Saudi Arabian Monetary Authority: Why Do Central Banks Hold Domestic and Foreign Currency Assets?

This chapter explains how domestic and foreign exchange reserves are accumulated and why they are held by central banks. Following a summary of trends in global foreign exchange reserves, this chapter provides a brief review of the benefits and costs associated with holding reserves. It then describes recent IMF work in refining traditional reserve adequacy frameworks. For practical illustration, the author draws on Saudi Arabia’s experience in accumulating foreign exchange reserves, considering the country’s fixed exchange rate regime and broader macroeconomic backdrop. The author sheds light on the pivotal role played by the central bank’s holding of foreign exchange reserves in maintaining monetary and financial stability for Saudi Arabia. He concludes that the costs associated with holding a sizeable pool of liquid assets are outweighed by a number of key benefits, including having the capacity to service an evolving set of liabilities and providing access to a countercyclical spending buffer, not least, during the country’s ongoing economic transition.