- International Monetary Fund
- Published Date:
- April 2005
Governance and Institutional Framework
Reserve management objectives and coordination
877. The objectives of management of reserve are three-fold:
Provide liquidity for intervention in the local foreign exchange market.
Earn reasonable rates of total return without exposing the reserves to excessive credit and market risks.
Earn good current income so as to achieve healthy accounting profit.
878. Oman is a small oil exporting country with its currency pegged to the U.S. dollar. Maintenance of the credibility of the fixed peg is of paramount importance for macroeconomic stability. The reserve management policy objectives have been designed primarily with a view of optimizing U.S. dollar resources to provide a credible cushion against current and capital account shocks, while at the same time clearing the local foreign exchange market on a day-to-day basis. These objectives have remained in place since the inception of the Central Bank of Oman (the Central Bank) over 25 years ago.
879. The Central Bank does not target any particular level of reserves. The current level of foreign exchange reserves at around US$2.5 billion provides import cover of about 4.5 months, which is considered adequate, given the fact that external debt of Oman is very low and is declining.
880. The scope of reserve management activity is confined to achieving the objectives of liquidity and growth/current income.
881. For the Central Bank, the most important monetary policy goal is to maintain the fixed peg of the rial Omani with the U.S. dollar. This is recognized as such in reserve management policy. Moreover, reserve management operations take notice of domestic liquidity conditions and the position of government balance with the Central Bank. Local banks are allowed short-term U.S. dollar-rial Omani buy-sell swaps as a mechanism for augmenting rial Omani liquidity, in case of need.
882. The imperatives of the monetary policy are reflected in the manner in which the foreign exchange reserves portfolio is structured. Currently, the external reserves are divided into four sub-portfolios or tranches:
(i) Liquidity Tranche: This is an all U.S. dollar portfolio that is meant for providing liquid resources for market intervention. As such, this tranche is invested in very short-term high-quality instruments, such as deposits and CDs of top-class banks and U.S. Treasury Bills. All inflows/outflows (which do not represent income/realized profit) with respect to the external reserves take place in the Liquidity Tranche.
(ii) Bridge Tranche: This is also an all U.S. dollar portfolio that is intended to provide support to the Liquidity Tranche in case of need. The size of the Bridge Tranche is generally kept within a maximum of 25 percent of the external reserves, excluding gold and SDRs. This tranche is invested in short- to medium-term high-quality instruments, such as deposits and CDs of top-class banks and U.S. Treasury Bills as well as U.S. Treasury notes with remaining maturity up to and including three years.
(iii) Income Tranche: This represents the stable portion of the reserves, which is a multicurrency portfolio, with the neutral share of U.S. dollar at 75 percent. The other permissible currencies are euros and pounds sterling. Until recently, the Japanese yen was also a permissible currency for this tranche. However, effective January 1, 2002, Japanese yen ceased to be a permissible currency in light of the continuing weakness of the Japanese economy. The permissible instruments for the Income Tranche include bank deposits, CDs, treasury bills, and dated securities representing debt obligations of top-quality sovereign and supranational institutions whose residual maturity does not exceed 10 years.
(iv) Bullion Tranche: This tranche contains the gold holdings of the Central Bank, which currently constitute around 3 percent of the external reserves. The gold, which is located at an overseas center, is placed in short-term lease (deposit) with top-quality banks.
883. There are performance benchmarks for the Liquidity, Bridge, and Income Tranches, which take into account investment objectives, liquidity requirements, and constraints. The investment policy with respect to the external reserves is reviewed from time to time, taking into account, among other things, fixed income and foreign exchange markets outlook.
884. Reserve management activities of the Central Bank are carried out under the overarching provisions of the Banking Law, which also covers other activities of the Central Bank. The Law mandates a fixed par value for the rial Omani and also stipulates maintenance of a minimum ratio between external reserve and currency in circulation. This Law has specific provisions regarding eligible currencies and instruments for deployment of reserves. The Law also mandates that international accounting standards be applied for accounting purposes with respect to the external reserve. The Board of Governors of the Central Bank is the highest body for policy decisions with respect to management of external reserves. The relevant provisions of the Banking Law with regard to the above are quoted below:
Level of external reserves
885. Article 31 states that the Central Bank shall at all times maintain a reserve of external assets that shall be related in value to the value of currency notes and coins in circulation in such ratio as may be prescribed from time to time by the Board of Governors, subject to approval of His Majesty, The Sultan.
Categories of external assets
886. As per Article 32, the reserve of external assets may consist of any one or more of the following, provided they adhere to all limits, classifications, constraints, restrictions, and qualifications whatsoever laid down by the Board of Governors:
Gold or silver coins, which are legal tender.
Bullion of gold, silver, or such other precious metals as may, from time to time, be utilized as a monetary asset and freely traded on international exchanges.
Foreign currencies or basket of currencies.
Bank demand and time deposits, certificates of deposit, and acceptances denominated in freely convertible foreign currencies.
Treasury bills, commercial paper, and any other short-term money market instrument denominated in freely convertible foreign currencies and issued by foreign banks, foreign governments, foreign public agencies, or supranational organizations.
Floating rate notes denominated in freely convertible foreign currencies and issued by foreign banks, foreign governments, foreign public agencies, or supranational organizations.
Fixed interest securities and notes denominated in freely convertible currencies and issues guaranteed by foreign banks, foreign governments, foreign public agencies, and supranational organizations.
Any internationally recognized reserve asset, including SDRs issued by the IMF.
887. Article 38 provides that the amount of profits, losses, credits, debits, depreciation, funded and unfunded reserves, and other financial analysis … shall be determined according to the generally accepted principles of accounting, including the International Accounting Standards insofar as they do not contradict any provisions of the Law, agreed by the Auditors appointed pursuant to Article 18(c) of this Law and approved by the Board of Governors.
888. Article 41 specifies that:
The par value of the rial Omani shall be determined from time to time by His Majesty, The Sultan.
The par value of the rial Omani, or any change thereof, shall be declared in terms of gold, units of SDR, a foreign currency, or a basket of currencies or an internationally recognized unit of account for currencies, provided, however, that any such determination shall be in accordance with the conditions of any international monetary agreement to which the Sultanate (of Oman) is then a party.
889. In Oman, foreign currency revenues of the government, arising mainly out of export of oil and gas with unit sales realization up to the price of oil and gas fixed annually for budget purpose (the budgeted price) are generally sold to the Central Bank against rials Omani, which serve as inflows into the reserves and are thus monetized. Any revenue of the government in excess of the budgeted prices of oil and gas are kept separately in a fund to be utilized if there is a budget shortfall subsequently. This portion of the external reserve of the country is owned and managed directly by the government. The name of the fund is State General Reserve Fund (SGRF). There is an institutional arrangement for consultation between the Central Bank and the SGRF on various investment-related issues, such as composition of benchmark, portfolio performance, etc.
890. There is a well-defined organizational structure within the Central Bank for all decisions regarding the external reserves. As mentioned earlier, the Board of the Central Bank is empowered to make all decisions with regard to investment policy and investment guidelines, including performance benchmark, etc.
891. The highest decision-making body for all investment decisions, in terms of the policy/guidelines approved by the Board, is the Reserve Asset Management Committee (RAMC), which is chaired by the Executive President (CEO of the Central Bank). The composition of this Committee is detailed in Table 21.
|Senior Vice President||(In charge of Treasury, Investment, and Settlement Departments)|
|Manager||(In charge of Treasury and Investment Department)|
|Senior Manager||(In charge of Financial Management Department, which is responsible for maintenance of accounts for the Central Bank)|
|Senior Manager||(In charge of Systems, Procedure, and Operations Department, which performs management service functions)|
|Investment Expert||In-house consultant on reserve management|
892. The RAMC decides on all issues concerning reserve management, including fixing of medium-term strategic (MTS) benchmarks with regard to currency allocation and duration.
893. The responsibility of the Central Bank with regard to management of external reserves arises exclusively out of the provisions of the Banking Law. The external reserves are owned by the Central Bank and as such there is no agency arrangement between the government and the Central Bank for this purpose.
894. The three main aspects relating to investment of external reserves, namely, guidelines, decision-making process, and procedure for operations with respect to transactions in the front office and their follow-up at the back office, have been established and documented. There is a system for periodic review of these documents.
895. There is a good deal of decentralization of decision-making power for risk decisions. The Central Bank has adopted a document delineating the powers and responsibilities of officials at various levels connected with decision making. The delegation of power and the chain of authority are well documented.
896. Internal control and audit systems for the reserve management functions and operations have been designed on sound governance lines. Major elements of the internal control systems are:
(i) Management Information Reports with respect to transactions, risk exposure, and exceptions (breach of guidelines, delegated powers, and procedure for operations) have been prescribed. These are intended to cause flow of critical information from the reserve management departments to the senior management (including CEO) on a regular basis. The Board of Governors is kept informed at periodic intervals about all important aspects of reserve management, including portfolio performance vis-à-vis benchmark.
(ii) There is an internal audit system that periodically examines the operations at the front office and the back office and reports to the CEO. Compliance with audit observations within a time frame is ensured.
897. Financial accounts of the Central Bank, including accounts relating to reserve management, are audited by external auditors at least once a year. Effective January 1, 2002, the Central Bank has implemented the provisions of International Accounting Standards 39 with respect to all its financial assets and liabilities, which are in conformity with the Banking Law referred to earlier. The audited accounts and the findings of the external auditor are reported to the Board of Governors. The Central Bank’s policy and procedure with respect to internal control and audit are well documented.
898. Information on foreign exchange reserves is provided in annual audited accounts and reports of the Central Bank. The present policy of the Central Bank does not envisage more disclosure with respect to reserve management.
899. Staff involved in reserve management are subject to a code of conduct and guidelines on conflict of interest regarding the management of their personal affairs.
900. The staff of the departments responsible for reserve management are all well trained and experienced. New staff are taken on the basis of very strict criteria for academic qualification and after thorough and comprehensive screening. The Central Bank devotes considerable resources to upgrading the knowledge and skill of its personnel. The Central Bank has not found feasible the idea of offering a better compensation package to reserve management personnel in order to attract and retain reserve management specialists. The present policy of uniform service rules and compensation packages for staff of all the departments of the Central Bank is working satisfactorily.
901. Retention of experienced staff has not been a problem so far, although some movement of staff, in search of better and well-paid jobs in the private sector, has been noticed in recent years. The present policy is to offer better career opportunities in the Central Bank for the talented and well-performing staff.
Establishing a Capacity to Manage Risk
902. The external reserves are exposed to currency, credit, liquidity, as well as interest rate risks. The approach toward risk exposure has been shaped by the following elements:
Provisions of the Banking Law with regard to currency diversification and choice of instruments.
Low appetite for downside risk with regard to currency revaluation, mark-to-market portfolio valuation, and income.
An empirically observed fact with respect to interest rate risk that the expected risk-adjusted return is optimal around a portfolio duration of 2.5 years for major markets.
Aversion to credit risk so as to keep the probability of getting involved in any default to a minimum.
903. The current investment guidelines embody the above approach with regard to prescriptions for the different types of risk exposures. The relevant provisions of the investment guidelines are as follows:
904. In the Income Tranche, the proportion of holdings in the approved currencies shall always remain within the maximum and minimum limits as indicated in the table below.
|Approved currencies||Neutral (percent)||Maximum (percent)||Minimum (percent)|
905. The neutral duration of investments in the Bridge Tranche shall be one year around which a maximum deviation of plus or minus six months will be permitted. The neutral or benchmark weighted-average duration of investment in the three approved currencies (in the Income Tranche) shall be as indicated in the table below:
|Approved currencies||Benchmark (in years)||Maximum (in years)||Minimum (in years)|
906. At the time of purchase, short-term money market instruments shall be rated not lower than F3 and the issuing banks rated not less than C (individual) and 3 (legal) by FITCH-IBCA or their equivalent. At the time of purchase, long-term instruments shall not be rated lower than A by Moody’s or its equivalent.
907. The current thinking with regard to the Income Tranche envisages a gradual elimination of diversification into non-U.S. dollar currencies and non-U.S. markets over a period of time. This is driven by a desire to stabilize earnings in U.S. dollar terms, with low downside risk.
908. Forward foreign exchange contracts are the only permissible derivative instruments. Short sale is prohibited. Further, although repo is a permitted instrument, it has not been used so far. However, in recent years bond lending activity has been undertaken for a large portion of the external reserves, including lending against cash collateral for the U.S. Treasury portfolio. The objective here is to earn additional income, while keeping the risk exposure at a low level. The approach with regard to any new activity has been to first understand and internalize the risk characteristics, put in place the necessary IT systems and internal controls, and then undertake it. This has been followed in the case of bond lending against cash collateral by ensuring that the risk on investment of cash collateral is always at an acceptably low level by prescribing suitable investment guidelines for this purpose.
909. Liquidity risk has been addressed by creating a three-tranche structure, as described earlier. In creating this structure, historical inflow/outflow data were analyzed to find out the liquidity requirement for undertaking intervention in the domestic market under a “worst-case” scenario. Further, to avoid issue concentration, which can have adverse liquidity implications, maximum holdings for individual issues of debt securities have been prescribed.
910. There are performance benchmarks for Liquidity, Bridge, and Income Tranches. All of these have been constructed on the basis of publicly available market indices. For the Liquidity Tranche, the benchmark is the one-month U.S. Treasury Bill rate. For the Bridge Tranche, as also for the Income Tranche, the performance benchmarks are a composite of market indexes, reflecting the neutral currency and duration configurations. The criteria for selection of the performance benchmarks are the following:
The benchmarks should correspond to the passive or neutral risk profile.
The benchmarks should reflect the broad pattern of investments.
The benchmarks should not have any inherent bias for over/under performance.
911. The performance benchmarks are prescribed in the investment guidelines for external reserves, which have been approved by the Board of Governors.
912. For the purpose of calculation of rates of return, the U.S. dollar acts as the base/numeraire currency. Calculation of return with respect to the investment portfolios and also the benchmark is outsourced at present. This is done primarily with a view to ensuring that the returns are calculated independently by an external agency. Return calculation is accompanied by full attribution analysis once in a quarter to highlight the factors responsible for over/under-performance vis-à-vis the benchmark.
913. Active risk taking for value addition vis-à-vis passive configurations with respect to currency and duration is also undertaken. For this purpose, there are two levels of decision making. At the level of the Reserve Asset Management Committee (RAMC), monthly currency and duration benchmarks (known as Medium-Term Strategic Benchmarks or MTS) are set, which are intended to beat the neutral performance benchmarks. At the level of the Department, deviation from the MTS benchmarks is permitted within prescribed limits in order to add value vis-à-vis the MTS.
914. Although the Central Bank is essentially a long-term investor, especially with respect to the Income Tranche, the investment horizon for all intents and purposes is one year at a time, reflecting the accounting year (January to December). The broad accounting principles currently applied in terms of IAS 39 with respect to the Liquidity, Bridge, and Income Tranches are the following:
All coupon and discount earnings as well as realized profit/loss on sale of securities are taken to the P/L.
All unrealized gain or loss on currency revaluation is booked under an equity head.
All unrealized gain/loss on mark-to-market valuation of securities/outstanding forward exchange contracts is booked under another equity head.
915. Premiums/discount on bonds and Treasury Bills at the time of purchase are amortized following an effective interest rate method.
916. Interest earnings on gold deposits and realized gain/loss (against cost price) on the sale of gold are taken to the P/L. Unrealized gain/loss on revaluation of gold holdings is booked under the same equity head as for currency.
917. As the rial Omani is pegged to the U.S. dollar, rates of return in terms of domestic currency are similar to those in U.S. dollar terms.
918. Gist of quarterly performance and attribution analyses is reported to the Board of Governors.
919. The Central Bank has a policy of engaging external managers for discretionary management of a small segment (there is a ceiling of 10 percent for this purpose) of the external reserves. The investment guidelines prescribed for the external managers have been given higher duration and also different performance benchmarks. External managers can hold debt securities with remaining maturity up to and including 30 years. This has been done on the basis of the fact that they have the requisite expertise and advantage of location to assume higher interest rate risk for the purpose of value addition.
920. A management information system to assess and monitor risks consists of the following:
A daily statement showing the portfolio summary with respect to the three tranches, which provides details, such as duration and currency composition vis-à-vis their respective neutral and MTS benchmarks, aggregate investment pattern, etc.
A monthly statement giving a stress test for interest rate risk.
921. There is a plan to set up an independent Middle Office with well-defined responsibilities for managing various risks with respect to external reserves. Also, steps have been taken to identify operational risks for the Central Bank as a whole for setting up appropriate systems and mechanisms for managing them. At present, custodial risks are minimized by appointing only the most reputable institutions as custodians.
922. For the purpose of undertaking buy/sell transactions in currencies and securities and for placement of deposits, etc., there are approved centers, most of which are in major OECD countries. Also, there are concentration limits for exposure to banks located in different centers. Moreover, transactions in currencies and securities are required to be undertaken only with approved counterparties, which are selected on the basis of their credit, reputation, market share, and relationship with the Sultanate of Oman in general and the Central Bank in particular.