A Tool for Measuring and Managing Credit Risk in Portfolios of Foreign Reserves

Improving the assessment of credit risk has become a priority for many central banks after the global financial crisis. Central banks need to decide how much effort to put into developing credit risk assessment tools, taking into account their resources and limitations. This paper proposes a tool that is both pragmatic and conceptually sound, which allows to improve the assessment of credit risk for foreign reserves managers and complements the information produced by the rating agencies. The tool we propose uses three different credit risk models in order to identify the issuers that have a high, moderate, or low probability of having a ratings downgrade below the minimum accepted rating, within the issuers that meet the minimum rating requirements. The signals from the tool are built from market and fundamental information of each issuer. Additionally there is a proposal for a framework to turn the outputs from the model into investment decisions.