Risk Management in the Central Bank of Bosnia and Herzegovina

Risk is a state in which there is a possibility of a negative deviation from the desired outcome we expect or hope for. Therefore, we can say that for risk to exist in financial operations, it must: be possible, cause economic damage, be uncertain and be accidental, reports the Bosnian news agency Patria.

In a dynamic business environment, risk is unavoidable, and within its operations, the CBBiH inevitably encounters various types of risk that may produce negative effects on the bank's operations. The task of the CBBiH is not to avoid risk, but to professionally manage its banking risks.

Risk management in the CBBiH aims to identify uncertainty and manage opportunities and threats in the bank's operations. The risk management process includes identifying, measuring and assessing risk with the goal of minimizing its negative effects on the financial result and capital.

Central banks, like traditional financial institutions, are exposed to various risks; however, due to the fact that they are non-profit institutions, central banks are less prone to risk.

Due to the pronounced need for the highest possible quality of risk assessment and management, and also as a response to the financial crisis that emerged during 2008 and brought uncertainty and increased risks to the European financial market, the Central Bank of Bosnia and Herzegovina established the Risk Management Department in 2009 as a special organizational unit responsible for risk management. The majority of this organizational unit's activities are related to the process of managing foreign exchange reserves.

The main financial risks accompanying this important process are:

Credit risk
Market risk
Operational risk

Credit risk

Credit risk represents the risk of non-fulfillment of obligations by the other party or contractual obligations by the other party in the contract. The Central Bank of Bosnia and Herzegovina is exposed to credit risk through investments in deposits with foreign banks, financial assets available for sale, and investments held to maturity. Given that the monetary liabilities of the Central Bank of BiH must at all times be covered by foreign currency assets, the CBBiH applies a very cautious approach when assuming credit risk.

Management of this type of risk is achieved by selecting counterparties with an acceptable credit rating, limiting the term, controlling the volume and dynamics of investment, and contracting specific provisions as an integral part of the contract.

Credit ratings are monitored on a daily basis, and strict business rules are in effect if the credit rating of a counterparty falls below the minimum prescribed level.

Liquidity risk

Liquidity risk is the risk of the inability to convert assets into cash, in the short term, when necessary. The Central Bank of Bosnia and Herzegovina creates an appropriate framework for liquidity management. Due to the need to guarantee the convertibility of the BAM, the CBBiH ensures daily liquidity through the maturity matching of foreign exchange reserves, with constant monitoring of actual and projected future cash flows. The minimum amount of the liquid portfolio of foreign exchange reserves is defined, as well as the minimum amount invested in instruments that determine daily liquidity. The volume of liquidity needs is continuously monitored and analyzed for adequate management and verification of whether the level of needs is well estimated during the observation period, and an analysis of the CBBiH's liquidity position for the past period is performed on a daily and monthly basis.

Market risk

Market risk represents the risk that a change in market prices, such as interest rates, financial asset prices and foreign exchange rates, will affect the bank's income or the value of investments in financial instruments. The goal of market risk management is to control and manage risks within acceptable parameters in order to optimize returns.

The Central Bank of Bosnia and Herzegovina is exposed to foreign exchange and interest rate risk as the most important components of market risk.

Foreign exchange risk represents the risk of a change in the value of foreign currency assets and liabilities due to changes in the exchange rate.

The Central Bank of BiH is exposed to foreign exchange risk through transactions in foreign currencies. Foreign exchange risk management is performed by matching the currency structure of assets and liabilities. Given that the foreign currency assets of the CBBiH are predominantly in euros, and the maximum amount that can be held in other convertible currencies subject to exchange rate changes must not exceed 50% of the total amount of the CBBiH's capital and reserves, exposure to foreign exchange risk is limited.

Interest rate risk is the risk of a change in the net value of a portfolio of fixed-income securities due to a change in interest rates.

The Central Bank of BiH is exposed to interest rate risk by investing foreign exchange reserves in deposits and debt instruments which, depending on the investment period, carry different interest rates. This risk is managed by determining the acceptable duration of deposit maturities and the maturity of debt securities in which investments are made.

Operational risk

In addition to the aforementioned financial risks, the Central Bank of BiH also pays attention to the process of operational risk management at the level of the bank as a whole.

Operational risk is related to the occurrence of negative effects on the financial result and capital of the bank caused by possible errors in employee work, lack of internal procedures and processes, poor information systems, and due to unpredictable external events.

Operational risk management in the CBBiH is carried out through the identification, measurement, monitoring and control of operational events that could lead to loss. The goal of management is to provide indicators and information that enable the Central Bank of BiH to identify and attempt to act preventively on possible risks before they negatively affect its operations and business.