The business models of Multilateral Development Banks (MDBs) depend crucially on Preferred Creditor Treatment (PCT). PCT refers to the de facto seniority that financially distressed sovereigns accord to MDBs from which they have borrowed.
In an earlier paper, Risk Control (2022), we showed, in a matched sample, that the Probability of Default (PD) of MDB sovereign loans is substantially less than those of the very same countries’ international bond issues or loans from commercial banks.
This paper extends that analysis by estimating PDs for MDB sovereign loans conditional on ratings. Our results are consistent with those of the earlier paper but show, in addition, that PCT is especially strong for low rated sovereigns. These latter contribute most of MDBs’ balance sheet risk.
Using the Basel Internal Ratings Based Approach (IRBA) capital formula, we show that, for loans to countries with ratings in the range crucial for MDBs of single B and CCC, PCT implies a reduction in Risk Weights (RWs) by a factor of 10 times. This may be compared with the reduction in RWs for PCT employed by Standard & Poor’s and Fitch which is by a factor of approximately 2 times.
Read the full paper here.
