management’S discussion and analysis
in the net spread between the rate earned on assets and the cost of borrowings that fund those assets. The second is the exposure to changes in the income earned on the portion of the assets funded with equity. The Bank mitigates its exposure to net spread changes through a cost pass-through formulation incorporated in the lending rates charged on most of its existing loans, in addition to a carefully designed term structure management. These cost pass-through loans account for 93% of the existing outstanding loan portfolio as of December 31, 2008; the remaining 7% are emergency and Liquidity Program loans, non-sovereignguaranteed loans and fixed-rate loans. Some of the cost passthrough loans, primarily the adjustable rate loans, pose some residual interest rate risk given the six-month lag inherent in the lending rate calculation (see “Development Operations—Financial Terms of Loans” above). The Bank funds and invests its liquidity at matching rate structures using specific duration gap constraints, thus avoiding any undue exposure to interest rate risk. The Bank mitigates its exposure to equity-induced income changes by investing these funds in assets with stable returns. Exchange Rate Risk: In order to minimize exchange rate risk in a multicurrency environment, the Bank matches the afterswap borrowing obligations in any one currency with assets in the same currency, as prescribed by the Agreement. In addition, the Bank’s policy is to minimize the exchange rate sensitivity of its TELR by performing periodic currency conversions to main-
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tain the currencies underlying its equity and allowances for loan and guarantee losses aligned with those of the outstanding loans and net guarantee exposure. In order to minimize currency misalignments, the Bank also aligns the currency composition of the special reserve assets with that of its outstanding borrowings. Figure 10 presents the currency composition of the Bank’s assets and liabilities (after swaps) at the end of 2008 and 2007. Liquidity Risk Liquidity risk arises from the general funding needs of the Bank’s activities and in the management of its assets and liabilities. It includes the risk of being unable to fund the portfolio of assets at appropriate maturities and rates (funding risk); the risk of being unable to liquidate a position in a timely manner at a reasonable price (liquidation risk); and the exacerbation of these two risks by having significant portions of a portfolio of assets or liabilities allocated to a specific type of instrument (concentration risk). The Bank manages liquidity risk through its liquidity policy, asset-liability management policy and its short-term borrowing program. The Bank’s liquidity policy determines a minimum amount of liquidity, which is designed to allow the Bank to refrain from borrowing for a period of time while continuing to meet its own obligations. The asset and liability management of the Bank, in addition to optimizing the allocation of equity and debt to fund the Bank’s various assets, determines the proper term-duration gap between loans and debt to both lower funding costs and reduce refunding risk. Finally,
Figure 10: CURRENCY COMPOSITION OF ASSETS & LIABILITIES December 31, 2008 and 2007 LIABILITIES — 2008
ASSETS — 2008 Swiss Francs 3% Japanese Yen 6% Euro 8%
U.S. Dollars 83%
Swiss Francs 3% Japanese Yen 5%
LIABILITIES — 2007
ASSETS — 2007 Swiss Francs 3% Japanese Yen 5%
Swiss Francs 3% Japanese Yen 6% Euro 10%
U.S. Dollars 83%
Euro 9%
U.S. Dollars 81%
Euro 13%
U.S. Dollars 79%