Different Strategies for Managing Political Risk

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Managing the risks of doing business in today's interconnected world has become increasingly challenging for American banking companies, say industry experts.

In response, banks and other financial services companies are turning to an array of sophisticated modeling tools and insurance products.

"Globalization has forever married 'the political' with 'the economic'," said Daniel Wagner, a senior co-financing specialist (guarantees) at the Manila-based Asian Development Bank. "Terrorists have proven their ability to change the course of national and international politics. The Madrid bombings were a perfect example of this."

The biggest dangers inherent in doing banking business in foreign countries are political, economic, and currency risks, say insurance experts. Most banks mitigate currency risk through hedges, and credit risks are handled by credit risk insurance.

Political risk is a different sort of animal, say insurance experts. A variety of strategies are available to banks for managing this type of cross- border risk, including strict limits on exposure in certain countries, modeling of potential problems, and specialized insurance products.

At Aon Corp., an international insurance broker based in Chicago, political risk is part of a larger class of risk called cross-border or country risks, said John Minor, a senior vice president and the company's national director of political risk. Political risk generally refers to government action that prevents, restricts, or hinders a bank's operations in the host country, he said.

"The most dramatic case would be the nationalization of the banking industry, where all foreign-owned banks operating in the country would become the property of the foreign government," he said.

Those kinds of actions are rare, he noted, but others "more subtle but probably more relevant" can also have dramatic effects on a bank's ability to collect loan payments or do other business.

Dan Riordan, an executive vice president and managing director at Zurich North America in Washington, said, "Our definition of political risks are events that occur in emerging markets that can, for banks, cause an interruption of scheduled payments that banks are getting through loans that they are offering to local companies."

Such risks include currency and convertibility and transfer risk; expropriation; and political violence. These risks could range from a regulatory action that restricts the flow of dollars, to a government's taking over funds or industries, to violence that makes it impossible for borrowers to make wire transfers or send mail.

The Latin American crisis in the late 1990s was a wake-up call for U.S. banks, many of which suffered from the economic meltdown in that region, political risk experts said.

"The banking industry was probably the most severely hit," Mr. Minor said. In response, the U.S. government drew up guidelines for country risk management.

For example, at the time, one of the Argentine government's first actions was to freeze foreign exchange transactions to prevent borrowers from gaining access to hard currencies, Mr. Minor noted. "People couldn't exchange Argentinean pesos for dollars or other hard currency without special permission."

Since most loans by foreign banks were made in dollars, this literally prevented borrowers from obtaining dollars to make their payments, he said.

Another problematic type of government regulatory action is a debt moratorium such as the one Russia imposed in 1998 when it halted any payment on hard-currency loans.

But most nations adopt such measures only in severe fiscal crises when there is no other way to keep the economy afloat, Mr. Minor said. "In the case of Argentina there was a financial crisis which was impacting the value of the currency and the government's ability to meet its hard currency obligations," he said. …