What is 'Foreign Exchange Reserves'

Foreign exchange reserves are assets held on reserve by a central bank in foreign currencies.

BREAKING DOWN 'Foreign Exchange Reserves'

Foreign exchange reserves are used to back liabilities and influence monetary policy. This refers to any foreign money held by a central bank, such as the United States Federal Reserve Bank. These reserves can include banknotes, deposits, bonds, treasury bills and other governmental securities. These assets serve many purposes but are most significantly held to ensure that a central government agency has backup funds if their national currency rapidly devalues or becomes all together insolvent.

It is a common practice in countries around the world for their central bank to hold a significant amount of reserves in their foreign exchange. Most of these reserves are held in the U.S. dollar, since it is the most traded currency in the world. It is not uncommon for the foreign exchange reserves to be made up of the British Pound (GBP), the Euro (EUR), the Chinese yuan (CNY) or the Japanese yen (JPY) as well.

Economists theorize that it is better to hold the foreign exchange reserves in a currency that is not directly connected to the country’s own currency in order to provide a barrier should there be a market shock. However, this practice has become more difficult as currencies have become more intertwined as global trading has become easier.

Foreign Exchange Reserves Around the World

The world's largest current foreign exchange reserve holder is China, a country holding more than 3.5 trillion of their assets in a foreign currency. Most of their reserves are held in the U.S. dollar. One of the reasons for this is that it makes international trade easier to execute since most of the trading takes place using the U.S. dollar.

Saudi Arabia also holds considerable foreign exchange reserves, as the country relies mainly on the export of their vast oil reserves. If oil prices begin to rapidly drop, their economy could suffer. They keep large amounts of foreign funds in reserves to act as a cushion should this happen, even if it’s only a temporary fix.

Russia’s foreign exchange reserves are held mostly in U.S. dollars, much like the rest of the world, but the country also keeps some of their reserves in gold. Since gold is a commodity with an underlying value, the risk in relying on gold in the event of a Russian economic decline is that the value of gold will not be significant enough to support the country’s needs. Another danger of using gold as a reserve is that the asset is only worth what someone else is willing to pay for it. During an economic crash, that would put the power of determining the value of the gold reserve, and therefore Russia’s financial fallback, into the hands of the entity willing to purchase it.

RELATED TERMS
  1. Working Reserves

    Working reserves, or excess reserves, are reserves held by banks ...
  2. Monetary Reserve

    A monetary reserve is a central bank's holdings of a country’s ...
  3. Foreign Debt

    Foreign debt is an outstanding loan that one country owes to ...
  4. Reserve Ratio

    The reserve ratio is the portion of depositors' balances that ...
  5. Free Reserves

    Free reserves are the reserves a bank holds in excess of required ...
  6. Lagged Reserves

    Lagged Reserves is a method of bank reserve calculation whereby ...
Related Articles
  1. Trading

    10 Countries with the Biggest Forex Reserves

    Without adequate reserves, a nation's economy can grind to a halt. Here are the 10 nations that hold the most foreign reserves.
  2. Trading

    Emerging Market FX Currency Reserves Growing

    Are emerging markets preparing for a period of volatility?
  3. Trading

    How the U.S. Dollar Became the World's Reserve Currency

    The U.S. dollar was first minted in 1914. Find out what occurred during the last century to make the U.S. dollar the world's reserve currency.
  4. Investing

    Protect Your Foreign Investments From Currency Risk

    Hedging against currency risk can add a level of safety to your offshore investments. Find out more about currency risk analysis in global investing.
  5. Trading

    How The Triffin Dilemma Affects Currencies

    Countries that issue reserve currencies are faced with a dilemma: keep other countries happy or achieve domestic monetary policy goals.
  6. Investing

    Who Holds The Largest Gold Reserves?

    The biggest holders of gold account for 30,500 of the world's estimated 160,000 tonnes.
  7. Investing

    How the Federal Reserve Devises Monetary Policy

    Learn about the tools the Federal Reserve uses to influence interest rates and economic conditions. Find out the types of action a central bank may take.
  8. Trading

    China's Foreign Exchange Reserves Fall By Almost $100 Billion

    Almost $100 billion evaporates from China's forex reserves as Beijing continues its support toward yuan.
  9. Trading

    6 factors that influence exchange rates

    Aside from interest rates and inflation, the exchange rate is one of the most important determinants of a country's level of economic health.
  10. Investing

    This Central Bank Owns U.S. Equities Worth 20% of GDP

    Discover more about Swiss National Bank's holdings of financial assets, and look into its recent accumulation of foreign equities.
RELATED FAQS
  1. What is foreign exchange?

    Foreign exchange is the conversion of a country's currency into another. In a free economy, a country's currency is valued ... Read Answer >>
  2. How are international exchange rates set?

    Knowing the value of your home currency in relation to different foreign currencies helps investors to analyze investments ... Read Answer >>
  3. What are the advantages of foreign portfolio investment?

    Learn the advantages that businesses can derive from foreign portfolio investment in an increasingly globalized business ... Read Answer >>
  4. The risks businesses face in international finance

    When an organization engages in international financing activities, it takes on additional risk, including foreign exchange ... Read Answer >>
Trading Center