Foreign Exchange Reserves
Holding and Managing of Israel’s Foreign Currency Reserves
Section 4(2) of the Law sets out that one of the Bank of Israel’s functions is “holding and managing the foreign currency reserves of the State”.
The foreign currency reserves that states hold fulfill three main functions:
- They provide the economy with an emergency stock of foreign currency that is sufficient for a crisis period (for instance, in case of war or natural disaster). At such times, there may be a need to maintain or rapidly increase imports to a significant extent in order to deal with the emergency situation, while exports may be seriously impacted so that foreign currency income is low. Under such circumstances, the government and the private sector will find it hard to raise foreign currency abroad, such that the foreign currency reserves become the country’s main source of finance in foreign currency.
- They allow the central bank to intervene in the foreign exchange market under circumstances where (1) the exchange rate deviates from the range that is in line with the economy’s basic equilibrium; or (2) the foreign exchange market is not functioning properly (market failure).
- They enable the central bank to act in the foreign exchange market in order to moderate the impact of significant capital flows of either nonresidents or citizens that may undermine the stability of the financial markets, and that may thereby harm economic stability (a specific case of the previous point).
As such, holding a proper level of foreign exchange reserves is considered by domestic and foreign financial institutions, companies, households, and ratings agencies to be a main indicator of the country’s economic strength, which increases the trust in the country’s ability to deal with economic, financial, and political shocks to the economy.
The Monetary Committee, which is chaired by the Governor and includes representatives of the public, is entrusted with setting the guidelines for investing the reserves. These include details of the assets, risk profile, and quantitative and qualitative limitations on the types of assets that are permitted for investment. Given these, and with the recommendation of the Markets Department, the Committee approves the strategic allocation of the reserves each year. The allocation sets out the main characteristics of the reserves portfolio, including its currency composition, its asset composition, and its duration.
Section 56 of the Law sets out that the Monetary Committee shall submit to the government and to the Knesset Finance Committee a report on the principles according to which the proper level of the long-term foreign currency reserves is determined, and the guidelines for the Bank’s investment of the reserves in the past year.
The Bank of Israel Markets Department carries out the actual investment of the reserves in financial assets abroad, and the ongoing management of those investments within the freedoms given to it by the Monetary Committee.