Handbook of Exchange Rates

19.10 Costs of Accumulation and Holding of Reserves

It is important to note that accumulating and holding reserves and managing them well does entail opportunity and other costs.

• Sterilization Accumulating reserves presents challenges for the central banks as it results in an injection, usually not warranted or wanted, into the domestic banking system. This requires that central banks embark on sterilization actions to drain the excess liquidity by issuing short-term bills or notes. This can cause significant losses for the central banks. For example, a central bank is holding US Treasury bills that are currently paying 0.50% interest. However, the central bank issues notes of a similar maturity in their currency to drain liquidity but pays interest of 2%. All things being equal, there will be a loss of 150 bps for the amount of reserves accumulated.
• Volatile or Declining Asset This is particularly true of Emerging Market economies, such as China, where the outlook for long-term economic growth would strongly suggest that their currencies will rise significantly against the dollar and Euro (USD and Euro currently comprising 90% of all reserves). Holding dollar and Euro assets then presents a particular challenge. As their currencies rise, the value and return of reserve assets, as measured against their local currencies, is likely to decline with potential ramifications for returns and also funds flowing to the government or SWF.
• Opportunity Cost The capital tied up in holding ...