International Reserves and Bank Reserves in Dollarized Economies
Mercedes Da Costa and V. Hugo Juan-Ramón 1
Washington, D.C., October, 2011
This note analyzes the connection between a central bank holding of gross international reserves (or
reserve assets) and reserve deposits form statistic and economic perspectives. We describe alternative
procedures that countries use for recording those concepts.
International Reserves
The stock of gross and net international reserves hold by central banks is a subset of its net external
assets account. In paragraph 6.64, the BPM6 defines reserve assets (gross international reserves) as:
“external assets that are readily available to and controlled by the monetary authorities for meeting
balance of payments financing needs, for intervention in exchange rate markets to affect the currency
exchange rate, and for other related purposes (such as maintaining confidence in the currency and the
economy, and serving as a basis for foreign borrowing).”
The composition of reserve assets and short-term, reserve-related liabilities are shown in the box 1
below, which is a simplified version of box 6.5 in the BPM6.
Box 1: Component of Reserve Assets and Reserve-Related Liabilities
Reserve assets (gross international reserves)
Monetary gold
Special drawing rights
Reserve position at the IMF
Other reserve assets
Currency and deposits
Claims on monetary authorities and other entities
Securities
Financial derivatives
Reserve-related liabilities to nonresidents (short-term on a remaining
maturity basis)
Credit and loans from the IMF
Debt securities
Deposits
Loans
Other short-term foreign currency liabilities to nonresidents
Source: Box 6.5 in BPM6, page 112.
1
We are grateful to Antonio Galicia (IMF Senior Economist) for valuable comments and
clarifications.
Although the recording of official reserve assets in external sector statistics is on a gross basis, an
alternative concept of Net International Reserves (NIR) could be derived from the difference between
the central bank’s reserve assets (or gross international reserves) and its short-term, reserve-related
liabilities to nonresidents.
The BPM6 stresses two key criteria to classify an asset as reserve assets: control and availability for use.
On control, paragraph 6.67 states “In general, only external claims actually owned by the monetary
authorities can be classified as reserve assets;” and on the issue of availability for use, paragraph 6.69
asserts that “Reserve assets must be readily available in the most unconditional form.”
Bank Reserves
Bank reserves are liquid assets held by banks to meet the demand for withdrawals of deposits in
domestic and foreign currency. Bank reserves comprise currency held by banks in their vaults and
deposits held by banks at the central bank. We consider an economy with a semi-dollarized financial
system; that is, a segment of the financial system’s deposits and loans are denominated and settled in a
foreign currency, such as the U.S. dollar.
Bank reserves have two components: legal or required and voluntary or excess. Legal bank reserves are
mandated by the central bank; that is, the fraction of deposits in domestic and foreign currency that
banks must put away as bank reserves. Voluntary bank reserves include a fraction of deposits that banks
decide to put away in addition to the legal ones.
Connection between International Reserves and Bank Reserves
The connection between international reserves and bank reserves arises in semi-dollarized financial
systems. As mentioned, deposits in dollars are subject to legal reserve requirement, which has to be
deposited at the central bank. The recording of this operation in the central bank balance sheet brings
out a relevant question: how those deposits should be classified on the liability and asset side of the
ledger? The matrix below shows plausible combinations.
Table 1: Matrix of Plausible Recording of Bank Reserves in the Central Bank
Balance Sheet Accounts
Domestic
Assets
Bank
Reserves Monetary
(domestic
Base
currency)
Bank
Reserves
(foreign
currency)
Gross
International
Reserves
Other
External
Assets
Other
External
Liabilities
Off
Balance
Sheet
*
Monetary
Base
*
*
Other
Liabilities
*
*
Off
Balance
Sheet
Shortterm
External
Liabilities
*
The matrix shows options for recording bank reserves in the central bank balance sheet. For example,
cell (1,1) (raw 1 and column 1) shows deposits in domestic currency held by banks at the central bank,
which are classified as central bank’s liability (concretely, a component of the monetary base) with a
corresponding entry in domestic assets (cash for example). Thus, domestic currency bank reserves have
not connection with international reserves.
For foreign currency bank reserves, the matrix shows five recording options: i) monetary base with a
corresponding entry in gross international reserves, cell (2, 2), ii) )monetary base and other external
assets, cell (2, 3), iii) other liabilities and gross international reserves, cell (3, 2), iv) other liabilities and
other external assets, cell (3, 3) v) cell (4, 6) shows an off balance sheet recording option. For example,
the central bank still mandates banks to put aside a fraction of their foreign currency deposits as legal
bank reserve; however, it authorizes banks to deposit those reserves in financial institutions abroad.
Thus, the central bank requirement is fulfilled, although it does not show up in its balance sheet.
The shaded cells highlight the fact that bank reserves in foreign currency are central bank’s liabilities
with resident banks; therefore, they are not external liabilities (liabilities with no residents).
Statistic Perspectives
The double-entry basis of recording balance of payments and monetary statistics allows for choices in
classifying some operations. In this respect, the IMF’s balance of payment and monetary manuals adopt
a flexible approach by providing useful guidelines and criteria, rather than rigid instructions. Thus,
countries have latitude to decide on concepts and recording procedures.
For example, taking the manuals’ criteria at face value, the “correct” option for recording foreign
currency bank reserves would be the one showed in cell (2, 3); that is, monetary base and other external
assets. Foreign currency bank reserves should be a component of the monetary base as it supports the
monetary aggregate which includes all types of deposits. Put it differently, changes in the legal or excess
ratios of bank reserves to deposits affect the monetary aggregate (multiplier effect) for a given
monetary base. The corresponding entry in other external assets would be justified because they are
external assets in possession of the central bank; however, they should not be classified as gross
international reserves (or reserve assets) if one thinks that those assets do not strictly pass the criteria
of control (i.e., being actually owned by the central bank) and availability for use (i.e., being readily
available in the most unconditional form to be used by the central bank).
Most countries, however, have opted for classifying foreign currency bank reserves as gross
international reserves on the asset side of the central bank balance sheet (option shown in cell (2, 2)).
This practice has been accepted by the IMF on the premises that, except for bank runs, foreign currency
deposits in banks are fairly stable, which makes the foreign currency bank reserves in possession of the
central bank fairly stable too, thus firming up the central bank’s control and availability for use those
assets.
Other options include classifying the foreign currency bank reserves as other liabilities instead of as a
component of the monetary base; with the corresponding entry in either gross international reserves,
cell (3,2), or other external assets, cell (3,3). In these cases, some IMF country reports follow this
presentation, with a memo line for a broader definition of monetary based.
A novel practice that has been recently adopted by few countries is shown in cell (4, 6). Under this
innovative system, the central bank “outsources” the responsibility of receiving and managing the
foreign currency bank reserves. Banks still have to put aside (deposit in financial institutions abroad) a
fraction of their foreign currency deposits to comply with central bank regulations.
Economic Perspective
The main objective of most criteria for recording economic operations is to facilitate economic analysis.
It might be that information presented in standard tables is not enough for this purpose and the analyst
would need complementary information. This is why IMF country reports’ tables show off table memo
lines. Some examples on the role of complementary information for economic analysis are discussed
next.
As mentioned, NIR could be defined as gross international reserve minus short-term external liabilities.
Suppose a central bank opts for recording foreign currency bank reserves as gross international reserves
with the corresponding liability entry either as monetary base or other liabilities, cells (2,2) and (3,2),
respectively. Under these recording strategies, NIR would increase when i) the central bank increases its
legal foreign currency bank reserves requirement, for a given level of deposits, ii) the financial
dollarization deepens, reveal as a shift from domestic currency deposits to foreign currency deposits. In
these circumstances, some analysts might consider the NIR as upwardly biased. May be, that is why
some countries and IMF country reports show as a memo item line the concept of “free international
reserves” obtained by subtracting foreign currency bank reserve from gross international reserves.
Another example arises from the analyses of the money supply and its multiplier. The economic
consideration is that in a semi-dollarized financial system with fractional reserve banking, both domestic
and foreign currency deposits enter in any definition of broad monetary aggregate. These deposits, net
of reserve requirements, are inputs for bank loans and, as it is well-known, banks actually create money
when they grant loans through a multiplier effect of a succession of deposit and loans. This feature is
captured in the well-known decomposition of the money supply between the monetary base and the
money multiplier, as shown in equation 1:
(1)
M =
(C / TD ) + 1
MB
(C / TD ) + α ( R / D) + (1 − α ) ( R * / D*)
Where M is a monetary aggregate defined as C + D +E D* , MB stands for monetary base defined as
C+R+ER*, E is the nominal exchange rate defined as the price of a U.S. dollar in terms of domestic
currency; C/TD is the non-bank public’s desired ratio of currency to total deposits, R/D is the ratio of
domestic currency bank reserves (legal plus excess) to domestic currency deposits, R*/ED* is the ratio of
foreign currency bank reserves (legal plus excess) to foreign currency deposits; and α is the share of
domestic currency deposits to total deposits.
The main point is that the framework given by equation 1 is relevant to study changes in the money
supply under any of the recording strategies shown in Table 1. For example, if a central bank decided to
follow a recording strategy of not including R* in its definition of monetary base, the economic process
of money creation by the banks via multiplier would still hold. As another example, if instead a central
bank decided to follow the strategy shown in cell (4, 6) (off-balance sheet), again the economic process
of money creation by the banks via multiplier would still hold. In both examples, information on R* will
be needed for analyzing the money supply.
An Officially Dollarized Economy
A country is considered to be officially dollarized when its authorities unilaterally adopts the currency of
another country, the U.S. dollar in this case. This is the case of El Salvador, for example, where the U.S.
dollar is the legal currency. The methodological issues discussed for a semi-dollarized financial system
applies for a fully dollarized economy. All deposits and loans are now in foreign currency as well as the
bank reserves. The central bank faces the same options for registering those reserves, for example, it
includes them in the monetary base with a corresponding entry in gross international reserves; and
again, a memo item line with the concept of “free international reserve” might be appropriate.
Currency held by the non-bank public, U.S. dollar bills and coins, is not part of the monetary base
anymore as currency is not a central bank liability anymore. Besides, if the central bank opted for
“outsourcing” the responsibility of receiving and managing bank reserves, there would be no monetary
base from a statistic viewpoint. However, changes in the public’s desired ratio of currency to deposits
would still affect the money supply via multiplier effect; similarly changes in either the legal reserve
ratios or the banks’ desired excess reserves ratios, would affect the money supply via multiplier effect.
Thus, regarding of the chosen recording strategy, the multiplier effects are the same as those in nondollarized economy. The analyst could use complementary information of an off-balance monetary base
defined as MB* = C* + R*, and a broad money supply defined as M* = C* + D* to view the money supply
as a multiplier times the monetary base, as shown in equation 2:
(2)
M *=
(C * / D*) + 1
MB *
(C * / D*) + ( R * / D*)
Of course, the monetary base is not under the control of the monetary authority, it can only change via
balance of payments; however, changes in the key ratios of currency to deposit and bank reserve to
deposit will affect the broad money supply.