Risk Management
Role of the Commission
The Commission's responsibilities in respect of the Bank’s balance sheet relate primarily to the discretionary investment assets and the Bank’s financial buffers. The Commission is responsible for determining the strategic parameters for the Bank’s investment assets.
In this way, the Commission, and the Risk Committee of the Commission are supported, via delegated authority for different items, by the Risk Management Committee (RMC), and the Financial Risk Working Group (FRWG).
Role of the Organisational Risk Division
The Organisational Risk Division, as second line of defence, is responsible for defining the risk management policies in addition to assessing and monitoring financial risks, consistent with the Bank’s risk appetite. The Central Bank defines the investment limit frameworks, conducts collateral due diligence, monitors both monetary and investment policy compliance, and assesses current and emerging risks within the Central Bank’s Balance Sheet. The Organisational Risk Division is also responsible for managing operational, enterprise and business continuity risks.
The Organisational Risk Division is operationally independent of the risk-taking divisions in the Central Bank, and supports and advises the relevant governance bodies of the Central Bank.
In addition to the work performed by the Organisational Risk Division, the Central Bank’s investment management and monetary policy operations are audited by the Central Bank’s Internal Audit Division, the Central Bank’s external auditors, as well as the Comptroller and Auditor General. The monetary policy operations are also audited by the ECB’s external auditors.
The Central Bank’s key financial risk exposures are;
Credit Risk is the risk of loss arising from failure of a borrower, issuer or counterparty with obligations to the Central Bank. The Central Bank is exposed to credit risk associated with the Central Bank’s investment activities and through monetary policy operations, including the Eurosystem’s Asset Purchase Programme (APP) and the Pandemic Emergency Purchase Programme (PEPP).
Credit risk in the Central Bank’s investment portfolios is controlled by a system of Bank-approved limits based primarily on external credit ratings provided by selected rating agencies. Credit exposure is mitigated on the Central Bank’s investment assets by implementation and maintenance of an approved investment policy framework.
Credit risks arising from Eurosystem monetary policy implementation are mitigated by applying strict eligibility criteria for counterparties and by compliance with the provisions of Article 18.1 of the Statute of the ESCB, which ensures that all Eurosystem credit operations are based on adequate collateral. To further control this risk, the Eurosystem Credit Assessment Framework (ECAF) ensures that the Eurosystem requirement of high credit standards for all eligible collateral assets is met. In addition, on-going risk control measures including valuation haircuts, and initial and variation margins are also applied. Where applicable, the credit risk to the Central Bank is further moderated by Eurosystem loss-sharing mechanisms which distribute losses arising from monetary policy operations in proportion to the capital key of member NCBs.
Credit risk in relation to the Eurosystem purchase programmes (including the APP and PEPP) is managed in accordance with the relevant Eurosystem frameworks.
Market risk refers to the risk of loss arising from adverse changes in market prices, such as interest rates. The Central Bank’s investment portfolios are managed in accordance with the risk management parameters, governance and control frameworks approved by the Bank’s governance bodies. Compliance and performance relative to these policies is verified and reported to the Bank’s governance bodies. A key source of market risk exposure for the Central Bank relates to the sensitivity of the value of its investment assets to interest rate changes. The Central Bank mitigates this market risk exposure on a portion of the investment portfolio through allocation to a hold-to-maturity portfolio.
Risk management preferences in relation to the remainder of the investment assets are expressed through an externally compiled benchmark, against which the investment portfolios are measured and managed. The interest rate risk of the Central Bank’s mark-to-market portfolios is calculated and managed using modified duration, while Value-at-Risk (VaR) and Expected Shortfall are used as supplementary measures of market risk on the Central Bank’s portfolios.
Interest rate mismatch risk refers to the current or future risk to the Central Bank’s capital and earnings arising from movements in interest rates that affect its Balance Sheet positions. In this respect, the Central Bank is exposed to a potential interest rate mismatch due to its holdings of long-dated fixed rate assets related to the APP and the PEPP, while its related shorter-term liabilities are tied to (variable) monetary policy rates. Over the last decade, the Central Bank of Ireland, as a member of the Eurosystem, has significantly increased the size of its monetary policy exposures arising from the purchase programmes. The purchase programmes have been undertaken in the pursuit of the Eurosystem’s aim of price stability, and to counter the serious risks to the monetary policy transmission mechanism and the outlook for the euro area posed by the COVID-19 outbreak. This in turn has led to an increased interest rate mismatch risk on the Central Bank’s balance sheet. This will impact the income of the Bank in future years, as the cost of liabilities has increased, with losses now anticipated over the coming years. Further detail on the impact of non-standard monetary policy measures on Eurosystem Central Banks’ balance sheets are examined in this Central Bank Quarterly Bulletin article and the Governor's Blog on the Central Bank's balance sheet.
The Bank has been actively building up financial buffers in recent years, to limit the impact of such a scenario. As part of its assessment of interest rate risk mismatch, and the identification of a potential interest rate mismatch, the Central Bank has deemed it prudent to hold a provision for financial risks, which at end 2022 stood at €3,000m.
Foreign exchange risk refers to the risk of loss due to changes in exchange rates. The majority of the Central Bank’s investment assets are denominated in euro. A strategic allocation to foreign currency denominated fixed income asset holdings is also held, in the context of building balance sheet resilience and diversification. The risk management approach to this allocation incorporates a combination of quantitative methodologies and assessments, VaR and stress testing as well as a variety of qualitative factors. The Central Bank is also exposed to currency risk through a net-asset position in IMF Special Drawing Rights (SDRs).
Liquidity risk is the risk stemming from the lack of marketability of an investment that cannot be bought or sold quickly enough to prevent or minimise a loss in the event of adverse price changes. Liquidity risk is mitigated through the allocation of a portion of the Central Bank’s investment portfolio to a liquid mark-to-market portfolio. To avoid excessive concentration, investments within the mark-to-market portfolio are subject to issue limits. In addition, issue limits are coupled with minimum credit ratings and an approved limits framework to moderate the impact of unscheduled disposals due to holdings falling outside the Bank’s risk appetite.
The Central Bank of Ireland also has exposures to gold and an equity fund on its balance sheet, that are subject to related risk of gold and equities price movements. The equity fund tracks the MSCI World and MSCI World Climate Paris Aligned Indexes with exclusions (as detailed in the Central Bank’s Sustainable Investment Charter). The fund is managed by an asset management company on behalf of the Central Bank. Risks for external funds are managed via diversification, clearly defined investment mandates and risk limits, while risks are monitored by both the Central Bank and the investment managers on a regular basis.
The Central Bank also measures climate factors as it transitions to a low carbon and sustainable organisation. The impact of these are provided in the Bank’s annual climate disclosures.