Credit Default Swaps and Insurance: Against the Potts Opinion

Little attention has been given to the possibility that CDS transactions might be construed as insurance contracts in English law. This article challenges the widespread “Potts opinion”, which states that CDSs are not insurance, because they do not require the protection buyer to sustain a loss or to have an insurable interest in the subject matter. CDSs often do provide protection against loss that the buyer is exposed to; loss indemnity is not a necessary characterisation of an insurance contract; insurable interest does not form part of the definition of insurance, but is an additional requirement of valid insurance; and what matters is the substance not the form of the contract. The situation in the US and Australia is also briefly considered.

Political Risk in Credit Evaluation: Empirical Studies and Survey Results

Financing trade between economic agents located in different countries is affected by many types of risks, resulting from incomplete information about the debtor, the problems of enforcing international contracts, or the prevalence of political and financial crises. Trade is important for economic development and the availability of trade finance is essential, especially for developing countries. Relatively few studies treat the topic of political risk, particularly in the context of international lending. This thesis explores new ground to identify links between political risk and international debt defaults. The core hypothesis of the study is that the default probability of debt increases with increasing political risk in the country of the borrower. The thesis consists of three essays that support the hypothesis from different angles of the credit evaluation process. The first essay takes the point of view of an international lender assessing the credit risk of a public borrower. The second investigates creditworthiness assessment of companies. The obtained results are substantiated in the third essay that deals with an extensive political risk survey among finance professionals in developing countries. The financial instruments of core interest are export credit guaranteed debt initiated between the Export Credit Agency of Finland and buyers in 145 countries between 1975 and 2006. Default events of the foreign credit counterparts are conditioned on country-specific macroeconomic variables, corporate-specific accounting information as well as political risk indicators from various international sources. Essay 1 examines debt issued to government controlled institutions and conditions public default events on traditional macroeconomic fundamentals, in addition to selected political and institutional risk factors. Confirming previous research, the study finds country indebtedness and the GDP growth rate to be significant indicators of public default. Further, it is shown that public defaults respond to various political risk factors. However, the impact of the risk varies between countries at different stages of economic development. Essay 2 proceeds by investigating political risk factors as conveivable drivers of corporate default and uses traditional accounting variables together with new political risk indicators in the credit evaluation of private debtors. The study finds links between corporate default and leverage, as well as between corporate default and the general investment climate and measeures of conflict in the debtor country. Essay 3 concludes the thesis by offering survey evidence on the impact of political risk on debt default, as perceived and experienced by 103 finance professionals in 38 developing countries. Taken together, the results of the thesis suggest that various forms of political risk are associated with international debt defaults and continue to pose great concerns for both international creditors and borrowers in developing countries. The study provides new insights on the importance of variable selection in country risk analysis, and shows how political risk is actually perceived and experienced in the riskier, often lower income countries of the global economy.

Essays on Microcredit in Rural Bangladesh

This thesis is a collection of three essays on Bangladeshi microcredit. One of the essays examines the effect of microcredit on the cost of crime. The other two analyze the functioning mechanism of microcredit programs, i.e. credit allocation rules and credit recovery policy. In Essay 1, the demand for microcredit and its allocation rules is studied. Microcredit is claimed to be the most effective means of supplying credit to the poorest of the poor in rural Bangladesh. This fact has not yet been examined among households who demand microcredit. The results of this essay show that educated households are more likely to demand microcredit and its demand does not differ by sex. The results also show that microcredit programs follow different credit allocation rules for male and female applicants. Education is an essential characteristic for both sexes that credit programs consider in allocating credit. In Essay 2, the focus is to establish a link between microcredit and the incidence of rural crime in Bangladesh. The basic hypothesis is that microcredit programs jointly hold the group responsibility which provides an incentive for group members to protect each other from criminal gang in order to safeguard their own economic interests. The key finding of this essay is that the average cost of crime for non-borrowers is higher than that for borrowers. In particular, 10% increase in the credit reduces the costs of crime by 4.2%. The third essay analyzes the reasons of high repayment rate amid Bangladeshi microcredit programs. The existing literature argues that credit applicants are able to screen out the high risk applicants in the group formulation stage using their superior local information. In addition, due to the joint liability mechanism of the programs, group members monitor each others economic activities to ensure the minimal misuse of credit. The arguments in the literature are based on the assumption that once the credit is provided, credit programs have no further role in ensuring that repayments are honored by the group. In contrast, using survey data this essay documents that credit programs use in addition organizational pressures such as humiliation and harassment the non-payer to recover the unpaid installments. The results also show that the group mechanisms do not have a significant effect in recovering default dues.