Central Banks Use of Derivatives and Other Contingent Liabilities: Analytical Issues and Policy Implications

IMF Working Papers, March 1, 2000

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Some central bank derivatives and other contingent liabilities arise from anomalous circumstances, but there are a number of positive reasons that explain their popularity.
Most of these operations are off-balance sheet; as a result they:
- increase the risk of central bank accounts, and
- reduce the transparency of central bank accounts.
Reduced transparency and higher off-balance-sheet risk make more difficult the assessment of:
- the financial position of the monetary authority, and
- by implication, the macroeconomic conditions of the country.
To address these problems, the authors suggest a comprehensive portfolio approach that values, in an economic sense, all assets and liabilities of the central bank.

Off-balance-sheet status of derivatives and contingent liabilities:
- Increases risk in central bank accounts.
- Reduces transparency of central bank accounts.
Assessment implications:
- Hinders accurate evaluation of the monetary authority’s financial position.
- Complicates assessment of macroeconomic conditions.
Rationale for central bank usage:
- While some operations stem from anomalous events, multiple positive motivations explain the popularity of derivatives and contingent liabilities for central banks.

Adopt a comprehensive portfolio approach that:
- Values, in an economic sense, all assets and liabilities of the central bank.
- Brings off-balance-sheet items into an economic valuation framework to improve transparency and risk assessment.