Sustainable Management of Central Banks’ Foreign Exchange Reserves

This paper from the Inspire research network explores the role central banks’ foreign exchange (FX) reserves portfolios can play in mobilising public sector investment to support of the net-zero transition.

The frameworks developed by central banks for managing FX reserves have traditionally balanced the objectives of liquidity, safety and return. The report argues that sustainability can be added to these goals explicitly, implicitly (by recognising the ways in which sustainability affects existing policy objectives) or through a combination of both approaches.

The authors outline a series of channels reserve managers can use to “green” their FX reserves, which fall into four categories:

• investing in sustainability-oriented markets
• integrating sustainability criteria
• climate and environmental risk management
• external engagement and disclosure

The paper looks at some examples of where action has been taken across the different channels. These include the Swiss National Bank which has excluded coal companies from its FX portfolio, and the Bank of England which has published a comprehensive climate disclosure.

The report draws several conclusions, one of which is that reserve managers will encounter some genuine challenges in balancing their different objectives. For example, a decision to purchase large numbers of green bonds may lengthen the portfolio duration and affect its liquidity. Central banks wishing to proactively address climate impacts may find it difficult to justify doing so within their existing mandates.

The authors advise a “stepwise” approach, where central banks concentrate on areas where action is more easily taken – such as the greening of pension funds and purchase of green bonds – and use the experience to progress on to other asset classes and portfolios.