From the Publisher
Every time I hear the words sovereign risk and country risk, especially in the Basel ii/ Basel iii frameworks, I feel depressed.
What do I mean depressed?
"The shadows of nightfall seemed more somber, my mornings were less buoyant, walks in the woods became less zestful, and there was a moment during my working hours in the late afternoon when a kind of panic and anxiety overtook me..." - William Styron, Darkness Visible
Why I feel depressed?
Because I feel the weakness, the difficulty to quantify sovereign risk and country risk.
According to Nagy (1984), 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 but definitely not under the control of a private enterprise or individual.
Country risk is a broader concept than sovereign risk is, which is restricted to the risk of lending to the government of a sovereign nation.
Again, these are difficult areas. It is very difficult to quantify the ability and willingness of sovereigns.
But now, we have a great paper that makes things easier: The BIS Papers No 72, Sovereign risk: a world without risk-free assets?
I really liked it. We have the proceedings of a one-and-a-half day seminar on sovereign risk hosted by the BIS in January 2013.
The event brought together senior central bankers, sovereign ratings analysts, fund managers and other market participants, sovereign legal specialists, risk managers at financial institutions and academics.
Some important parts:
"Sovereigns are unique debtors.
Unique in two senses: they are uniquely vulnerable and they are uniquely protected.
They are uniquely vulnerable in that, unlike a corporate debtor or an individual debtor, there is no bankruptcy code that applies to a sovereign.
They are not subject to their own bankruptcy codes, nor anyone else's.
That means that an over-extended sovereign confronted with a maturing debt obligation has only two choices: pay it or face the prospect of a lawsuit and be compelled to pay it.
To put it differently, a sovereign cannot seek the protection of bankruptcy courts; there is no Chapter 11 for a sovereign.
In that sense, of all the debtors in the world, sovereigns are uniquely vulnerable.
That said, sovereigns are uniquely protected in this sense: until the middle of the 20th century, most countries recognized a theory of absolute sovereign immunity.
A sovereign could not be sued in the courts of another country without its consent.
Moreover, sovereign property, wherever held, was treated as immune from any compulsory seizure.
This was the doctrine of absolute sovereign immunity.
It changed in the middle of the 20th century.
For reasons we do not need to go into here, the trend developed in most countries toward a restrictive theory of sovereign immunity; a theory which says that when a sovereign elects to go into the international marketplace and conduct itself as though it were a commercial actor, it ought to be accountable to judicial process as though it were a commercial actor."
[From Sovereign debt restructurings: the legal context, Lee Buchheit, Partner, Cleary Gottlieb Steen & Hamilton LLP]
"In terms of risk management, it is important to distinguish between credit risk (default risk) and credit spread risk.
Credit risk reflects the risk of potential credit losses due to a counterparty default event (default risk), or a credit migration event (a downgrade from one rating grade to another) or a country transfer event.
Credit spread risk, which is part of the market risk incurred by a bank, reflects the market risk due to fluctuations in daily credit spreads (assuming no rating change) as distinct from the credit risk arising from a rating downgrade.