Financial risk arises due to instability and the probability of loss inherent in financial markets caused by movements in prices, currencies, interest rates and other factors, which may impair the ability to provide a reasonable return.
Credit risk arises due to the fact that a counterparty to a transaction may fail to meet its contractual obligation. A counterparty is deemed to be in default when it fails to settle its obligation on due date. The Bank manages credit risk within a policy framework set by the GEC and Resmanco. The policies are augmented by the investment guidelines, investment management agreements and custodial arrangements. Credit risk is continuously assessed at counterparty and aggregated levels. In this respect, credit rating agencies play a role, although the Bank utilises a number of models and tools to reduce over-reliance on ratings for investment decisions. Credit risk is mitigated through exposure limits, collateral requirements, and netting-off arrangements with certain counterparties usually through the International Swaps and Derivatives Association (ISDA) agreements. More dynamic measures are also used, such as credit default swap spreads and market implied ratings, to determine the market’s perception of default risk associated with a counterparty.
Concentration risk is the risk posed to the Bank by any single or group of exposures which have the potential to incur large losses. The Bank mitigates this risk through diversification, and by limiting the extent of exposure to any one institution relative to the market value of the portfolio. This excludes government owned entities and guaranteed securities of highly rated countries.
Credit risk monitoring and model validation
Counterparty credit risk in the reserves portfolios is monitored by using market data from a variety of sources such as data vendors, credit rating agencies and publically available data. There is ongoing monitoring of transactional and credit risk aspects for the Bank’s portfolio including monitoring of limits and credit risk exposures of the gross reserves portfolio. Credit risk models are built to capture credit spreads, credit limits and ratings of counterparties and these factors are monitored dynamically and validated according to sound market intelligence.
Adverse price movements
The Bank is exposed to market risk through unfavourable price movements affecting the gold price, interest rates and foreign exchange rates. Market risk is managed within a policy framework defined and set by the GEC and Resmanco. Credit limits are combined with operational limits to further mitigate market risk e.g. transactional and counterparty limits. Gold price risk arises out of the possibility of the price of gold moving adversely. The Bank holds gold as part of its reserve assets.
Interest rate risk
Interest rate risk is the sensitivity of a portfolio to adverse movements in market interest rates. The Bank faces interest rate risk through its holding of interest bearing assets. Interest rate risk is measured and analysed by using amongst others duration, convexity and VaR. Interest rate risk is taken at two levels, the strategic level as represented by the strategic asset allocation benchmarks and at a tactical level, where fund managers change their interest rate risk exposure away from that of the benchmarks.
Foreign exchange risk
Foreign exchange risk refers to the risk of adverse movements in currencies which can result in a change in the value of foreign reserves. The Bank has approved certain currencies for its portfolio of foreign exchange reserves. Gains and losses arising from moves in the exchange rate of the Rand are passed against the Gold and Foreign Exchange Contingency Reserve Account (GFECRA).
Liquidity risk refers to the possible difficulties in selling (liquidating) large amounts of assets timeously. The risk usually arises in adverse market conditions where prices are deteriorating rapidly, causing market disorder. The Bank manages its liquidity risk on the basis of prudency and a framework captured in the investment guidelines prescribing that assets’ issue sizes should be of a certain minimum threshold in respective currencies, and that securities must be sellable within a reasonably short period.