MUHAMMAD ATIF

Topic: Role of Risk in Reserve Management

Department: IMID

HAILEY COLLEGE OF COMMERCE

Objectives of presentation includes to
develop your understanding about:

What is Reserve Management

Objectives and transparency

Risk Governance

Risk in Reserve Management

Risk Management practices of RBA

Risk Management practices of BCRP(Peru)

Recommendations
Reserve Management

Definition

Reserve management is a process that ensures that adequate

official public sector foreign assets are readily available and
controlled by the authorities for meeting a defined range of
objectives for a country.
Cont…..
Objectives
Foreign exchange reserves are available for
meeting a defined range of objectives.
Market, exchange rate and credit risks are
controlled in a prudent manner.
Reasonable earnings are generated over the
medium to long term on the funds invested.
Assist the Govt. in meeting foreign exchange
needs and external debt obligations.
Cont……..
Scope
 Management of liabilities
 Short foreign exchange positions
 The use of derivative financial instruments.

Transparency and Accountability

 Clarity of roles, responsibilities, and objectives of financial agencies
responsible for reserve management
 Open process for reserve management market operations
 Public availability of information on foreign exchange reserves
 Accountability and assurances of integrity by agencies responsible for
reserve management
Governance
Describes the overall management approach through which
senior executives direct and control the entire organization,
using a combination of management information and
hierarchical management control structures.

Internal Governance Structure Guidelines

Risk
 Probability or threat of a damage,injury,loss or negative
occurance
 caused by external or internal vulnerabilities

Risk framework
A Model of risks in the organization. Risk frameworks typically enumerate
the various classes of risk and the degree of Risk that Management
expected.

Risk Management Framework

o Identifies and assesses the risks of reserve management operations
o Allows the risks within acceptable parameters
Risk in Reserve Management
EXTERNAL MARKET-BASED RISKS:
Liquidity risk.
Credit risk
Currency risk
OPERATIONAL RISKS
Control system failure risks
Financial error risk
Financial misstatement risk
Loss of potential income
Reserve Bank of Australia
Benchmark portfolio
United States Europe Japan

Currency allocation (%) 45 45 10

Asset allocation (%) 45 45 10

Duration (Months) 30 30 30

Composition of Benchmarks

United States Europe Japan

Asset Class % of Total Asset Class % of Total Asset Class % of Total

Deposits 22 Deposits 30 Deposits 22

Treasury bills 21 Treasury bills 15 Treasury bills 33

Treasury Notes 57 Bonds 55 Bonds 45

Weaknesses in system
Strengths in the system
There is a latitude for managers to invest and deviate from benchmark.

Use of benchmark and separation of duties of back, middle and front offices

The reserve management hierarchy is responsible for defining the objectives

and responsibility of implementing the mandate

All the policies are clearly understood by staff and control system, and the
investment mandate is documented

Any needed change requires management approval before the change is

made
 CENTRAL RESERVE BANK OF PERU(BCRP)

CURRENCY COMPOSITION IN TERMS OF MATURITY AND

CREDIT RISK

Currencies Jun-30- Term to maturity Jun-30- Long term rating Jun-30-

2010 2010 2010

US$ 82.2 82.2 0-3 Months 43.1 AAA 74.5

3-12 Months 11.9 AA+/AA/AA- 17.5
Other currencies
15.7
<1year 45.0 A+ 8.0
Gold 2.1
Strengths
The BCRP’s reserve management involves a
risk neutral and replicable portfolio even
when the market is very volatile.Its portfolio
is based on the market indicies

The purpose is to maximize the return on

investment and latitude also given to the
fund managers.Actual and banchmark
portfolio is monitored on the daily basis at
market prices

The BCRP has managed its liquidity risk by

diversifying in different investments.Deposits
are held with first class banks that are
assigned A-1 and A+ credit rating.

The BCRP manage their interest rate risk by

matching the term structure of assets and
liabilities.Most of their investments are in
AAA securities.
 Most of BCRP’s assets and
Their investment in long term
external debts are dollar
income funds that has higher
denominated that poses the
interest rate but it could affect
great exchange risk if USD
the value of asset
loses its value.
Weaknesses in system
Recommendations for effective risk management in
reserves
Decision making authority for reserve
management clearly defined, Authority should
develop the objectives of reserve management.
A strategic long term portfolio that is best trade off
between different risk
A latitude for the fund managers to deviate from
benchmark as provided by RBA and BCRP
If SBP don’t want to do so then it can transfer the
authority to the treasurer to assign extra limit to
fund managers if they can provide the solid reason
to invest.
Cont…..
If fund managers are allowed to deviate their performance and accountability can be
measured through comparison of actual and benchmark portfolio and it should be
reviewed regularly.

The risk management should apply the same principles to external and internally
managed funds and careful selection of reputable external managers that is a task of
middle office.

Establish a separate unit or assign a position within the middle office to monitor the
activities of external managers.

Risk exposures should be monitored regularly to determine that it could not be

extended beyond acceptable limit with either deviation.
 Cont…..
 Fund managers should be aware of potential
losses and other consequence of risk exposures
so they could be prepared to accept the results.

 The eligibility criteria for the selection of

trading counterparties should be clearly defined.
 There should be a framework for determining
the maximum credit exposure permitted with
each party.
 Active risk management is good approach to
mitigate the risk than passive risk management
practices.