De Nederlandsche Bank Investing in government securities: central - - PowerPoint PPT Presentation

De Nederlandsche Bank

Investing in government securities: central bank perspective

Risk & Asset Management

Pieter Moore, Oct. 2016

Central bank - policy objectives

• Financial stability
• Allow people to save, borrow, invest and hedge financial risks that they are

unwilling to bear themselves

• Price stability (protect purchasing power)
• Smooth and safe payment system (everybody is able to pay)
• Reliable and robust financial institutions (rely on your savings, insurance policies,

pensions and investments)

• Independent (economic) advisor to the government
• Academic and policy-related scientific research
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Reasons to invest

• Ability to credibly intervene
• High quality and liquid assets in multpile currencies at is disposal
• Generate return
• Supporting financial and therefore operational independence
• Understanding the markets
• Build a network of market participants to gather market intelligence.
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Determining portfolio characteristics

• Institutional framework
• Strong central bank
• Central bank objectives trump all other tasks
• Balance sheet is one of the main drivers of its reputation
• Therefore we need to be
• Big and liquid enough
• Risk averse enough
• Financial risk
• Reputational risk (i.e., headline risk)
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But also (mostly) exogenous factors

• Credit crisis
• Solvency crisis
• Sovereign debt crisis
• Low growth, shrinking credit supply and no inflation
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Required policy responses

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• Policy rates have been lowered to (below) 0,00%
• Long-term refinancing operations
• Massive assets purchases

Which shaped our balance sheet

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Which shaped our balance sheet (triple in size)

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Mostly government debt securities (>90%)

Reduced our profit outlook

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• Interest rates are the main driver of our profitability

And our willingness/ ability to take investment risks

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And our willingness/ ability to take investment risks

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And our willingness/ ability to take investment risks

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• No tolerance for FX risk
• Interest rate risk (duration) significantly lowered
• 95% of portfolio is Fixed Income; 5% is equities
• Little tolerance for credit risk; 95% > AA-rating

Which puts further preasure on our profitability

• Yields have dropped below the

deposit facility rate

• This is our minimum cost of funding
• This implies that if yields do not

drop any further

• The marginal cost of our investment

portfolio will be greater that its return

• Which necessitates us to explore
• ther investment opportunities
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Actions to improve the risk-/return characteristics

• f the investment portfolio
• Introduction of new asset classes
• Invest in corporate bonds in both EUR and US
• Through external managers
• Pay attention to Socially Responsible Investing and Environmental Social

Governance principles

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Actions to improve the risk-/return characteristics

• f the investment portfolio
• Introduction of new assets
• Invest in government bonds outside EUR and US
• Pay attention to cost of hedge
• Cross currency basis swap important driver of returns!
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Cross currency basis swap

• Spot and future exchange rates should be explained by the

difference in intererst between the two countries

• If interest in country A > country B; currency B should appreciate
• Else we could profit by borrowing in country B and investing it in country A
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• Explained by:
• Diverging monetary policy (EUR liq)
• Banking regulation
• Shrinking balance sheets (FX swaps)
• Money markets reform (USD

commercial paper)

Current themes

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• Determining appropriate size and risk of investment portfolio
• One integrated balance sheet approach
• Own investments treated separately
• Taking financing costs into account
• How to determine when to increase strategic duration
• ‘Valuing’ SRI and ESG principles
• Sustainability of CCBS investments