Transfer risk under Basel Pillar 1

Amit Agarwal, Paul Harrald, YinYee Kan, Peter Thompson

Abstract

ABSTRACT

All else being equal, debt obligations in local and foreign currencies to the same obligor carry different default risk. The incremental default risk on a foreigncurrency obligation is due to transfer risk: the risk that a government will impose controls on the transfer or convertibility of the foreign currency required for private-sector debt servicing. The Basel framework allows for transfer risk to be capitalized using the internal ratings-based approach under Pillar 1, although it does not actually require it.We derive formulas that allow for a transaction-level adjustment of the default probability.