Country risk, or sovereign risk, represents the possibility that a foreign government will interfere with the payment of loans by foreign borrowers or that it itself will fail to honor its debts. This type of risk affects not only investors in sovereign bonds, but also those who invest in companies operating in countries outside the Eurozone or in nations with less stable economic and political systems.
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Country risk for international investors
For investors who diversify their portfolios on a geographic basis, country risk becomes a crucial factor to consider. Companies located outside financially sound or politically stable regions have greater exposure to default risk or government interference. This is especially the case in emerging markets, where political dynamics can quickly affect economic stability.
In these situations, investors may face sudden changes in economic policies, such as nationalization of companies or capital freezes, that put their investments at risk.
Country risk for banks and financial intermediaries
Not only investors are exposed to country risk, but banks and financial intermediaries operating outside the Eurozone must also pay attention to this factor. When calculating banks’ minimum capital requirements, this risk directly affects the solvency ratio. In fact, this parameter determines the risk weightings applied to loans granted by banks to foreign governments.
Banking supervisors can use country risk ratings provided by export credit agencies to assess the solvency of foreign government entities. In this context, it is crucial for Italian and international banks to maintain a solid hedge of risks associated with transactions with counterparties residing in countries outside the OECD.
The role of banks in international financial crises
The increasing involvement of banks in managing international financial crises has increased their exposure to country risk. In fact, banks grant large amounts of financing to debtor countries in difficulty, taking more risk on themselves. This requires more judicious management of country risk, which is in addition to traditional counterparty and market risks.
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Giuseppe Fontana
I am a graduate in Sport and Sports Management and passionate about programming, finance and personal productivity, areas that I consider essential for anyone who wants to grow and improve. In my work I am involved in web marketing and e-commerce management, where I put to the test every day the skills I have developed over the years.
