Transfer risk under Basel Pillar 1

Amit Agarwal, Paul Harrald, YinYee Kan and Peter Thompson

Journal of Credit Risk

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.

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