Holding and managing the foreign currency reserves of the State

Section 4(2) of the Law states that one of the functions of the Bank of Israel is "Holding and managing the Foreign Currency reserves of the State."

The reserves serve three main purposes:

(1) They provide the economy with an emergency supply of foreign currency that is sufficient at times of crisis (for instance, in the event of war or natural disaster).  At such times, it may be necessary to support or re-establish imports or to increase it rapidly and significantly in order to deal with the emergency situation, while exports may be seriously impaired, which would lead to low foreign currency revenue.   Under such circumstances, the government and the private sector would have difficulty raising foreign currency abroad and the foreign currency reserves would constitute the country's main source of foreign currency financing.

(2) They enable the central bank to intervene in the foreign exchange market when (a) the exchange rate deviates from the range that is consistent with the economy's basic equilibrium; or (b) the foreign exchange market is not functioning properly (market failure).

(3) They enable the central bank to act in the foreign exchange market in order to moderate effect of significant capital transactions on the part of nonresidents or domestic residents that may undermine stability in the financial markets, and thereby impair the stability of the economy.

Holding sizeable foreign exchange reserves is considered by domestic and foreign financial institutions, companies, households, and ratings agencies as a main index of the country's financial resilience, which increases trust in the country's ability to deal with economic, financial, and political shocks to the market.

The Monetary Committee, led by the Bank of Israel Governor, is entrusted with setting the guidelines for the investment policy applied to the reserves, which include details of the assets, the risk profile, and the quantitative and qualitative restrictions on the types of assets permitted for investment.  Within these limitations, at the recommendation of the Markets Department, the Committee approves the strategic allocation of the reserves each year, which determines the main characteristics of the reserves portfolio, including its currency composition, asset composition, and term.

The Bank of Israel, like other central banks, manages the reserves on the basis of a cautious approach that has three main goals in mind:

• preserving the value of the reserves in terms of their uses; 
• managing the reserves at a high level of liquidity; 
• earning a reasonable yield on the reserves portfolio without contravening the previous two principles.  

Accordingly, the reserves are invested primarily in liquid or relatively short-term assets and in a mix of currencies that corresponds to the reserves' expected uses. The reserves are invested in overseas financial markets, deposits with foreign banks, foreign government bonds, and other financial instruments as the Bank of Israel Law allows. To make its investment decisions and determine changes in the portfolio, the Department constantly monitors developments in financial markets abroad. ​

Section 56 of the Bank of Law states that the Monetary Committee shall submit to the government and to the Knesset Finance Committee a report on the principles by which the proper level of the foreign exchange reserves is determined in the long run, and the guidelines for the Bank's investment policy regarding the reserves in the previous year.

The actual investment of the foreign exchange reserves in financial assets abroad and the on-going management of the reserves within the limitations set out by the Committee are performed by the Bank of Israel Markets Department.