Country Risk

OBJECTIVE
To comprehend:
Country Risk
Concentration Risk
Counter Party Risk
Settlement Risk
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)
Country Risk
For rating countries, Political risk analysts use
Qualitative methods focusing on political analysis.
Credit rating agencies use quantitative models and
focus on financial analysis.
Controlling Country Risk:
Central banks fix exposure limits to different
countries.
Also individual banks fix country wise exposure
limits.

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
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
Concentration Risk
Therefore loans weighted towards a specific
economic sector would create a higher ratio than
a set of evenly distributed loans because evenly
spread loans would serve to offset the risk. This is
called Risk of Default.
Two types of Concentration Risk:
Uneven distribution of exposures to its borrowers
is called Concentration Risk
Uneven distribution of exposures to particular
sectors, regions, industries or products is called
Sectorial Concentration Risk.

Counterparty Risks
Counterparty is a party with which a transaction
is done. If A sells something to B, then B is a
counter 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 or
by failing to deliver securities is called
counterparty risk
Tracking and managing counterparty risk in much
the same way as any credit risk.
Counterparty risk
The counterparty risk from securities trading
are either simple credit risk (other party will
not pay) or a combination of credit risk with
the risk of a position in a derivative (other
party will not deliver securities).
A large financial institution will be a
counterparty to many others, and therefore
the knock-on-effects of its failure pose a
systemic risk.
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 of
delivery. Security delivery and payment are
simultaneous.
b. Central counterparty
The central counterparty guarantees the
performance of the underlying transaction by
acting as a matching seller to the buyer and a
matching buyer to the seller.

Settlement Risk/Cross Country
Settlement Risk
Definition: The risk that one party fails to
deliver the terms of the contract with another
party at the time of settlement.
Settlement Risk is some times called Herstatt
Risk.
Settlement risk is foreign exchange settlement
risk or cross-currency settlement risk.
Settlement Risk is possibility your counter
party will never pay you.

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.
HERSTATT RISK
Herstatt risk is named after well known failure of
German Bank, BANKHAUS HERSTATT.
On 26
th
June 1974, the bank had taken its foreign
currency receipts in Europe. That day, a number
of banks had released payment of DEM to
Herstatt in Frankfurt in exchange for USD that
was to be delivered in New York.
On the same day, German regulators forced the
troubled Bank Herstatt into liquidation because
of a lack of income and capital to cover liabilities
that were due.

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.
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 they
had paid the German bank earlier on in the day.
The banks in Germany had done the remittances
in good faith, believing they would receive US
dollars later in the same day in New York.
This led to a huge crisis in international market.

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 United
States) formed a standing committee under
the auspices of the Bank for International
Settlements (BIS). This is called the Basel
Committee on Banking Supervision. It was
established in 1974.