Scrutinizing Country Credit Risk

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Industries that get engaged in international lending or that acquire cross-border exposure, undertake country risk. That’s because the transaction involves two countries taking a risk. Therefore, there is greater need for skilled risk management strategies in international companies.

The country of the industry involved is the key factor that differentiates the concept of domestic and international lending. Country risk encompasses every form of risk and uncertainty arising from political, economic and social conditions of the country. These factors can lead to constraints for the industry, preventing it from fulfilling its obligations to international clients. As a result, the pressure on people implementing best practices increases.

In addition to the above risks, it is also likely that country risk may result due to expropriation or nationalization. Moreover, exchange control, devaluation of currency and government repudiation also contribute to country credit risk. As a result, constraints on decision-makers of the company increase. To ensure best practices for risk management, they are forced to refrain from delivering the goods across border. Instead, they resolve to trade within the country to mitigate losses.

However, the plus point here is that country risk is one that industries can influence directly. International companies, therefore, must ensure that they utilize adequate technology and systems to manage cross-border exposure. In order to ensure risk management, CEO’s should concentrate on best practices to avoiding risk in the first place.

The success and sophistication of risk management systems implemented depend on the complexity of cross-border exposure.

Forms of Country Risks

International companies are liable to exposure to six main forms of country risks. These include:

  • Sovereign risk: This denotes the willingness and capacity of foreign governments to repay direct or indirect financial obligations. These are usually in foreign currency.
  • Transfer risk: This form of risk denotes the inability of a borrower to obtain foreign exchange to be able to fulfill external obligations. This often happens because of social, economic and political problems. The consequence of which is drained foreign currency reserves of the country. As a result, borrowers cannot convert local currency funds to foreign currency.
  • Contagion risk: This risk results when adverse conditions of one country cause negative impact on the credit of other countries in its region. This can happen regardless of whether neighboring countries are credit worthy or not.
  • Currency Risk: This is a risk associated with the probability of cash flow and domestic currency reserves becoming inadequate, due to devaluation.
  • Indirect Risk: This is when the ability to pay cross-border is endangered due to economic, social and political reasons.
  • Macroeconomic Risk: When interests go high due to failing economy, the borrower’s risk increases. This leads to constraints in best practices for international businesses that cause increase in country risk.

Therefore, it is country risk management that is important, as far as country credit risk is concerned. Banks plan an important part in this and must implement the best risk management strategies.

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