Transfer risk is the risk that a non-sovereign entity, which is able and willing to service its foreign currency obligations, cannot obtain the required currency or cannot transfer this money to the receiver abroad. This transfer inability is caused by the imposition of restrictions on convertibility or capital transfers by the government. Transfer risk applies to all types of international investments, especially in emerging market countries. Due to this, it is more important than ever in these days of globalization. The New Basel Capital Accords require the consideration of transfer risk, too.
The author Philipp Hauger describes the different types of risk occurring in international borrowings and investments. The political and corporate determinants of transfer risk are examined. The book illustrates the reasons why monetary unions reduce the risk of a transfer event, even though they have no influence on the sovereign risk. In addition, the author details how transfer risk is assessed by international professionals and describes two interesting approaches to estimate transfer risk in a quantitative way.
This book is intended for professionals and students who are interested in the risks of international investments and for everybody working in international business, who has to differentiate between sovereign risk and the risk of a corporate default.
Table of Contents
1 Introduction
2 Types of Risk in International Capital Transactions
2.1 Default Risk
2.1.1 Corporate Default Risk
2.1.2 Sovereign Default Risk
2.2 Country Risk
2.2.1 Political Country Risk
2.2.2 Economic Country Risk
2.2.3 Social Country Risk
2.3 Rating Implications
2.3.1 Historical Application of the Sovereign Ceiling
2.3.2 Local versus Foreign Currency Ratings
2.3.3 Transfer and Convertibility Risk Ratings
3 Determinants of Transfer Risk
3.1 Political Determinants
3.2 Corporate Determinants
4 Empirical Examples of Transfer Risk Determinants
4.1 Influence of Monetary Unions
4.1.1 European (Economic and) Monetary Union
4.1.2 Central African Economic and Monetary Community
4.1.3 Common Monetary Area
4.1.4 Adoption of a foreign currency and currency board
4.2 Sovereign Crises with and without Transfer Events
4.2.1 Venezuela (1994)
4.2.2 Dominican Republic (2005)
5 External Assessments of Transfer Risk
5.1 Assessment by Political Risk Insurers
5.2 Regulatory Assessment of Transfer Risk
6 Quantifying Transfer Risk
6.1 Monte Carlo Simulation
6.2 Merton Approach
7 Summary
8 Conclusion & Trends
Research Objective and Key Topics
The primary objective of this thesis is to analyze the nature of transfer risk in international capital transactions, distinguishing it from general sovereign risk, and to evaluate whether banks can grant credit to creditworthy companies located in less creditworthy, highly indebted countries.
- Distinction between sovereign risk, country risk, and transfer risk.
- Analysis of determinants that increase or mitigate transfer risk.
- Impact of monetary unions on transfer risk exposure.
- Case studies of sovereign financial crises and their effect on private debt servicing.
- Quantitative assessment methods, specifically Monte Carlo simulations and the Merton approach.
Excerpt from the Book
1 Introduction
In international lending the borrower has to go through a two-stage process to honour its debt (figure 1). The first stage is to earn enough domestic currency to provide the debt service. The second stage is to convert that domestic currency into foreign currency used to denominate its debt and to transfer this foreign currency to the creditor. It is this second stage that gives rise to transfer risk. In this thesis transfer risk is defined as the inconvertibility and the non-transferability of foreign currency.
Transfer risk is the risk that a non-sovereign entity, which is able and willing to service its foreign currency obligations cannot obtain or transfer the money to the receiver abroad. This transfer inability is caused by the imposition of restrictions on convertibility or capital transfers by the government. Transfer risk applies to all types of international investments.
Transfer risk is a substantial part of credit risk, whenever a bank extends credit across international borders and the extension of credit is denominated in a currency external to the one of the country of residence of the obligor. In these circumstances and the absence of the ability to earn foreign currency abroad, an obligor has to obtain the foreign currency needed to service its obligation from the national central bank. Where a country is beset by political, economic, or social turmoil leading to shortages of foreign currencies at the central bank, the borrower may be unable to obtain or transfer the foreign currency and thus default on the obligation to the lending bank or, alternatively, request a restructuring of the debt.
Summary of Chapters
1 Introduction: Provides the definition of transfer risk as a two-stage process and outlines the thesis's core question regarding lending to private entities in high-risk sovereign environments.
2 Types of Risk in International Capital Transactions: Explains the differences between corporate default risk, sovereign default risk, and various types of country risk, concluding with rating implications.
3 Determinants of Transfer Risk: Examines political and corporate factors that influence the likelihood and severity of transfer risk and how they can be managed or mitigated.
4 Empirical Examples of Transfer Risk Determinants: Analyzes the mitigating role of monetary unions and presents case studies of financial crises in Venezuela and the Dominican Republic.
5 External Assessments of Transfer Risk: Compares approaches to evaluating transfer risk used by political risk insurers and U.S. regulatory bodies.
6 Quantifying Transfer Risk: Discusses quantitative modeling techniques, specifically the Monte Carlo simulation and the application of the Merton approach to sovereign transfer risk.
7 Summary: Recaps the main findings regarding the impact of globalization on transfer risk and the potential for mitigating strategies.
8 Conclusion & Trends: Answers the central research question by confirming that lending is feasible through effective mitigation, despite sovereign risks.
Keywords
Transfer risk, Sovereign risk, Country risk, International lending, Capital controls, Foreign currency, Monetary unions, Credit rating, Default risk, Merton approach, Monte Carlo simulation, Debt restructuring, Globalization, Foreign exchange reserves, Political risk insurance.
Frequently Asked Questions
What is the central focus of this thesis?
The thesis explores the dynamics of transfer risk in international lending, specifically investigating whether banks can safely lend to private corporations in countries with high sovereign risk.
What is the difference between transfer risk and sovereign risk?
Sovereign risk relates to a government's failure to honor its own debt, while transfer risk is the risk that a healthy private entity cannot move local funds into foreign currency due to government-imposed restrictions.
What is the primary research question?
The study addresses whether banks can extend credit to creditworthy companies operating in countries that are themselves not considered creditworthy or are highly indebted.
Which quantitative methods are discussed?
The author evaluates the use of Monte Carlo simulations to model contagion effects and the adaptation of the structural Merton model to analyze sovereign transfer events.
What role does globalization play in transfer risk?
Increased integration into global trade and production networks tends to raise the economic costs of imposing capital controls, thereby reducing the likelihood of governments declaring a general transfer moratorium.
What are the key mitigation factors for a corporation?
Strategies include maintaining a robust export base, multinational production capabilities, support from an offshore parent company, and access to committed international credit lines.
Why did the Dominican Republic case differ from Venezuela?
While both experienced sovereign financial distress, the Dominican Republic avoided a generalized transfer moratorium, opting instead for market-friendly debt restructuring, unlike the restrictive measures taken by Venezuela in 1994.
How does the author view the "sovereign ceiling"?
The author argues that the traditional sovereign ceiling is less applicable in modern, globalized economies, as private entities can often demonstrate resilience against sovereign intervention.
- Quote paper
- Master of Science (MSc) Philipp Hauger (Author), 2006, An Analysis of Transfer Risk in Comparison to Sovereign Risk, Munich, GRIN Verlag, https://www.grin.com/document/62752
