Banking and Finance Law Daily OCC provides guidance on ‘implied sovereign support’ in determining credit risk
Wednesday, August 29, 2018

OCC provides guidance on ‘implied sovereign support’ in determining credit risk

By Nicole D. Prysby, J.D.

The Office of the Comptroller of the Currency has released guidance regarding implied sovereign support in determining a borrower’s obligor and facility credit risk ratings. The guidance applies to all OCC-supervised banks that have foreign credit exposures and reminds banks that because implied sovereign support is not a legally binding guarantee, it should be viewed as no more than a mitigating factor when evaluating a borrower’s credit risk. According to the Aug. 28, 2018, guidance (OCC Bulletin 2018-25), titled "Informal or Implied Support From Foreign Governments (Implied Sovereign Support)," a bank may determine that implied sovereign support justifies a change in the regulatory risk rating, but it must do so pursuant to a policy that adequately defines how implied sovereign support is being applied to determine a final regulatory risk rating and what constitutes sufficient supporting analysis.

Appendix E of the "Rating Credit Risk" booklet of the Comptroller’s Handbook covers classification of foreign assets and the issue of how much weight should be given to informal expressions of support by a country’s central government for a particular borrower or category of credit. It provides the following four considerations for evaluation:

  • What standard is the government likely to apply in determining which credits it will support?
  • How important is the obligor to the country’s economy? (If the government does not have the capacity to support the entire stock of, for example, trade credit, how likely is it that the credit being evaluated will be selected for support?)
  • How important is this U.S. bank’s presence in the country, and is its role in the economy likely to influence the government’s decision on whether to support its obligors?
  • If support is provided, how prompt is repayment likely to be?

According to the OCC guidance, analyzing a sovereign’s ability to informally support an obligor requires a consideration of the relationship between the obligor and the sovereign. An obligor’s importance to the sovereign’s local economy does not necessarily demonstrate a willingness to provide an obligor with financial support. Banks must consider any precedent in which the sovereign supported an obligor and assess whether the precedent would likely apply to the bank’s obligor. The bank may also consider whether changes in the political environment, economic conditions, or new legislation could affect the sovereign’s ability or willingness to support an obligor. In addition to looking at the relationship between the parties, banks should evaluate whether the potential magnitude of implied support for an obligor could negatively affect a sovereign’s creditworthiness or the perception of its creditworthiness in the capital markets. This evaluation will require an assessment of the sovereign’s other contingent liabilities.

An appropriate policy on the application of implied sovereign support would apply to all business units within the bank and incorporate the following elements: (1) criteria to define how an obligor’s stand-alone risk rating may be changed due to recognition of implied sovereign support; (2) methods for determining whether implied sovereign support will be considered in a bank’s risk rating decisions; and (3) appropriate documentation standards that include a tracking process to promote the consistent and appropriate application of the policy’s criteria.

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