DEFINITION of Reserves
Reserves represent the liquid assets put aside for future use. That may do an individual, central bank or business.
WHAT IT IS IN ESSENCE
Usually, that can be currency or a commodity, such as gold. For traders, reserves usually are kept as cash that can be accessed quickly.
Companies keep cash reserves by retaining earnings.
Because they want to be secure of any unforeseen problems in their day-to-day business.
Speaking about banks, this is usually a requirement set out by their governing body.
Governments also keep cash reserves in the form of foreign exchange and gold or other commodities that can be liquidated quickly.
In terms of financial assets classifications, the reserve assets can be classified as Gold bullion, Unallocated gold accounts. Also Special drawing rights, currency, Reserve position in the IMF. As well as interbank position, other transferable deposits, other deposits, debt securities. Or loans, equity (listed and unlisted), investment fund shares and financial derivatives. Such as forwarding contracts and options.
Speaking about foreign exchange, the foreign currencies are holding by a country’s central bank. You can find them also under the name foreign currency of foreign reserves. There are seven reasons why banks hold them. The most important reason is to manage their currencies’ values.
Foreign exchange reserves are reserve assets in the balance of payments and are located in the capital account.
HOW TO USE
There is no counterpart for reserve assets in liabilities of the International Investment Position. Usually, when the monetary authority of a country has some kind of liability, this will be included in other categories, such as Other Investments.
There are seven ways central banks use foreign exchange reserves.
First, countries use them to keep the value of their currencies at a fixed rate.
Second, those with a floating exchange rate system use it to keep the value of their currency lower than the dollar.
A third and critical function is to maintain liquidity in case of an economic crisis. For example, a flood or volcano might temporarily suspend local exporters’ ability to produce goods.
A fourth reason is to provide confidence. The central bank assures foreign investors that it’s ready to take action to protect their investments.
Sixth, some countries use their reserves to fund sectors, such as infrastructure.
Seventh, most central banks want to boost returns without compromising safety. They know the best way to do that is to diversify their portfolios. That’s why they’ll often hold gold and other safe, interest-bearing investments.