Risk Management of Public Debt: Notes from Turkish Experience

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Treasury

The 27th Annual ICGFM International Conference

Good PFM Practices in a Period of Global Adjustment

Fatoş KOÇ

Head of Department

Turkish Treasury

May 19-24, 2013

Risk Management of Public Debt:

Notes from Turkish Experience

1



Outline

The Concept: Risk Management of Public Debt

Risk Management in Turkish Treasury

• History of Establishment

• Organizational Structure and Functions• Methodological Approach

• Market Risk Management

• Credit Risk Management

• Operational Risk Management

Lessons Learned

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The Concept:

Risk Management of Public Debt

3



Risk Management

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Risk management is the process of identification,

assessment, prioritization, control, avoidance,

minimization, or elimination of unacceptable risks.

Risks can come from uncertainty in financial markets,legal liabilities, credit risk, accidents, operational

procedures, natural disasters, or events of uncertain or

unpredictable root-cause.

A complete management of risks aims to protect not onlythe value already created by the organization, but also

its future opportunities.

Source: www.wikipedia, ISO 31000

Description

http://www.wikipedia/

http://en.wikipedia.org/wiki/ISO_31000

http://en.wikipedia.org/wiki/ISO_31000

http://www.wikipedia/



Process Phases

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Reporting

& monitoring SettingStrategies

Defining & modellingrisk measurement

techniques

Defining risks

5

Risk Management




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Debt managers face cost and risk trade off when

determining how to finance the borrowing requirements

Debt portfolio can be structured on the bases of cost and

risk criteria to reduce vulnerabilities to various shocks:Strategic debt targets

Strategic debt targets provide medium term guidelines

for debt management operations

Risk management policies and risk control procedurescover formulation and implementation of strategic debt

targets

Source: Advances in Risk Managment of Government Debt, OECD 2005

The concept and the role



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Cost

Risk 7


Trade off between cost and risk



Methodology of Risk Management

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Identification of Relevant Risks

Contingent

Liabilities

Main Exposures

Credit Risk Market Risk

Re-financing

Risk

OperationalRisk

Liquidity

Risk

Operational

Risk

Direct

Liabilities

8




In most cases, risk management includes market

(interest and currency risk), credit and operational risks.

Risk management activities are handled in middle offices Policies and tolerance limits are approved by political

level (Ministry of Finance, appropriate Ministry,

Parliament or High Level Committees)

Risk-based analyses require comprehensive dataset,appropriate tools and technical capacity

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Common features of design




Estimations of debt level and profile under different budget targets

are useful for public financial management Ministry of Finance

Comparing strategic targets with realization figures is helpful for

assessing debt management performance Audits

Operational risk management reports and control mechanisms can

be used in internal control Internal Audits

Sharing the perspective and analyses helps developing risk

awareness and spreading risk culture Public Financial Sector Risk management of state guarantees and receivables avoids moral

hazard and urges better financial management in other public

institutions Local Governments, State-owned Institutions

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Externalities of risk management



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Risk Management in

Turkish Treasury

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History of Establishment

Necessity of risk management

Globalisation in financial markets

Increasing volatility in international capital markets

Deterioration on risk profile of sovereign debt portfolio

following 2000 and 2001 macroeconomic crises

The need to establish a medium-long term perspective

for public debt management

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Establishing Risk Management

Legal Framework

Organizational Structure

Technical Capacity

Risk Awareness

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Legal Framework

The Law on Public Finance and Debt Management (2002)

Defines Treasury as the sole borrowing entity

Specifies the limits for new borrowing and Treasuryguarantees

Defines the procedural rules for domestic borrowing,

guarantee issuance and undertakings, on-lent loans,

collection of financial receivables

Assures transparency and accountability

Re-structures organization

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Legal Framework

Regulation on the Principles and Procedures of Coordination andExecution of Debt and Risk Management (2002) sets followingprinciples:

To follow a sustainable, transparent and accountable debtmanagement policy that conforms to monetary and fiscalpolicies, considering macroeconomic balances,

To meet financing requirements at the lowest possible cost inthe medium and long term, taking into account the risks,regarding costs as well as domestic and international marketconditions.

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Debt and Risk

Management

Committee

Minister

Front Office Middle Office Back Office

Undersecretary

Organizational Structure and Functions

Back Office

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Organizational Structure of Risk Management

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RISK MANAGEMENT

(MIDDLE OFFICE)

MARKET RISK

MANAGEMENT

CREDIT RISK

MANAGEMENT

OPERATIONAL RISK

MANAGEMENT

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BUDGET MONITORING

AND ANALYSIS




RE-FINANCINGRISK

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Borrowing mainly in fixed

rate instruments

Borrowing mainly in TL

Buffer cash reserve

Increasing average maturity

Guarantee Limit

Guarantee FeePartial Guarantee

INTERESTRATE RISK

EXCHANGERATERISK

CREDIT

RISK

MARKET

RISK

Idetification of Relevant Risks

OPERATIONALRISK

Incident Reports

Risk Matrix

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The Need to Define

Overall

Objectives of Debt

Management

The Need for

Performance

Measurement

Formulation of a Benchmark Strategy to

serve as aguideline

Setting the Benchmarks

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Forward looking medium-long term borrowing policy to guide front

offices in the context of debt management’s overall risk/cost

preferences based on following principles.

Full coverage of financing requirement

Consistency among the short and medium/long-term objectives with long

term concentration

Applicable set of instruments fitting the market structure

Aiming the market development

Balancing cost

–

risk trade off Be realistic by avoiding strict assumptions

Simple tools

Setting the Benchmarks

Market Risk Management

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Modeling of Strategic Benchmarks:Cost-at-Risk (C@R) Approach

Aims to identify probable limits within which the costs of

debt may fluctuate (the degree of market risk) for a given

strategy.

Serves as a tool for comparison of alternative borrowing

strategies in terms of expected costs and risks.

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Macroeconomic

Scenario

Generation

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Debt

Database

Alternative

Strategies

Expected

cost & risk

of a given

strategy

Cash Flow Modelling and

Borrowing Requirement

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Market Risk ManagementModeling of Strategic Benchmarks:Cost-at-Risk (C@R) Approach



Modeling of Strategic Benchmarks: Complementary Analyses

Supplemental analysis for liquidity risk management

• Level of Liquidity Buffer

• Debt Concentration Indicators

• Currency composition of FX reserves

Data analysis and modelling for volatility and co-

variance of FX rates

Evolution of yield curves

Spreadsheet model for sustainability and sensitivity

analysis

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Strategic Benchmarks for 2013-2015: The direction we would like to move

Keeping a certain level reserve of cash : Reduce liquidity risk

Borrowing mainly in TL in domestic cash borrowing : Reduce currency risk

Using fixed rate TL instruments as the major source of domestic cash

borrowing and decreasing the share of debt which has interest rate refixing

period less than 12 months: Reduce interest rate risk

Increasing the average maturity of domestic cash borrowing taking market

conditions into consideration and decreasing the share of debt maturing

within 12 months: Reduce refinancing risk

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Monitoring and Reporting

Medium-term Guidelines

Monthly Risk Bulletins

Monthly and Annual Public Debt Management Reports

Short Notes on Spesific Issues

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20

40

60

80

100 20003000

40005000

60007000

80009000

10000

4

6

8

10

Vade (Gün)

Dönem

G e t i r i

Y i e l d

Maturity

Period

Evolution of Yield Curves

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35,0

33,0

31,0

32,1

32,8

32,7

36,135,8

30

34

38

42

46

2008 2009 2010 2011 2012 2013 2014 2015

( % )

Debt Sustainability Analysis

28

Source: Pre-Accession Economic Programme 2013-2015




29

48.853.8 50.1 54.0 55.7 56.9 53.4 56.0 59.2 59.8 59.0

51.246.2 49.9 46.0 44.3 43.1 46.6 44.0 40.8 40.2 41.0

0

25

50

75

100

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013March

Fixed Floating

Interest Composition of Central Government Gross Debt (%)

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3030

53,758,5 62,4 62,8

68,7 66,270,9 73,3 70,4 72,6 73,1

46,341,5 37,6 37,2

31,3 33,829,1 26,7 29,6 27,4 26,9

0

25

50

75

100

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

March

TRY FX

Currency Composition of Central Government Gross Debt (%)

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Percentage of Domestic Debt Maturing within 12 Months

41,7

45,7

42,5

35,4

31,8

29,2

38,7

27,2

22,2

33,135,1

20,0

30,0

40,0

50,0

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

March

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Percentage of TL Debt Refixed within 12 Months

32

93,7

86,3

80,0 80,2

72,7

75,6

78,3

71,6

67,0

70,371,5

65,0

70,0

75,0

80,0

85,0

90,0

95,0

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

March

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Credit Risk Management

Covers credit risk of contingent liabilities andreceivable portfolio

Guarantee and On-lent Loan Limit

Guarantee/ On-lent Fee

Partial Guarantee

Debt Repayment Account

Risk Account Efficient collection regime

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Credit Risk ModelQuantitative spreadsheet models where the behaviors of

guaranteed institutions are simulated under different

macroeconomic conditions

Credit Scoring Model

Model that forecasts default one period ahead through a linear

weighted combination of observable explanatory variables

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Guaranteed Debt and Undertaken Amounts

-

100

200

300

400

500

600

700

800

-

2.000

4.000

6.000

8.000

10.000

12.000

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 U n d e r t a k

i n g s a r i s i n g f r o m T r e a s u r y G u a r a n t e e

s

( M i l l i o n U S

D o l l a r )

G u a r a n t e e d E x t e r n a l D e

b t ( M i l l i o n U S D )

Guaranteed External Debt Undertaken Debt

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35



Operational Risk Management

Operational Risk (OR)

The risk of direct or indirect lost resulting from inadequateor failed internal processes, people, system or fromexternal events.

Operational Risk Management (ORM)

A continual cyclic process resulting in acceptance,mitigation or avoidance of risk.

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Measuring Operational Risks

Likelihood and Impact

Importance Level of Risks

Total Risk Area

High Level Risk Area

Setting Up Risk Matrixes

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Insignificant Minor Moderate Major Catastrophic

Very Low

Low

Medium

High

Very High

Importance Level 1 2 3 4 5

Frequency

Impact

L i k e l i h o o d

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Developing Appropriate Management Strategies

Check Lists

Technology Based Solutions

Protocols/Agreements New Plans/Updates for Business Processes

Training Programs

Internal Control

Business Guides

Business Continuity Plan

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Monitoring ORs

Updating risk profile table

Incident reports (Users)

Monitoring reports (Heads of Department)

Reporting ORs

Monthly Operational Risk Bulletin (Heads of Department)

Quarterly Operational Risk Bulletin (Debt and RiskManagement Committee)

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LESSONS LEARNED

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Lessons Learned

By adopting risk based debt management approach, wecannot avoid a crisis, however, we can minimize its

effects on debt management via increasing resilience

Risk-based analysis is vital for

• Better understanding,• Comprehensive measurement and

• Effective management

of sovereign debt

Risk management is an evolving process in which newsolutions to new challenges have to be created

A credible risk management unit has to adopt a robust

stance

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Lessons Learned

Risk-based debt management is necessary but notsufficient for a prudent debt management

Other elements of a prudent debt management are

• Efficient co-operation and coordination withmonetary and fiscal authorities

• Close communication with investor base including

non-banking institutions

• Ensuring transparency and accountabilityprinciples

Documents

Risk Management of Public Debt: Notes from Turkish Experience