Risk control policy framework
The risk control policy framework governing the Bank’s asset management and monetary policy operations is established by the Commission of the Bank and is reviewed regularly. The framework consists of various risk policies, procedures and limits. Our code of conduct for dealers, settlement staff and decision makers covers potential conflicts of interest, private financial accounts, insider trading, dealing limits and related issues.
Role of our Organisational Risk Division
Our Organisational Risk Division, a formal autonomous Division, is responsible for the measurement, monitoring and reporting of the Bank’s risk exposures and for monitoring and reporting compliance with limits etc. The Division also measures the return on the Bank’s investment portfolios. The measurement of performance involves the attribution of return across portfolios, sectors and instruments. The Bank’s performance in terms of the return achieved on its portfolios is measured against a notional benchmark portfolio that is compiled externally by Bank of America Merrill Lynch.
The Organisational Risk Division is operationally independent of the dealing function and presents regular reports to the relevant decision-making bodies of the Bank including the Commission, the Commission Audit Committee, the Commission Risk Committee, and the Executive Risk Committee.
In addition to the work performed by the Organisational Risk Division, the Bank’s asset management and monetary policy operations are audited by the Bank’s Internal Audit Division, by the Bank’s external auditors – the Comptroller and Auditor General and RSM Farrell Grant Sparks and by the ECB’s external auditors – Pricewaterhouse Coopers (PwC).
The main risks associated with managing the investment portfolio are;
Currency risk is the risk of capital losses as a consequence of fluctuations in exchange rates. This risk is managed by minimising our holdings of volatile foreign assets while taking Eurosystem obligations into account. The currency distribution of the portfolio is reviewed periodically using quantitative techniques such as Value at Risk (VaR) and stress testing as well as a variety of qualitative factors. We currently manage portfolios denominated in euro.
Market risk relates to the impact of changes in interest rates on the value of the investment portfolio. The management of market risk in the Bank is primarily based on duration, although Value at Risk and stress testing techniques are also used. The duration of a portfolio determines its sensitivity to interest rate changes – the higher the duration the more risk is assumed. Global economic conditions, bond yields, views of market participants, optimisation models, and liquidity requirements are all factors that are taken into account in setting the duration for the investment portfolios.
Credit Risk relates to the possible loss in asset value due to the default of counterparty banks, issuers of securities or other counterparties. Credit risk is managed by confining exposures to approved instruments and to counterparties with high credit ratings under the Commission approved limit setting methodology. Approved counterparties and issuers must have an acceptable credit rating from at least one of the international credit rating agencies. The methodology also incorporates other economic-based indicators to allow distinctions to be drawn between similarly rated eligible issuers or counterparties.
Liquidity risk refers to the possible losses or difficulties that could arise in converting assets into cash. This risk is managed by ensuring that the investment portfolio is invested in instruments for which deep and active markets exist, such as securities issued by governments and other high-quality issuers and by applying maximum exposure limits per issuer and per issue.
Operational risk is the possibility of direct or indirect losses, or of reputational damage, arising from inadequate or failed internal processes, people and systems or from external events. This risk is managed by the segregation of the dealing, settlement and risk management functions; by restricted physical access to the dealing and settlements areas; and by a comprehensive body of controls and procedures aimed at minimising the risk of unauthorised trading.
The Bank’s Executive Risk Committee, chaired by the Deputy Governor (Central Banking), oversees the management of operational risk in the Bank. The operations of each function are reviewed regularly to ensure that potential exposures are identified and that appropriate controls are implemented. A full review of operational risk is furnished to the Commission on an annual basis.