Central banks are playing an increasingly active role in promoting the move towards a sustainable global economy. One area in which they are thus involved is in guiding attempts to mobilise funds to contribute to the large-scale public sector investment required to achieve the goals of the Paris Agreement. A key tool in this context is foreign exchange reserves, with green bonds being an increasingly popular investment choice among reserve managers.
In this paper, we explore how central banks might expand the usual triad of objectives - liquidity, safety and return - to fit environmental sustainability considerations into their reserve management frameworks. This can be done either by explicitly articulating sustainability as a defined purpose of holding reserves, or implicitly as a supporting aspect of existing policy purposes. In each case, this will involve additional trade-offs. We assess these, based on the example of green bonds.
We find that sustainability objectives can be integrated into reserve management frameworks without forgoing safety and return. Indeed, the results of an illustrative portfolio construction exercise suggest that adding green bonds to a conventional bond portfolio allows reserve managers to improve their reserves' risk profile without sacrificing expected return. This is explained mainly by diversification benefits.
Central banks' frameworks for managing foreign reserves have traditionally balanced a triad of objectives: liquidity, safety and return. Pursuing these objectives involves explicit trade-offs. More of an emphasis on returns, for instance, may require central banks to sacrifice some of the safety and liquidity of their overall holdings. Most recently, central banks have shown significant interest in incorporating environmental sustainability considerations into their policy frameworks, including their reserve management. This paper first explores whether sustainability considerations would support a tetrad of reserve management objectives, by drawing on the results of a recent BIS Survey on Reserve Management and Sustainability. It then illustrates how central banks might analyse (and weigh) all four objectives in allocating part of their foreign exchange reserves to green bonds using currently available market data.
JEL classification: E58, F31, G11, G17.
Keywords: central banks, green bonds, reserve management, sustainability.
Read the full paper at: https://www.bis.org/publ/work849.htm