International diversification of loans can best reduce the bank's overall default risk if

Question

Quizplus · Accepted Answer

If the countries where loans are given have economic cycles that do not move together over time, the bank's overall default risk will be reduced as default rates in one country are less likely to have an impact on default rates in another country. This is because economic cycles that are uncorrelated or negatively correlated increase the probability that some borrowers will be able to repay their loans even if others cannot. If the countries are clustered together in a single continent, they are more likely to have similar economic cycles and therefore diversification benefits will be limited.

International Diversification of Loans Can Best Reduce the Bank's Overall