Risk management

In investing financial assets, we seek the highest return within an acceptable level of risk.

Risk is an inherent part of investment activity. When investing in financial markets, the Bank of Lithuania takes on and manages the following risks:

• market,
• credit,
• liquidity.

The effective management of these risks ensures that the Bank of Lithuania maximises return within the acceptable level of risk. This risk level is determined by the amount of the Bank’s statutory and reserve capital, provisions and revaluation accounts.

Market risk is the risk of loss arising from decreased value of investments resulting from adverse changes in interest rates, as well as equity, foreign exchange, and commodity prices. In managing market risk, the Bank of Lithuania employs the ex-ante value at risk (VaR) measure. Ex-ante VaR is derived from modelling possible future changes in the value of investments. The VaR modelling applied at the Bank of Lithuania complies with the best risk management practices, widely used in financial industry. The modelling of possible future changes in the value of investments is based on the economic forecasts produced by international organisations or other reputable institutions as well as observed interlinkages between economic and market variables. Advanced financial models are used to generate potential future paths for market variables, such as interest rates, equity prices and foreign exchange rates. To maintain market risks within the acceptable level, the Bank of Lithuania decides on such a combination of investments that market risk with high probability does not exceed the acceptable risk level established by the Board.

In addition, the Bank of Lithuania regularly performs investment stress testing. Stress testing assesses possible market value changes of investments under unlikely, yet plausible, events in markets.

Credit risk is the risk of loss arising from the possible default of a counterparty or an issuer. At the Bank of Lithuania, the credit risk management system is based on external credit ratings assigned by the three biggest rating agencies: Moody’s, Fitch and Standard&Poors and supplemented by additional financial measures. The Bank of Lithuania invests only in high-credit-quality financial securities and conducts transactions that are exposed to credit risk only with those counterparties, which have an investment grade rating. Settlement risk is a part of Credit risk. Settlement risk is the risk that settlement of a transaction will not happen and, because of that, the Bank of Lithuania will suffer losses. To manage settlement risk, the Bank of Lithuania applies various widely used and accepted settlement risk management instruments, such as the delivery-versus-payment settlement, debit and credit turnover management, and obligating counterparties to sign ISDA Master Agreements.

Liquidity risk is the risk that the Bank of Lithuania will be unable to meet its obligations on time. The liquidity risk is managed by matching the duration and amount of liabilities and corresponding investments.

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Main risk management indicators

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