Risk Management for Sovereign InstitutionsInnovations in strategic risk management for volatile times

Published March 2012 Updated February 2014 16 lectures
Prof. Dr. Jérôme L. Kreuser
Executive Director and Founder, The RisKontrol Group GmbH, Switzerland

In this series we will focus on risk management for sovereign institutions. We use the term “risk management” in a broad sense and not just in terms of risk and return. For example, objectives may consist of social concerns or multiple concerns such as safety, liquidity, returns, and stability for... read morecentral banks. We also consider related topics such as the institutional risk culture that is imperative in a successful institutional risk management program. By “sovereign institutions”, we mean the institutions that have direct support of the sovereign or through explicit or implicit contingent liabilities. This includes central banks, ministries of finance, sovereign wealth funds, national pension funds, or institutions or processes for measuring risks across the country or across government institutions.

For example, central bank foreign exchange reserves risk management concerns balancing many objectives and issues, ranging from broad macroeconomic policy objectives, such as monetary policy and foreign exchange management, to micro aspects, such as the definition of portfolio benchmarks and the evaluation of investment managers. Central bank objectives are not to maximize profits but to accomplish various social goals. Furthermore, constraints arising from legal, human resources, asset markets, and institutional set up affect the actual achievability and implementation of reserves management objectives. While the macroeconomic aspects of reserves management have been much analyzed, they continue to draw attention, especially the relationship between financial crises and reserves and external debt management. The micro aspects of improving reserves management have also received much more attention with the wider investment universe and the broader range of financial tools that have become available.

While these macro and micro issues have been considered for some time and are analyzed in much detail in various strands of literature, often these aspects are not being considered in an integrated manner, at least not within one common analytical and empirical framework. Furthermore, strategic risk management has lagged far behind because existing approaches tended to mimic those used by business firms, did not incorporate country-specific factors, lacked strategic interactions, often excluded trade flows and fiscal dimensions, had inadequate modeling flexibility, failed to dynamically realign portfolios, and the treatment of uncertainty was far from robust.

It is in this vein that this series is organized. Sovereign institutions are different and different tools are required than for commercial institutions. On the other hand, commercial institutions could benefit from this series of presentations especially because the recent financial crisis pointed out the desirability of incorporating macroeconomic factors into risk management.