By Kabula Irene Mulihano
March 2015
The major problem that guided this study was to examine the effects of the global financial crisis in East Africa Central Banks with a focus on how Central Banks reacted to the crisis in the context of foreign reserves asset allocation. The global financial crisis of 2008, originated from rapid defaults on subprime mortgage loans in the U.S. housing market and spread rapidly to other sectors of the economy. It was witnessed since mid-2007 and had a significant impact on the financial landscape that has led to changes in reserve management practices. Set in this context, Central Banks have to choose an appropriate asset allocation of the foreign reserves in agreement with policy objectives which are safety, liquidity and return. Asset allocation is a high level decision which reflects the institution’s overall risk tolerance and investment objectives and constraints over the planning horizon.

To focus on this important issue, the main aim of this research have been to investigate the effects of the global financial crisis in East Africa Central Banks in terms of asset classes, currency composition and maturity structures and explore ways in which CBs re-allocated their reserves and evaluate the effects associated with such decisions. To achieve this, the general research problem has been to identify the effects of the global financial crisis and its implication to reserves management objectives.

Qualitative and quantitative approach have been deployed and findings are based on the data derived from East African Community member countries. The entire sample was drawn from five East African Central Banks and data was collected through the use of a questionnaire/survey. The research is built upon a deductive approach; hence no new theory is generated but rather conclusion have been drawn from the comparisons of collected data with previous made researches.

The analysis led to the conclusion that, given the effects of the global financial crisis of 2008; all East African Central Banks had chosen to reallocate their financial assets without changing priorities of the key reserves management objectives of preserving capital, providing liquidity and generating reasonable return. Furthermore, Central Banks re allocated financial assets by investing a portion of their reserves in non-traditional currencies as a way to diversify from developed economies and to enhance return. In a way, this suggested that Central Banks risk tolerance changed. When examined the asset allocation prior and after the crisis, the findings from the research connotes that, before the crisis, Central Banks reserves were held in traditional reserves currencies of USD, EUR and GBP, eligible assets were deposits and liquid government bonds. However after the crisis, Central Banks diversified their currency composition to non-traditional currencies such as AUD, CAD and RMB, increased percentage allocation to government bonds and Supranationals and approved Inflation protected bonds and MBS/ABS as other eligible assets in their portfolios.

In view of the analysis above, this paper recommends the following:

 Improve risk management practices and procedures because many of the disastrous losses would have been avoided if good risk management practices were in place.
 Ensure robust portfolio and risk management infrastructure is in place: this is due to the fact that reserves management has become more complex, resulting in Central Bank reserves managers, needing to build capacity to up-skill staff and invest in sophisticated IT and risk management systems which can handle the complex transactions CBs are now engaging in.
 Over reliance on single credit rating models should be avoided as this led to similar risk management strategies and decision. To supplement ratings from credit rating companies, an in-house credit risk management system may need to be established. However, it requires heavy investment in human, information technology and financial resources.
 Diversification of assets to non-traditional countries and currencies with high credit rating with caution that any increase in the range of allowable instruments and markets that includes non-traditional investment areas should be done within the permissible risk parameters and tolerance limits.