Foreign exchange reserves

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1. Foreign exchange reserves represent foreign exchange assets of monetary authorities (usually the central bank of a particular country). The Central Bank of Bosnia and Herzegovina manages the foreign exchange reserves of BH.

How foreign exchange reserves will be used depends on the monetary policy implemented in a particular country. The choice of monetary policy determines also the operation of the Central Bank, as well as the management system, purpose and use of foreign exchange reserves. Generally, foreign exchange reserves may include foreign currency, foreign currency deposits in banks, foreign government securities denominated in foreign currency, gold, and special drawing rights of the International Monetary Fund.

Although in theory there is no single position on the optimal level of foreign exchange reserves, in practice a set of indicators is used to assess the minimum level required to maintain the country's balance of payments position. The most commonly used indicators are the following:

• Quarterly coverage of the country's imports - which is insurance against potential shocks on the country's current account,

• Minimum 20% coverage of the monetary aggregate M2, as this maintains public confidence in the domestic currency,

• Coverage of all debt liabilities of the country maturing in the next twelve months, which ensures the settlement of external obligations of the country in the event of interruption of capital inflows into the country from abroad.

• The Central Bank of Bosnia and Herzegovina uses the ARA metrics of the IMF, which is a kind of standard. The ARA indicator (acronym for Assessing Reserve Adequacy) was developed by the IMF after the great economic crisis of 2008. It represents the weighted average of short-term external debt, other foreign liabilities, exports and the broader monetary aggregate M2 (as an approximation for short-term domestic liquid assets) as potential sources of foreign exchange reserves outflow, which is a reference value against which foreign exchange reserves are compared. The key point is that the Central Bank should have adequate foreign exchange reserves covering all potential previously listed sources of outflow of foreign exchange reserves expressed by one comprehensive indicator. The recommended level of foreign exchange reserves is from 100 to 150 percent in relation to the ARA indicator. Today, it is widely used as one of the key indicators of the adequacy of foreign exchange reserves.

The Central Bank of Bosnia and Herzegovina uses foreign exchange reserves to support the domestic currency, which arises from the provisions of the Currency Board arrangement being the chosen monetary policy model, in accordance with the Law on the Central Bank. More at: https://cbbh.ba/Content/Read/14

2. The Law on the Central Bank of Bosnia and Herzegovina stipulates that one of the basic tasks of the Central Bank of Bosnia and Herzegovina, which is performed under the authority of its Governing Board, is to hold and manage official foreign exchange reserves primarily in a safe manner while being guided by principles of liquidity and profitability. The Central Bank of Bosnia and Herzegovina invests the foreign exchange reserves primarily in securities of the euro area countries with the highest credit ratings and deposits in selected central banks in the euro area, the Bank for International Settlements (BIS), as well as selected foreign commercial banks with high credit ratings, taking into account the investment restrictions in each individual instrument, each individual country and each commercial bank. In addition to the above, monetary gold is represented in the portfolio of foreign exchange reserves of the Central Bank of Bosnia and Herzegovina, to a lesser extent.

Bearing in mind that the Central Bank of Bosnia and Herzegovina operates on the principle of the Currency Board, and that the domestic currency KM is pegged to the euro, it is understandable that we hold in euro by far the largest share of foreign exchange reserves of the Central Bank of Bosnia and Herzegovina. More at: https://cbbh.ba/Content/Read/14

3. The Central Bank of Bosnia and Herzegovina may not use foreign exchange reserves in any circumstances for any purpose other than the purpose stipulated by the Law. That is not the money of the Central Bank of Bosnia and Herzegovina. Foreign exchange reserves are assets of the Central Bank of Bosnia and Herzegovina, generated on the basis of liabilities. Liabilities of the Central Bank of Bosnia and Herzegovina are cash in circulation, bank reserve account with the Central Bank, and deposits of internal depositors (primarily government). Confidence in the domestic currency rests on the belief of depositors that each banknote and coin owned by them, at their request, will buy the same amount of euros as in the past, and that this ratio will not change in the future. The same principle applies when commercial banks hold funds in a reserve account with the Central Bank of Bosnia and Herzegovina, or when the government, for example, holds deposits with the Central Bank of Bosnia and Herzegovina for servicing the due external debt. Keeping the exchange rate fixed against the euro is one of the largest contributions that the Central Bank of Bosnia and Herzegovina can make to the stability of the system. Any perception of a potential Currency Board volation would have unforeseeable negative consequences for Bosnia and Herzegovina. More at: https://cbbh.ba/Content/Read/14

4. Net foreign assets represent the amount by which the coverage of monetary liabilities by net foreign exchange reserves is higher than 100% and it is a basic indicator of compliance with the rules of the Currency Board. Theoretically, a central bank in the currency board arrangement must have coverage of its monetary liabilities in foreign exchange reserves in the amount of at least 100%. In practice, even greater coverage is needed, as confidence in the currency board and central bank independence would not be undermined by changes in the fair value of foreign exchange reserves. Coverage above the minimum, i.e. net foreign assets, has the role of amortizing shocks due to changes in the market value of financial instruments in which foreign exchange reserves are invested.