Notes on risk management

Risk management and control of risks in investment of financial assets

Investment activities are exposed to risks, which risk management seeks to identify, measure and limit. In managing these risks, the Bank of Finland uses widely employed risk management methods, market and credit risk models as well as sensitivity analyses.

Risk management of investment activities by the Bank of Finland has been entrusted jointly to the Administration department’s Risk Control and Financial Accounting division and the Market Operations department. Risk control of investment activities and reporting on risks and returns are the responsibility of the Administration department’s Risk Control and Financial Accounting division.

Risks to investment activities are reported daily to the persons involved in operational investment activities and monthly to the Bank of Finland Board. Developments in investment returns are reported monthly to the persons involved in investment activities and the Board member responsible for investment activities. Returns are considered every quarter in the Markets Committee, chaired by the Board member responsible for investment activities. The Board discusses risks and returns twice a year. Cases of non-compliance with the limits imposed are reported immediately. A report on total financial risks is submitted to the Board at quarterly intervals.

Decision-making framework for investment of financial assets and risk management, and various risk committees

Decisions on investment of financial assets and related risk management are taken by the Bank of Finland Board, the Markets Committee and, in the case of operational matters, also by the Investment Group and the Risk Group.

The Board is responsible for decisions on the objectives of investment activities, investment policy as well as risk management and principles for responsible investment. Such decisions relate, among other things, to the size of the Bank’s own financial assets and foreign reserves, currency distribution of foreign reserves, long-term investment activity, the strategic allocation of the fixed-income investment portfolio by investment category, the leeway permitted in fixed-income investment activities by investment category and the level of interest rate and credit risks. The Board also decides on maximum credit risk limits.

Within the limits imposed by the Board, the Markets Committee makes detailed decisions on the investment of the Bank’s financial assets and risk management. Such decisions include the criteria for counterparties and issuers and more specific credit risk limits. The chair of the Markets Committee, who is also responsible for decision-making on the Committee, is the Board member responsible for the Bank of Finland’s own investments.

The emphasis of work in the Investment Group and the Risk Group is on the preparation of matters to be considered by decision-making bodies. In addition, the Investment Group acts as an internal decision-maker within the Market Operations department and as coordinator of matters common to the investment and risk control functions. Decisions on new counterparties to investments are taken mainly by the Investment Group or in exceptional cases by the Markets Committee. The Head of Market Operations chairs the Investment Group and makes decisions therein. The Head of the Administration department’s Risk Control and Financial Accounting division chairs the Risk Group and makes decisions therein.

In addition to the decision-making bodies specified above, the Bank of Finland also has an internal working group on responsible investment. The working group makes decisions on the companies to be excluded from or brought back within the scope of the Bank’s investment activities. These decisions are based on responsible investment principles and are taken using analyses of an external service provider.

The Bank of Finland has a Financial Risks Committee which, independently of the management of financial assets is tasked with supporting the Board by supervising and assessing financial risks that may affect the Bank’s balance sheet. The committee is not a decision-making body but instead gives recommendations and may submit matters to the Board for information or decision, as necessary. The Financial Risks Committee is chaired by the Board member responsible for risk control.

The Bank of Finland also has an Operational and Cyber Risks Committee. The task of the committee is to evaluate the Bank’s level of operational and cyber risks management and to give instructions and make recommendations on development of risk management procedures. Similarly to the Financial Risks Committee, the Operational and Cyber Risks Committee is not a decision-making body but instead gives recommendations and submits matters to the Board for information or decision, as necessary. The Operational and Cyber Risks Committee is chaired by the Board member responsible for risk control.

Risk measures and breakdowns

Breakdown of debt instruments and deposits in the Bank of Finland’s financial assets, by credit rating¹

Breakdown of debt instruments and deposits in the Bank of Finland’s financial assets, by home country of issuer/counterparty (according to market value)

Sensitivity of the Bank of Finland’s financial assets to market changes

Allocation of the Bank of Finland’s fixed-income investment portfolios at the end of 2022

Definitions and concepts

• Market risk means the risk that the net value of assets will decline due to changes in market prices. Market price changes refer to changes in, for example, interest rates, exchange rates, the price of gold or stock prices, which are referred to as interest rate risk, exchange rate risk, gold price risk or equity risk, respectively.
• Credit risk means the risk of financial losses arising from changes in the creditworthiness of a counterparty to a financial transaction or a securities issuer or from default by a counterparty or issuer.
• Liquidity risk means the risk that assets cannot be made available when the need arises or their conversion into cash causes additional costs.
• Operational risk refers to risk of extra costs or losses resulting from inadequate or failed internal processes, personnel, systems or external events.
• Investment portfolio consists of foreign currency-denominated and euro-denominated fixed-income investment portfolios and long-term investments. Its objective is to safeguard the value of financial assets and the Bank of Finland’s ongoing ability to meet with its central bank commitments.
• Foreign reserves consist of unhedged foreign-currency investments and claims. These include the foreign-currency fixed-income investment portfolio and net receivables from the IMF.
• Cash refers to covered and uncovered short-term bank deposits.
• Modified duration is a measure of interest rate risk, indicating how much the value of a fixed-income investment or investments changes in response to a small change in interest rates. For example, if the modified duration is 2 and interest rates rise by 1%, the value of fixed-income investments falls by 2%.
• VaR figureat a certain confidence level means a loss in excess of which a loss occurs with a probability corresponding to the confidence level in question, over a target horizon. For example, if VaR 99% on a one-day horizon is EUR 3 million, this means there is a 1% probability that the current day’s result will be worse than a loss of EUR 3 million (and a 99% probability that the result will be better).
• Expected shortfall (ES) at a certain confidence level indicates the size of the expected loss in the event that the loss exceeds the VaR-level loss for that confidence level. For example, with an ES of 99%, this corresponds to the average loss in a 1% risk event.