Quantifying Preferred Creditor Treatment by Rating Grade

This technical report quantifies the concept of Preferred Creditor Treatment (PCT) as it relates to Multilateral Development Banks (MDBs) and sovereign ratings. The report builds on previous research, specifically the findings from Risk Control (2022), which indicated that the Probability of Default (PD) for MDB loans is significantly lower than that for international bonds or commercial loans from the same countries. The current study estimates PDs for MDB sovereign loans based on ratings, revealing that PCT is particularly pronounced for lower-rated sovereigns, which contribute significantly to MDBs' balance sheet risk. The report discusses the implications of PCT on risk weights as determined by Basel Internal Ratings Based Approach (IRBA) capital formula, illustrating that PCT can lead to a tenfold reduction in risk weights for loans to countries rated single B and CCC. This analysis is crucial for understanding the risk management practices of MDBs and the impact of sovereign ratings on their lending strategies.