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Management of interest rate risk

Interest rate risk refers to the risk of changes in the value of the financial reserves and in the cost of debt arising from changes in interest rates.

  • The interest rate risk of the Stabilisation Reserve Fund is measured on a VAR (value-at-risk) basis, with a VAR limit.
  • From 2014 to May 2020, the interest rate risk of financial assets (meaning the Liquidity Reserve and on-lending portfolio) and outstanding debt was measured using modified duration. The duration of the financial assets could not exceed 0.45 years (5.4 months). The outstanding debt’s duration could not exceed 0.5 years (6 months). This limit was set based on ALM principles, taking into account that the Liquidity Reserve was larger than the debt portfolio. By maintaining a similar duration of financial assets and liabilities, the overall impact of changes in interest rate levels for the State was minimized.

Graph: Liquidity Reserve and outstanding debt (in million euros, left axis) with modified duration (in years, right axis)

  • During the second quarter of 2020, the level of government debt increased significantly due to the government response to tackle the spread of COVID-19 and to support the economy. This meant that the size of the debt portfolio substantially exceeded the size of the Liquidity Reserve, a situation that was expected to continue for the foreseeable future, so that the previous policy, based on an ALM approach where financial assets exceeded liabilities, was no longer appropriate. In June 2020, the government therefore revised the principles of interest rate risk management.

    According to the new principles, the interest rate risk management of financial assets is no longer fully combined with interest rate risk management of liabilities under an ALM approach.

    The principles for interest rate risk management of the financial assets (the Liquidity Reserve and the on-lending portfolio) remains unchanged – the modified duration of these financial assets must not exceed 0.45 years.

    The risk management principles for the liabilities (the outstanding debt) were however updated – from June 2020, the interest rate risk of the outstanding debt is measured using the average interest rate re-fixing period method. Two separate limits are in place: (i) the average interest re-fixing period of any outstanding debt up to EUR 600 million cannot exceed 0.5 years (i.e., a continuation of the ALM-principle as discussed above) and (ii) the average interest re-fixing period of any outstanding debt over EUR 600 million must exceed 3 years, with the maximum interest re-fixing period set periodically by the Minister of Finance based on the State’s long-term risk-bearing capacity. As of 31 October 2021, the weighted average interest re-fixing period of the total debt portfolio was 4.90 years.

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Last updated: 5 November 2021