The government’s activities expose it to a variety of financial risks: credit risk, liquidity risk, and market risk (including interest rate risk, foreign exchange risk, and price risk). Individual entities are responsible for ensuring that appropriate risk management policies are in place.
34.5.1 Risk management policies and financial risk factors
Traditional risk management in the private sector aims to maximise investor return while maintaining risk at an acceptable level. Government risks are normally related to financing arrangements to provide funds for public services and infrastructure. Each year, the government will assess the costs and risks associated with different possible patterns of debt issuance taking into account the most up-to-date evidence and information about market conditions and demand for debt instruments.
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The government has accepted financial risks through its financial services interventions on the basis that the costs of inaction would have been far greater for the economy as a whole. In return for taking on the financial risk, fees are charged to the institutions participating in the interventions. Through its risk management, the government seeks to minimise overall fiscal risk to the public sector while maximising taxpayer value.
The government’s risk appetite in relation to its financial assets and liabilities are categorised into four types (credit risk, liquidity risk, interest rate risk, and foreign exchange risk). Within the government’s risk boundary, public bodies have some discretion to take the actions judged to best achieve the cost minimisation objective.
Much of the government’s risks arising from financial risk are managed through HM Treasury and the central funds, including the National Loans Fund (NLF), the Debt Management Account (DMA) administered by the Debt Management Office (DMO), the Exchange Equalisation Account (EEA), and National Savings and Investments (NS&I). The NLF is central government’s principal borrowing and lending account. The DMA’s principal role is to meet the financing needs of the NLF through its debt and cash management operations. The NS&I finances a part of the government’s borrowing by selling investment products to retail savers and investors. The EEA and the NLF hold the UK’s official reserves of gold and currencies. Overall management of the EEA is the responsibility of HM Treasury which delegates day-to-day to the Bank of England, which acts as its Agent and Advisor. The structural relationship between HM Treasury, DMA, NLF, EEA and NS&I is designed to manage transactions between government departments and minimise the government’s financial risk. Cash requirements of central government departments are met through the Estimates process, with Parliament annually approving the supply financing requirements of central government departments. Therefore financial instruments play a more limited role in creating risk than would apply to a non- public sector body of a similar size. The government’s cash management objective is to ensure that sufficient funds are always available to meet any net daily cash shortfall and, on any day when there is a net cash surplus, to ensure this is used to the best advantage. HM Treasury and the DMO work together to achieve this, with HM Treasury’s role being to make arrangements for a forecast of the daily net flows into or out of the Exchequer; its objective in so doing is to provide the DMO with timely and accurate forecasts of the expected net cash position over time. The DMO’s role is to make arrangements for funding and for placing the net cash positions, primarily by carrying out market transactions in the light of the forecast; its objective being to minimise the costs of cash management while operating within the risk appetite approved by ministers.
Local authorities adopt independent liquidity and interest rate risk management, and this is done within a statutory framework. Local authorities are required by the Local government Finance Act 1992 to provide a balanced budget, which ensures sufficient funds are raised to cover annual expenditure. Medium term plans generally set targets for liquidity ratios, which are approved as part of the annual budget setting process. To manage liquidity risk, local authorities can access
borrowings from the money markets to cover any day to day cash flow need and can access longer term funds from financial institutions and the Public Works Loan Board (PWLB).
The government’s overall risk management programme focuses on the unpredictability of financial markets and seeks to minimise potential adverse effects on the government’s financial performance and play an enhanced role in wider financial stability. Specialist teams and committees support senior management in ensuring that agreed standards and policies are followed; identifying and evaluating financial risks.
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34.5.2 Credit risk
Credit risk is the risk that one party to a financial instrument will cause a financial loss to the government by failing to discharge the obligation. The government was exposed to credit risk through a number of its financial assets.
The government’s material credit risk was centred in the central funds (particularly the DMA and EEA), HM Treasury, the Bank of England and the Department for Business, Innovation and Skills. The main credit risks arose from the loans and guarantees provided by the Treasury to the financial institutions, the purchases of assets from the financial institutions, including reverse sale and repurchase agreements (‘reverse repos’) entered into by the DMA and by the Bank of England, and student loans provided by Department for Business, Innovation and Skills.
Granting financial guarantees results in a credit risk exposure, which is the maximum amount an entity could have to pay if the guarantee is called on, which may be significantly greater than the amount recognised as a liability. The tables below do not include contingent liabilities that give rise to credit risk, for example guarantees to the European Investment Bank of £25.8 billion in 2014-15. Further information is available in Notes 31 and 32.
The government’s material exposures to credit risk are analysed below:
AAA or equivalent AA or equivalent A or equivalent Not strong Not rated 2014-15 Total £bn £bn £bn £bn £bn £bn
Cash and cash equivalents 2.8 0.4 - - - 3.2
Loans and receivables - - 28.7 0.2 115.4 144.3
Available for sale financial assets - - - - 1.7 1.7
Financial assets held for trading 48.3 12.4 6.9 0.4 9.0 77.0
Total material exposure 51.1 12.8 35.6 0.6 126.1 226.2
AAA or equivalent AA or equivalent A or equivalent Not strong Not rated 2013-14 Total £bn £bn £bn £bn £bn £bn
Cash and cash equivalents 2.2 0.1 0.4 - 0.6 3.3
Loans and receivables - 7.5 32.2 3.2 117.5 160.4
Available for sale financial assets - - - - 2.1 2.1
Financial assets held for trading 38.3 8.6 6.8 0.1 9.2 63.0
Total material exposure 40.5 16.2 39.4 3.3 129.4 228.8
The credit ratings in the tables above include those from the Exchange Equalisation Account (EEA) which uses an internal source for rating their financial instruments.
The tables above do not include a credit analysis of financial assets held by the Bank of England of £18.3 billion (2013-14: £16.9 billion). Where the Bank considers certain disclosures inappropriate to its central banking functions, it discloses less detail (such as information on credit risk) than would be required under adopted IFRS or the Companies Act.
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Financial assets that are ‘not rated’ included UKAR’s loans and advances to banking customers of £52.6 billion (2013-14 restated: £61.2 billion), student loans of £48.5 billion (2013-14: £39.0 billion) and the government’s holdings and quota subscription of IMF Special Drawing Rights of £18.9 billion (2013-14: £19.0 billion).
UKAR loans to banking customers
Residential Loans Commercial Loans Unsecured Loans 2014-15 Total £bn £bn £bn £bn
Neither past due nor impaired 48.3 0.4 1.1 49.8
Past due, but not impaired
- Less than 3 months 1.9 - - 1.9
- 3 to 6 months 0.7 - - 0.7
- Over 6 months 0.5 - 0.1 0.6
Impaired 0.6 0.2 - 0.8
Total loans to customers 52.0 0.6 1.2 53.8
Impairment allowances (0.9) (0.1) (0.2) (1.2)
Total loans to customers net of impairment allowances
51.1 0.5 1.0 52.6
Source: HM Treasury 2014-15 Annual Report and Accounts
The government’s material exposures to credit risk are analysed below, by geographic area:
UK Europe North America
Asia Other 2014-15 Total
£bn £bn £bn £bn £bn £bn
Cash and cash equivalents 2.8 0.1 0.1 0.2 - 3.2
Loans and receivables 129.9 2.5 0.1 0.1 11.7 144.3
Available for sale financial assets 1.7 - - - - 1.7
Financial assets held for trading 4.2 30.4 30.7 2.7 9.0 77.0
Total material exposure 138.6 33.0 30.9 3.0 20.7 226.2
UK Europe North America
Asia Other 2013-14 Total
£bn £bn £bn £bn £bn £bn
Cash and cash equivalents 2.5 0.1 0.1 0.5 0.1 3.3
Loans and receivables 142.5 3.7 2.0 - 12.2 160.4
Available for sale financial assets 2.1 - - - - 2.1
Financial assets held for trading 6.0 26.8 19.3 1.9 9.0 63.0
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