Bank of Lithuania generates positive return amid challenging financial market environment
In 2020, the Bank of Lithuania earned positive return in spite of extremely low interest rates and high volatility observed in financial markets during the pandemic, and generated a total of €225 million over the three-year investment horizon. The current environment of particularly low interest rates remains a major challenge, thus the Bank of Lithuania is constantly employing investment innovations in pursuit of higher return over the longer term
“Generating positive return on safe investments eligible for the central bank’s purposes in an environment of extremely low or even negative interest rates remains a real challenge. We systematically review our investment strategy, look for new ways and patterns of putting financial assets at work and are happy that advanced innovations help achieve positive results,” said Jonas Kanapeckas, Director of the Banking Service of the Bank of Lithuania.
Last year’s return on financial assets amounted to €13 million, whereas the overall result for 2018–2020 increased by approximately one-fourth compared to 2017–2019 and reached €225 million. The Bank of Lithuania assesses its investment performance over a rolling three‑year investment horizon. This approach helps eliminate the impact of short‑term fluctuations or exchange rate changes. Moreover, it allows achieving higher return over the medium term by assuring risks not exceeding its one-year risk budget. This year, the latter was increased by €50 million, to €250 million, in a bid to achieve higher return over the longer term.
The expanded range of financial instruments and the application of an advanced investment distribution method – risk parity approach – helped deliver positive results during the period under review. This approach ensures equal allocation of investment risks across the largest possible number of risk sources. It not only mitigates the impact of short-term shocks but also helps achieve higher returns in the medium and long term. The Bank of Lithuania was among the first central banks in the world to introduce this approach towards investment and risk diversification.
In 2020, the Bank of Lithuania launched testing of advanced algorithmic trading, increased its investment in debt securities issued by Canada and the United Kingdom as well as in global equities, and turned to active management of its portfolio of mortgage-backed securities issued by US government agencies. This year, the central bank began active management of its equity portfolio.
The Bank of Lithuania manages the largest investment portfolio in the country: in 2020, the average value of its financial assets unrelated to monetary policy operations stood at roughly €4.6 billion. The gold reserves recovered after the restoration of Lithuania’s independence remain unchanged at 5.8 tonnes. Under favourable investment conditions, gold returns not only cover its storage costs but also increase return on financial assets. In 2020, return on gold investment amounted to €0.8 million. The main objective of holding financial assets is to ensure the stability of the Lithuanian and euro area financial systems and provide a buffer against economic and financial shocks and other extraordinary circumstances.
The Bank of Lithuania covers its operating expenses and contributes to the financing of public expenditure – each year, a certain share of the Bank of Lithuania’s total profits is transferred to the state budget. In 2021, this amount reached €16.6 million. The central bank aims to increase this contribution steadily over time while ensuring the appropriate level of all necessary risk provisions and a sufficient capital buffer for potential losses.