Sovereign or country risk refers both to the possibility of default on foreign loans and to unanticipated restrictions of cash flows to the parent country. There are two major differences between domestic loans and foreign loans. First, because repayment of international loans must go through the exchange market, international banks must assess prospects for exchange rates and for controls on capital flows. Second, a common legal system or an ultimate arbitrator does not exist to settle disputed claims. Under this condition, some debtor countries are unlikely to accept the decisions of Western-oriented international legal frameworks. Thus, country risk assessment is critical for commercial banks to safeguard their international loans against country risk.
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