Q&A: Sovereign Exposure Exchanges Allow MDBs to Reduce Portfolio Concentration Risks

What is an exchange of sovereign exposures?

A sovereign exposure exchange is a cost-effective risk management tool used by multilateral development banks (MDBs) to reduce sovereign portfolio concentration risks. It provides capital relief for MDBs by exchanging loan guarantees on credit exposure from borrowing countries where an MDB is highly concentrated for exposure to countries where the MBD’s exposure is lower or nonexistent.

Why does ADB need to enter into these agreements?

ADB’s sovereign portfolio is highly concentrated, with its top five sovereign exposures representing over half of its portfolio. This high level of concentration increases the level of capital usage. By lowering exposure concentration, ADB lowers its capital usage, increasing its lending capacity in general.  The exchange also lowers the net credit exposure to individual borrowers, thereby increasing the limit headroom for the borrowers included in the exchange.

What are the benefits of exposure exchanges?

The benefits of exposure exchanges include: 

• Reduced concentration risk, which will allow MDBs to lend more through improved capital utilization ratio.  This increased lending capacity benefits all borrowers; and,
• Reduced net exposure to borrowers included in the exposure exchange transactions, providing additional borrowing headroom under ADB’s limits framework.

Are actual loans being exchanged?

No. The exchange is “synthetic” in nature as it does not entail the actual transfer or removal of specific loans from either MDB’s balance sheet and only involves the guarantee for a portion of the overall exposure. The exposure exchange transaction does not change the relationship between the original lender and the borrower.

Has ADB considered pursuing EEAs with new partners?

ADB is a member of the MDB Exposure Exchange Master Agreement, along with African Development Bank (AfDB), Inter-American Development Bank (IDB) and the International Bank for Reconstruction and Development (IBRD). Of these institutions, IBRD is the only one with which ADB does not have an exchange in place, although discussions remain ongoing. The EEA mechanism is only one among many tools that ADB has at its disposal in terms of risk transfer arrangements with others including guarantees with bilateral or multilateral partners.