Credit risk

We assign ratings to all countries to which we have exposure. Sovereign ratings express the probability of occurrence of a country risk event that would lead to impairment of our claims. The default probabilities and the mapping to the ratings of the major rating agencies are the same as for counterparty rating classes (as described under "Probability of default"). In the case of country rating, the three lowest classes (12 to 14) are designated "distressed".

For all countries rated 3 and below, we set country risk ceilings approved by the Chairman's Office or under delegated authority. The country risk ceiling applies to all exposures which we may have to a client, counterparty or issuer of securities in the country, and to financial investments in that country. Our country risk measures are comprehensive and cover both cross border transactions and investments, and local operations by our branches and by subsidiaries in countries where the risk is material. In determining the size of a country risk ceiling we also take into account goodwill resulting from acquisitions. Extension of credit, transactions in traded products and positions in securities may be denied on the basis of a country ceiling, even if exposure to the name is otherwise acceptable. Within this group of countries, those that have yet to reach a mature stage of economic, financial, institutional, political and social development or have significant potential for economic or political instability are defined as emerging market countries. The country data provided on the next page cover only country risk exposures to emerging market countries.

Counterparty defaults resulting from multiple insolvencies ("systemic risk") or general prevention of payments by authorities ("transfer risk") are the most significant effects of a ­country crisis, but in our internal measurement and control of country risk we also consider the probable financial impact of market disruptions arising prior to, during and following a country crisis. These might take the form of severe falls in the country's markets and asset prices, longer-term devaluation of the currency, and potential immobilization of currency balances.

We measure the potential financial impact of severe emerging markets crises by stress testing. This entails identifying countries that may be subject to a potential crisis event, making conservative assumptions about potential recovery rates depending on the types of transaction involved and their economic importance to the affected countries, and thereby determining potential loss.

Country risk exposure

Our exposure to emerging market countries amounted to CHF 30.6 billion on 31 December 2006, compared with CHF 21.4 billion on 31 December 2005. Of this amount, CHF 19.9 billion or 65% is to investment grade countries. The growth of CHF 9.2 billion in total emerging markets exposure arose to a large extent in Latin America following the integration of Pactual on 1 December 2006.

The pie chart opposite shows our emerging market country exposures (excluding those which are of a temporary nature) on 31 December 2006, based on our main country rating categories. The table below analyzes emerging market country exposures by major geographical area and product type on 31 De­cember 2006 compared with 31 December 2005 and 31 December 2004. Given the increasing importance of temporary exposures arising from loan underwriting in these markets, they are shown in the table on a separate line.