Emmanuel Tumusiime-Mutebile: Advanced risk management and
modeling for foreign exchange reserves
Opening remarks by Prof Emmanuel Tumusiime-Mutebile, Governor of the Bank of Uganda,
at the Macroeconomic and Financial Management Institute of Eastern and Southern Africa
(MEFMI) regional workshop, Kampala, 19-30 April 2010.
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The Programme Officer, Financial Sector Management
MEFMI
Distinguished resource persons
Workshop participants
Ladies and gentlemen
Good morning,
On behalf of the Bank of Uganda, it is my pleasure to welcome you all to this workshop on
Advanced Risk Management and Modeling for Foreign Exchange Reserves. I wish to extend
an especially warm welcome to all of the participants who have come here from outside
Uganda and to wish you a productive and enjoyable stay in our country.
It is befitting at the start of this workshop to pay tribute to the outstanding work of MEFMI in
building capacity for macro-economic and financial management in Eastern and Southern
Africa. Many of my staff in the Bank of Uganda have benefitted from MEFMI's programmes
to the extent that the Institute has made a major contribution to the building of technical
capacities in the Bank. An especially valuable feature of MEFMI's programmes is that they
are designed through close collaboration with the Institute's members specifically to meet
their requirements for capacity building. Hence MEFMI's capacity building is genuinely
demand driven; a feature which distinguishes it from the technical assistance programmes
offered by many other agencies. MEFMI also provides an excellent example of the benefits
to be gained from building up indigenous institutions at the regional level in Africa to serve
the needs of their clients and members for technical assistance, instead of relying on the
traditional donors.
The subject of this workshop is risk management and the modeling of risk. Risk is an
inherent feature of human endeavours and has been since humans first walked on the earth.
For much of human history, risk was simply accepted as fate: something arbitrary and
inevitable in the face of which human society was helpless. Arguably, risk management
began in the second half of the 17th century, when London merchants meeting in a coffee
house made small contributions to a pool with which to ensure themselves against the
possible loss of their vessels on the high seas, thus creating an embryonic insurance
industry. Subsequent efforts to understand the nature of risk, to quantify it, however
imperfectly, and to manage it, using scientific theory and empirical observation, have been
integral to the growth of modern economies. This is because managing risk is essential for a
rational allocation of capital among competing investment projects, which is essential for
economic growth. Although the strategic objectives of management in the public sector are
often different from those in the private sector, effective risk management is essential in both
sectors.
The timing of the workshop is especially opportune, coming in the wake of the most severe
global financial crisis in more than 50 years. The global financial crisis has provided salutary
lessons for risk managers in financial institutions all over the world. Risk managers have
begun to understand that financial risk is a much more complex phenomenon than had
hitherto been realized, prior to the crisis, not least because risk can be generated
endogenously within the financial system, rather than being simply the consequence of
exogenous shocks to the financial system. The global financial crisis has demonstrated that
even those assets and financial institutions regarded as relatively risk free - investment
grade securities for example - can suffer substantial losses. We now know that tail risks, the
low probability risk of very large losses - sometimes referred to as "Black Swans" - occur
much more often than is predicted by many statistical models. Risk managers have also
learned that the liquidity of financial assets and institutions is much more fragile than they
had previously thought, especially in transactions based financial systems, and that a drying
up of liquidity can generate large losses in asset values.
The value of rating agencies and the ratings that they provide have also become the subject
of critical review as a result of their performance in the run up to the global financial crisis.
Reputable rating agencies issued Panglossian ratings for securities, such as collaterised
debt obligations, the risks of which they did not properly understand. Investors who
purchased these securities in the belief that they carried negligible risk suffered serious
losses.
Looking ahead, it is difficult to be sanguine about the prospects for stability in global financial
markets. The large structural imbalances which characterize the global economy will
eventually have to be rectified; a process which could generate further volatility in asset
prices, such as the exchange rates of the major international currencies. The global
economic crisis itself has severely damaged public finances in many of the industrialized
economies and this is bound to have consequences for the price of government debt and
possibly also exchange rates in the medium to long term. As a result, the type of assets
which traditionally comprise the bulk of central bank foreign exchange reserves may become
much more volatile in the future.
In such circumstances the task of investment managers and risk managers will be very
challenging. They need to re-evaluate their strategies for risk management and strengthen
their tools and capacities for modeling risk. This workshop has been designed to contribute
to building capacity to meet these challenges. The workshop will also provide regional and
international experts with an opportunity to exchange views, ideas and their own experiences
of managing risk.
A major focus of the workshop is the use of modeling techniques to guide risk management.
Statistical models have become integral to risk management in financial institutions and
among financial investors. Such models have made a crucial contribution to the development
of risk management; providing it with a more rigorous, scientific foundation. But, for the
reasons that I have already mentioned, some of these models are now attracting critical
scrutiny from policy makers, regulators, investment managers and academics.
Notable among the statistical models is the value-at-risk model, which has become the
principal tool for the management of market risk, and to some extent, the management of
credit risk in many financial institutions. If this model is such a powerful tool, as its
proponents claim, why did financial institutions make losses which were many times greater
than the amount which value at risk models estimated was possible? Risk models and risk
management in general are based on the assumption of normal market conditions, where
willing buyers and sellers exist, with adequate market liquidity to enable assets to be priced
in the market. What happens when the market collapses? It is clear that risk management
models perform poorly in such circumstances.
Nevertheless, statistical models will continue to play an important role in risk management,
despite their shortcomings, but practitioners must be wary of placing too much faith in the
results of models alone. Sound judgement, based on a comprehensive knowledge of
markets and a thorough understanding of economic and financial theory is an essential
complement to the use of statistical models.
MEFMI has assembled an impressive line-up of international and regional resource persons
to conduct this workshop. They bring a huge amount of experience and expertise in the
various issues will be covered here in the next two weeks. I am confident that the workshop
will help all of you who are participating to master the statistical modeling techniques which
are essential for risk management and to improve your understanding of the concepts and
theories of risk management.
With these few words, I declare the workshop open. I wish you fruitful deliberations.