How sovereign credit ratings assess
institutional risk
Sovereign credit ratings shape the global allocation of capital. They influence borrowing costs, market access, and fiscal space for countries worldwide.
Yet a significant share of sovereign ratings rests on qualitative governance assessments that are opaque, inconsistently applied, and often based on indicators never designed to predict default risk. Many of these tools rely on perception-based surveys, legacy governance proxies, and discretionary overlays that can be slow to reflect institutional reform or improvements in resilience.
As climate volatility, geopolitical fragmentation, and debt stress reshape the global risk landscape, outdated qualitative scoring models risk mismeasuring institutional performance and mispricing sovereign risk.
This report examines the “soft” side of sovereign credit rating methodologies. It analyses how perception-based indicators, discretionary overlays, and legacy governance proxies, such as components of the World Bank’s Worldwide Governance Indicators, can distort institutional risk assessment when used beyond their intended scope.
The paper sets out practical reforms to strengthen the transparency, consistency, and empirical grounding of qualitative scoring, ensuring that credit ratings more accurately reflect institutional performance, resilience, and the real drivers of sovereign credit risk.
Reforming qualitative governance scoring in
sovereign credit ratings
The issue is not whether governance matters for sovereign credit risk, but how it is measured, validated, and updated. The following recommendations aim to strengthen the transparency, consistency, and empirical grounding of qualitative inputs in sovereign credit ratings.
1. Measure what actually drives sovereign credit risk: Update qualitative scoring so institutional and governance assessments are clearly linked to default risk, reducing the current reliance on weak proxies.
2. Modernise qualitative scoring with advanced analytics: Use forecasting methods, pathway-based approaches and AI-enabled tools to improve forward-looking institutional risk assessment, reduce bias and strengthen consistency.
3. Recognise resilience as a credit strength: Explicitly incorporate climate and nature resilience such as disaster preparedness and adaptation planning into qualitative scoring.
Why this matters
How qualitative governance indicators are defined and applied has direct consequences for borrowing costs, fiscal space, and investment capacity.
Improving these frameworks would strengthen sovereign credit assessment in three important ways:
1. Improving capital allocation: When governance is mismeasured, sovereign risk is mispriced. This raises borrowing costs, weakens market access and shrinks fiscal space for climate and development.
2. Addressing a structural blind spot: While reforms have focused on improving “hard” macro-fiscal data, qualitative determinants of creditworthiness carry disproportionate weight in ratings despite being less transparent, less verifiable and more prone to inconsistency.
3. Ensuring credibility in a changing risk landscape: As climate volatility, geoeconomic fragmentation and technological disruption reshape sovereign risk, outdated governance indicators and static scoring models increasingly fail to capture real-world performance, resilience and policy effectiveness.
Looking ahead
This report builds on NatureFinance’s broader work on sovereign debt markets and resilience, including Nature Loss and Sovereign Credit Ratings, Assessing Nature-Related Issues in Sovereign Debt Investment, and our recent Nature as a Shock Absorber research.
Together, these publications make a consistent case: climate and nature risks are financially material to sovereign credit, and the methodologies used to assess institutional strength must evolve to reflect that reality.
The findings will inform ongoing engagement with policymakers, credit rating agencies, investors, and multilateral institutions on how to modernise sovereign risk assessment methodologies.
The findings will inform ongoing engagement with policymakers, credit rating agencies, investors, and multilateral institutions on how to modernise sovereign risk assessment. Through our role as Secretariat of the Sustainable Sovereign Debt Hub and continued collaboration with MDBs, regulators, and market actors, NatureFinance is advancing practical reforms to make sovereign risk analysis more transparent, performance-based, and resilience-aware.
If capital is to flow in ways that stabilise economies in a more volatile world, the tools shaping sovereign risk must adapt accordingly.
This paper was authored by Arend Kulenkampff with contributions from Vera Songwe, Guillaume Thomassin, Hanan Amin Salem, Julie McCarthy, Justin Mundy, Isobel Cohen, Teal Emery, Chris Humphrey, and Erik Berglof. Editorial assistance by Amandine Ambregni, Lucy Martin, Natan Aquino, Barbara Oldani, Martina Tamvakou, Eva Sirp, Shereen Wiseman, and Justine Doody.
This work was made possible through the support of the Children’s Investment Fund Foundation.
For comments or queries, please contact: arend.kulenkampff@naturefinance.net
