Quantifying Preferred Creditor Treatment by Rating Grade

This technical report presents an analysis of Preferred Creditor Treatment (PCT) as it relates to Multilateral Development Banks (MDBs) and sovereign loans. The study builds on previous research by Risk Control and aims to estimate the Probability of Default (PD) for MDB sovereign loans based on ratings. It highlights the significance of PCT, which allows MDBs to maintain lower risk weights for loans to lower-rated sovereigns, thereby reducing their capital requirements. The report details the methodology used to assess PDs, including techniques for low default portfolios and maximum likelihood estimation. Results indicate that PCT is particularly strong for low-rated sovereigns, which contribute significantly to MDBs' balance sheet risk. The findings suggest that PCT-adjusted risk weights for MDB loans differ substantially from those used by rating agencies like Standard & Poor's and Fitch. The document concludes with implications for risk management practices, including provisioning and economic capital calculations.