Updated Methodology for Assigning Credit Ratings to Sovereigns

The investment of foreign exchange reserves or other asset portfolios requires an assessment of the credit quality of investment counterparties. Traditionally, foreign exchange reserve and other asset managers relied on credit rating agencies (CRAs) as the main source of information for credit assessments. In October 2010, the Financial Stability Board issued principles to reduce reliance on CRA ratings in standards, laws and regulations, in support of financial stability. Moreover, best practices in the asset management industry suggest that investors should understand the credit risks they are exposed to and, more broadly, that they should rely on internal credit assessments to inform investment decisions. In support of these objectives, the Bank of Canada first published its sovereign rating methodology in 2017. It provided a detailed technical description of the process developed to assign internal credit ratings to sovereigns, using only publicly available data. This publication updates the internal sovereign rating methodology to stay abreast of evolving best practices and leverage internal experience. This updated methodology proposes three key innovations: (i) a new approach to assessing a sovereign’s fiscal position, (ii) adjustments to the approach to assessing monetary policy flexibility and (iii) the explicit consideration of climate-related factors.