How do central banks acquire currency reserves and how much are they required to hold?

A currency reserve is a currency that is held in large amounts by governments and other institutions as part of their foreign exchange reserves. Reserve currencies usually also become the international pricing currencies for products traded on the global market such as oil, gold and silver. Currently, the U.S. dollar is the primary reserve currency used by other countries.

Manipulating reserve levels can enable a country's central bank to intervene against volatile fluctuations in currency by affecting the exchange rate and increasing the demand for and value of the country's currency. Reserves act as a shock absorber against factors that can negatively affect a country's exchange rates and, therefore, the central bank uses reserves to help maintain a steady rate.

The most popular currency held in reserves is the U.S. dollar. In the U.S., almost all banks are part of the Federal Reserve system and it is required that a certain percentage of their assets be deposited with the regional Federal Reserve Bank. The reserve requirements are established by the Board of Governors and by varying the requirements, the Fed is able to influence the money supply. Reserves also keep the banks secure by reducing the risk that they will default by ensuring that they maintain a minimum amount of physical funds in their reserves. This increases investor confidence and stabilizes the economy.

Basically, the Board of Governors of a central bank meets and decides on the reserve requirements as a part of monetary policy. The amount that a bank is required to hold in reserve fluctuates depending on the state of the economy and what the Board of Governors determines as the optimal level.

For further reading, see Formulating Monetary Policy, Get To Know The Major Central Banks and What Are Central Banks?


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