Contingent Liabilities Risk Management: A Credit Risk Analysis Framework for Sovereign Guarantees and On Lending?Country Experiences from Colombia, Indonesia, Sweden, and Turkey
Sovereign credit guarantees and government on lending can catalyze private sector investment and fulfill specific policy objectives. However, contingent liabilities stemming from guarantees and contingent assets stemming from on lending expose governments to risk. Prudent risk management, including risk analysis and measurement, can help identify and mitigate these risks. This paper proposes a four step structure for analyzing and measuring credit risk: (i) defining key characteristics to determine the choice of a risk analysis approach; (ii) analyzing risk drivers; (iii) quantifying risks; and (iv) applying risk analyses and quantification to the design of risk management tools. This structure is based on an assessment of approaches discussed in academia and applied in practice. The paper demonstrates how the four steps of credit risk management are applied in Colombia, Sweden, and Turkey. It also discusses how the proposed framework is applied in Indonesia as it develops a credit risk management framework for sovereign guarantees. Country experiences show that although sovereign risk managers can draw on insights from credit risk management in the private sector, academic literature, and practices in other countries, approaches to risk management need to be highly context specific. Key differentiating factors include characteristics of the guarantee and on lending portfolio, the sovereign's specific risk exposure, the availability of market information and data, and resources and capacity in the public sector. Developing a sound risk analysis and measurement framework requires significant investments in resources, capacity building, and time. Governments should view this process as iterative and long term.