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CMA Final · Risk Management in Banking and Insurance · Sovereign Risk and Insolvency Risk

An Indian bank has a large exposure to a foreign government that has announced it will not honour interest payments on its own external debt, although the government has enough foreign currency reserves to pay. Which type of sovereign risk event does this most precisely describe?

This is a willingness-to-pay default, a strategic or political repudiation. The government has the reserves to pay but chooses not to, so the cause is unwillingness rather than inability, which distinguishes it from transfer risk caused by a foreign exchange shortage.

  1. ATransfer risk arising from a shortage of foreign exchange
  2. BWillingness-to-pay default, i.e. a strategic or political repudiation of debtCorrect
  3. CCurrency convertibility restriction imposed on private borrowers
  4. DSettlement risk arising from time-zone differences in payment

Explanation

Sovereign default can arise from inability to pay or unwillingness to pay. Here the reserves are adequate, so the cause is a political decision not to pay, which is willingness-to-pay default. Transfer risk would apply only if the shortage of foreign exchange prevented payment, which is not the case here.

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