Procyclicality in Central Bank Reserve Management: Evidence from the Crisis
IMF Working Papers, June 1, 2010
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Bibliographic details
- Authors: Jukka Pihlman, Han van der Hoorn
- Published: June 1, 2010
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781455201334.001
Key findings
- A decade-long diversification of official reserves into riskier investments came to an abrupt end at the beginning of the global financial crisis.
- Many central bank reserve managers started to withdraw their deposits from the banking sector in an apparent flight to quality and safety.
- The paper estimates that reserve managers pulled around US$500 billion of deposits and other investments from the banking sector.
- Although not the main cause, this procyclical investment behavior is likely to have contributed to the funding problems of the banking sector.
- The funding problems of the banking sector required offsetting measures by other central banks such as the Federal Reserve and Eurosystem central banks.
- The behavior highlights a potential conflict between the reserve management and financial stability mandates of central banks.
Quantitative estimate
- Estimated withdrawals from the banking sector: US$500 billion
Analysis and lessons
- The paper analyzes reserve managers’ actions during the crisis and draws lessons for strategic asset allocation of reserves going forward.
- The analysis emphasizes the tension between pursuing higher yields through diversification and the implications for financial stability during periods of stress.
- Reserve managers’ flight-to-quality and safety behaviors can have systemic spillovers to banks’ funding conditions, necessitating coordinated central bank responses.
Policy implications and recommendations
- Central banks should consider the potential conflict between reserve management objectives (including yield-seeking diversification) and financial stability mandates when designing strategic asset allocation.
- Strategic asset allocation of reserves going forward should account for the risk of procyclical behavior under stress and its possible systemic impacts on the banking sector.
- Coordination among central banks may be necessary to offset unintended funding pressures on the banking sector that arise from reserve management actions.
Procyclicality in Central Bank Reserve Management: Evidence from the Crisis — IMF Working Paper by Jukka Pihlman and Han van der Hoorn, June 1, 2010.