Banking

Four insights for reserve managers

Today’s central banks are pivotal institutions in every modern economy, and most central banks are independent institutions with the authority to perform critical functions. These functions often include creating money, setting interest rates, running the payment system, supervising financial institutions, backstopping the financial system, and managing foreign currency reserves.

Central banks play a pivotal role in responding to crises, and central bank independence has enabled them to respond quickly. The most recent crisis, which is still ongoing – the COVID-19 pandemic – has witnessed central banks reacting with a speed, scope, and scale unprecedented in history. Central banks responded with extraordinary measures to ensure financial system stability and faster economic recoveries across the globe. A key element of the response measures was deploying foreign exchange reserves to provide foreign exchange liquidity to domestic market participants if and when necessary.

Holding and managing a country’s official foreign reserves are among a central bank’s core functions. Central banks’ reserve management operations have always been part of their monetary policy function. Holding foreign reserves has various purposes. Most notable are self-insurance for balance-of-payments crises and support of exchange rate policies. In some countries, reserves also support financial stability by providing lender-of-last-resort functions in foreign currency. The availability of sufficient reserves has insulated countries against disruptions and volatility in international capital markets and successive financial crises, including the ongoing COVID-19 pandemic. Foreign reserves have grown significantly over the past four decades, and they are now at record highs (see figure 1).

Figure 1. Accumulation of Foreign Reserves Worldwide

Source : blogs.worldbank.org

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