After a very interesting morning dedicated to recent financial stability challenges in a negative euro area interest rate environment, I am introducing a panel on reserve management challenges in a context of negative euro area interest rates.

Financial stability and reserve management are two topics that are intertwined together for the reasons we have discussed this morning. Due to widespread euroization, countries in the region are exposed to exchange rate shocks that may impair the debt servicing capabilities of unhedged borrowers, raise financial stability risks, and may ultimately impair the effectiveness of monetary policy transmission. Therefore, key policy questions are: what the appropriate level of FX reserves should be and how they should be invested to make sure they are readily available when needed to fulfill the different purposes for which FX reserves are held.

Adequate levels of FX reserves are needed to mitigate financial stability risks, to support the exchange rate policy, to meet government foreign currency needs.

This means, however, that FX reserves may represent a sizeable part of the central bank’s balance sheet. This exposes the central bank’s balance sheet to costs due to the differential between the rate of return of FX assets and the return on alternative assets denominated in the domestic currency. Such costs are exacerbated by the negative interest rate environment, which has depressed the rate of return on FX assets.

Central banks are not profit-maximizing institutions. Almost everywhere now their primary objective is to maintain price stability. Central banks do, nevertheless, care about their balance sheets, in particular their profit and loss account, because avoiding losses is important to preserve independence, which ensures our ability to fulfill our mandate. Lorenzo Bini Smaghi, former ECB Executive Board Member, in 2007 reiterated this importance since, I quote: “A central bank cannot credibly operate in an independent way without proper financial means; it would be under a ‘Damocles’ sword’ if it depends on the government for the financing of its operative expenses.”

Therefore, the lower return on FX assets may become problematic if the lower returns structurally undermine the central bank’s profitability.

Although several strategies can be theoretically envisaged to temper the effects on profits of the negative euro area interest rates, such as currency diversification, they can hardly be deployed in the region without partially undermining the role FX reserves play.

What we can, do, however, is to right-size the level of FX reserves. In Albania, we are very proud of having recently adopted a state-of-the-art FX reserve optimization model with support from IMF technical assistance (TA). This ensures that our FX reserves are adequate to meet all possible contingencies for which reserves are needed, but it prevents us from holding more than we need taking into account FX reserve opportunity costs.

These challenges are not unique to the region, but are probably shared with several countries in proximity of the euro area and beyond, from which we will also hear today.

We have a very qualified panel to discuss the reserve management challenges in the current low interest rate environment and the varying responses of different central banks.

We start with Roberto de Beaufort of the World Bank. Roberto is the Lead Financial Officer of the Reserves Advisory and Management Program (RAMP), responsible for managing the technical assistance program for central banks and sovereign wealth funds of member countries. Roberto has been several times in Albania. We will benefit from the unique breadth of his cross-country experience.

We have then Victor Andrei, Head of the Market Operations Department of the National Bank of Romania, and Sándor Ladanyi, of the Monetary Policy Instruments, FX Reserves and Risk Management Directorate of the Hungarian Central Bank. Romania and Hungary are two countries in the EU, with strong economic and financial links to the euro area, with an Inflation Targeting framework and flexible exchange rates. They have, therefore, several similarities with countries in the region, like Albania and Serbia.