herstatt risk is named after well known failure ofGerman Bank, BANKHAUS HERSTATT.

On 26thJune 1974, the bank had taken its foreigncurrency receipts in Europe. That day, a numberof banks had released payment of DEM toHerstatt in Frankfurt in exchange for USD thatwas to be delivered in New York.

On the same day, German regulators forced the

troubled Bank Herstatt into liquidation becauseof a lack of income and capital to cover liabilitiesthat were due.


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HERSTATT RISK

It was 4:30 pm in Germany and 10:30 am in

New York.

Herstatt stopped all dollar payments to

counterparties, leaving the counterparties

unable to collect their payment.


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HERSTATT RISK

Herstatt's New York correspondent bank

suspended all outgoing US dollar payments from

Herstatt's account, leaving its counterparties fully

exposed to the value of the Deutschemarks theyhad paid the German bank earlier on in the day.

The banks in Germany had done the remittances

in good faith, believing they would receive USdollars later in the same day in New York.

This led to a huge crisis in international market.


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BCBS

After the Herstatt debacle, the G-10 countries(G-10 is actually 13 countries: Belgium,Canada, France, Germany, Italy, Japan,

Netherlands, Luxembourg, Spain, Sweden,Switzerland, United Kingdom and the UnitedStates) formed a standing committee underthe auspices of the Bank for International

Settlements (BIS). This is called the BaselCommittee on Banking Supervision. It wasestablished in 1974.

Pre ClassPPT 2

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