The types of risks that
a government loan portfolio can face are market, rollover, liquidity,
credit, operational and settlement risks.
Market
risk
Market risk arises from changes in interest
and foreign exchange rates affecting the cost of debt service
and the prices of commodities and other variables that have an
impact on foreign exchange earnings and government revenue influencing
the ability to make scheduled debt service payments.
Rollover
risk
Rollover risk arises when debt falling due cannot be rolled over
if continuing access to the same volume and currency of funds
is required or that it can be rolled over only at a very high
cost.
Liquidity
risk
Liquidity risk is related to rollover risk
and arises due to a) unanticipated cash flow obligations or difficulties
of short-term borrowing leading to a sudden reduction in available
foreign exchange reserves, and b) costs or penalties that investors
could face due to the exit of bondholders from the market.
Credit risk
Credit risk is the risk of non-performance
on loans by borrowers and counterparties on financial contracts.
Operational
risk
Operational risk covers those arising from
transaction errors, failure of internal controls, legal issues,
security breaches, damage to the reputation of the borrower and
disasters affecting the normal business activity of the borrower.
Settlement
risk
Settlement risk covers the potential loss
to the government of a failure to settle by the counterparty for
reasons other than default.
Strategic benchmarks are
thresholds set for some characteristics of the loan portfolio
such as the domestic and foreign mix, currency mix of the foreign
segment, and interest and maturity structure. These may be expressed
as the minimum and maximum levels of acceptable risk exposure
and specified as:
(i) the acceptable interest
rate set as a target level or range and the ratios of fixed and
floating rates of interest in the debt outstanding;
(ii) the desired currency
composition with a breakdown of foreign and domestic currency
debt and the currency composition within the foreign currency
component; and
(iii) the debt maturity
profile expressed as a ceiling or a proportion of the debt outstanding
that would mature at the end of each year.
Strategic benchmarks may be set for the
total portfolio of the government though there may be separate
benchmarks for the domestic and foreign currency components.
