GOVERNOR PUBLIC APPERANCE
Speech by Mr. Ardian Fullani,Governor of the Bank of Albania at the Forum organized by the Bank of Albania, jointly with the World Bank, ''Trends in foreign reserve management'', Hotel ''Tirana International'', 29 October 2007

Dear All,

It is my great honour to welcome you today in this forum jointly organized with the World Bank. The purpose of this gathering is to provide an opportunity for the discussion of the latest trends in the reserve management area by the central banks.

Referring to Nugee 2000, one's country foreign reserve represents a part of national wealth. Being managers of this wealth, central banks are held accountable to the public. Foreign assets held in favour of the third parties always imply a high obligation of trust. Considering this, the Bank of Albania has built a bilateral institutional cooperation with the World Bank for the modern management of foreign reserve.

Following the 90's the change of the concept of the role of foreign reserve, of its holding and management by the central bank made this initiative even more important.

The classical concept of foreign reserve as an amortizer to sudden exchange rate developments changed into a safety valve to capital flows ceases and associated exchange rate shocks. This was also because the radical changes in the liberalization of current account developed at a great extent the capital flow between different countries and the shift of exchange rate regimes from fixed or less flexible to totally free floating. Subsequently, developed countries had an upward trend in foreign reserve, while developing countries shifted from countries with net external debt to countries with net foreign assets.

We have witnessed a sharp increase in the foreign exchange reserves that are managed by the central banks globally. Starting the new millennium global reserves have more than doubled in size amounting up to 5.1 trillion USD by the end of 2006. This rapid growth in foreign exchange reserves has been associated with a shift of focus from liquidity and preservation of capital concerns only, to a total return management approach, which aims to reduce the opportunity cost caused by the holding of reserves. The implementation of this approach is closely related to the preliminary determination of what represents a sufficient level of reserves for meeting the main objective of the central bank.

There are several indicators that are used to first evaluate reserve adequacy and then decide on what portion of your reserves may be dedicated to active management.

I would like to take this opportunity and say a few words on the experience that we, at the Bank of Albania, have had on forex reserves management area. When the Bank of Albania was first established in 1992 our Forex Reserves were less than 2 million USD and now they amount at approximately 2 billion USD.

Year 2006 marked the beginning of a new era in the management of foreign reserve. First, we went through a complete review of the regulatory base on forex reserves management with the Investment Policy and the Governance Framework being the most important documents that were approved by our Supervisory Board. In comparison to the previous document the new Investment Policy clearly states the objectives that will guide the investment process of forex reserves. It has enabled the quantification of the sufficient level of reserves and the identification of areas for an active management. More specifically, the liquidity objective is referring to the availability of a sufficient level of reserves in order to:
- provide for import coverage;
- provide coverage for all short-term foreign debt obligations;
- support monetary and exchange rate policy;
- provide confidence in the economy by serving as a buffer in time of crisis.

The practical approach we have followed in implementing the new definition of liquidity objectives is by setting up several tranches which would serve to the fulfilment of our liquidity needs based on their specific maturity. Taking this into consideration and the criteria approved, in terms of return and the level of risk tolerance, benchmarks derived through a Strategic Asset Allocation process, are assigned to each reserve portfolio. As a result, the actual structure of net reserves reflects higher risk and return targets in accordance with the liquidity objectives, when moving from the Working Capital to the Liquidity and the Investment Tranche.

The Governance Framework was designed to specify the responsibilities of the Supervisory Board and the Investment Committee as related to the decision-making in the reserve management process. This document actually reflects a two-tier authorization decision-making structure, with the Supervisory Board which decides on the broad criteria for the investment process, while the Investment Committee assumes the responsibility of translating these criteria into actual benchmarks and risk limits.

The Investment Committee is much more actively engaged in the investment process now. It has the responsibility of reviewing yearly the Strategic Asset Allocation and make a decision on the new benchmarks, based on different market expectations scenarios. This and other decisions of the Investment Committee as related to active management, risk budgeting and risk limits are defined in the Operational Guidelines.

The above decision-making structure has already proved to be much more effective in that it provides for the flexibility needed to accommodate the investment process to financial market developments, thus ensuring that no opportunity is missed and that any risk beyond the risk tolerance is avoided.

Having this new decision-making structure in place we are now focused on establishing an investment culture which is the key to proper and complete risk evaluation and for a more effective decision-making in the future. The development of this culture, in addition to the clear division and the delegation of responsibilities, also presupposes the establishment of proper conditions for the ongoing education of the staff and the growing team work.

The Investment Policy represents a document which leads and supports the investment process, and the Strategic Asset Allocation is the essential part of it. This is because more than 90 percent of the return of the portfolio is determined by the respective benchmark, which is derived through the SAA process. The rest of the return is determined by the allowed level for undertaking the risks during the active management. A successful active management is an indicator for very good abilities, first in assessing the profiting opportunities provided by the market and second, in measuring accurately the potential risks.

At last, I would kindly ask you some few more minutes to say some words on the excellent cooperation that we have had so far with the World Bank. It is almost two years now that the Bank of Albania has been engaged in an investment management and consulting agreement with the World Bank with the purpose of obtaining technical support in order to upgrade the reserve management operations at the Bank of Albania. The Sovereign Investments Partnerships Department at the World Bank has been providing during this two-year period valuable assistance and technical expertise in all areas that are related with the reserve management activity at a central bank. This cooperation has been especially priceless in terms of building and developing the professional capacities of the people who work in the forex reserves management area.

We should be initiating very soon an important project as related to the acquisition and implementation of a Portfolio Management System. We are all aware that the establishment of a good information technology infrastructure is quite critical in providing a solution to our immediate and future needs as concerning to the management of risks undertaken in the investment process. In addition, our near future plans include the selection and contracting of external managers, through whom it will be aimed the maximization of profit provided for the same level of allowed risk.

I believe today's seminar will provide the answers to many questions which may naturally derive nowadays:
The modern management of foreign reserve, the shift from passive to active management requires a complete and clear concept of the foreign reserve and the way it is managed. It requires:

' Clear and accountable structures;
' Accountability and transparency;
' Organic relation between the participant units and the interested groups;
' High information technology and above all PROFESSIONALISM.

Thanking the World Bank once again for being involved in organizing this forum, I would like this forum to provide the answers to some critical issues such as:
' Why do central banks hold foreign exchange reserve?
' What is the optimal level and how does it conform to the latest trends?
' What does active management mean and how can we optimize the associating risk?
' How is the foreign exchange reserve increased and what are the associating costs?
' Which are the decision-making structures and what does strategic asset allocation mean?

There are a number of questions that may be asked; however, let us now turn to the experts and I invite you to listen to their presentations.

Thank you!