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FED ERAL RESERVE BANK OF N E W YO RK November 17, 1978 U N IF O R M PROCEDURE O F "C O U N T R Y R I S K " IN 7o C A ib /R x e c M U v e 0 / / : c e r o / 'E a c / : FOR E X A M IN A T IO N IN T E R N A T IO N A L L E N D IN G M cw A er :w fAe JecowJ Fecfera/ ^e^erve DMfncf. Following is the text of a statement issued by the Board of Governors of the Federal Reserve System on their ow behalf and on behalf of the Office of the Comptroller of the Currency and the Federal n Deposit Insurance Corporation: The three Federal bank regulatory agencies today [JVoveTM&er #] announced adoption o f a uniform exam in ation procedure for evaluating and commenting on "country risk " factors involved in international lending by United States banks. Under the new system, examiners for the three agencies — Comptroller o f the Currency (supervisor o f national banks); Federal Reserve Board (supervisor o f State chartered mem ber banks) and the Federal Deposit Insurance Corporation (supervisor o f State chartered banks that are not members o f the Federal Reserve System) — will segregate country risk factors from the evaluation o f other lending risks, and deal with this special category o f lending risks in a separate section o f their examination reports. The commercial credit risks in the banks' international portfolios will continue to be assessed on an individual loan basis and according to traditional standards o f credit analysis. The new procedures will emphasize diversification o f exposure to individual countries as the primary method o f moderating country risk in international portfolios. Country risk in bank lending refers to the possibility that economic, political or social factors within a country might create a situation in which borrowers in that country would be unable to service or repay their debts to foreign lenders in a timely manner. This concept o f country risk embraces virtually all external credits to a country, whether they are to public or private parties. Diversification is a long-standing, practical and prudential principle o f sound lending. It is particularly relevant to international lending because the assessment o f country risk involves great uncertainties and is subject to a considerable margin o f error. The agencies believe proper diversification o f loan portfolios provides the best protection for a U .S. bank and the banking system against a dramatic turn in the economic or political fortunes o f a country or group o f countries. Determinations o f the adequacy o f diversification within a bank's portfolio will be based primarily on comparisons o f individual country risk exposures to a bank's capital funds. W here concentrations are found, examiners will separate a bank's loans in a country by type o f credit, type o f borrower and loan maturities. The degree o f risk involved will be assessed in the light o f these components as well as o f internal and external factors impacting the debt-service capacity o f public and private borrowers within the country. The special section o f the examination report dealing with country exposure will consist o f four parts: 1. A list o f concentrations o f a bank's loans subject to country risk exposure; 2. Com ments on such concentrations; 3. Classification o f credits as substandard, doubtful or loss; 4. An analysis o f a bank's ability to monitor and control its country risk exposure. (O v er) W ith the primary objective o f encouraging appropriate diversification in the international lending portfolio o f U .S . banks, the country exposure examination will attempt to point out special risk situations and, where necessary, secure corrective action. Examiners will list all exposures to country risk that seem large in relation to the lending bank's capital funds. In addition, examiners will make special com m ent on concentrations o f loans in countries with high debt service requirements or other actual or potential balance o f payments weaknesses. Normally, these comments will refer to relatively large exposures in such countries and give particular emphasis to situations that include a high proportion o f longer-term loans. Lending in any country able to meet its current obligations will not be subject to special comm ent unless the lending is considered excessive relative to a bank's capital funds. Examiners will classify a bank's aggregate credits to a country under the categories o f "su b sta n d a rd ," "d o u b tfu l" or " l o s s " due to country risk only when there has been an interruption in debt servicing or when such an interruption is considered imminent. Senior bank management will be expected to monitor closely all situations listed or commented on by examiners. Another key element o f the new procedures will be an assessment o f a bank management's ability to analyze and monitor country risk in its international lending. Examiners will include in their country risk reports an evaluation o f a bank's procedures for monitoring and controlling exposure to country risk, the bank's system for establishing limits to lending in a country and the bank's methods for analyzing country risk. The examination system for assessing country risk concentrations will be administered by a nine-member committee made up chiefly o f experienced examiners from the three Federal bank regulatory agencies. The committee will be known as the Interagency Country Exposure Review Committee. Its primary functions will be to: 1. Review and make judgm ents about economic conditions in countries where loans are made by U .S. banks; 2. Determine the levels o f a bank's capital funds at which concentrations should be commented on; 3. Determine when credits should be classified as substandard, doubtful, or loss due to an interruption in payment or when an interruption is imminent; and 4. Prepare commentaries on developments in foreign countries for use by examiners. The committee will draw on country studies especially prepared for its use within the Federal Reserve System, as well as on supplementary analyses by staffs o f each o f the three agencies and information from other available sources. A n y q u estio n s re g a rd in g this m a tte r m a y b e directed to our B a n k E x a m in a tio n s D e p a r tm e n t (T e l. N o . 2 1 2 -7 9 1 -5 8 9 2 ) . PAUL A. VOLCKER, Pre-Mt/enf.
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