Managing Reserve Assets

Christian Buschmann

From the 1950s onwards, the asset side of a bank’s balance sheet would usually show a portfolio of sovereign bonds and bills. This changed in the first decade of the 21st century: with the flawed thinking that market liquidity can be taken for granted, the practice of holding assets of sovereign debtors fell into disuse in favour of holding higher yielding bank bonds and corporate bonds. This would have been attractive from the return point of view, as government debt carries lower returns than bank debt (Choudhry 2012, p. 622). It turned out, however, that these investments were less liquid than government debt.

Prior to the 2007–9 financial crisis, the assumption of guaranteed liquidity was somewhat correct: financial markets were liquid, and funding was easily available at low cost, but the emergence of the crisis showed how rapidly market conditions can change, leading to a situation where several institutions, regardless of their capital levels, experienced severe liquidity issues, forcing either an intervention by the central bank or a shutdown of the institution (Bonner and Eijffinger 2016).

Analogously to their thinking about market liquidity, banks did not consider pr

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