Why Does A Country Need to Keep Sufficient Foreign Exchange?

Various currencies are held by the central bank of a country as foreign exchange reserves. Foreign reserves alike are also known as foreign exchange reserves. A bank holds reserves for seven reasons. However, managing the currency value is the main reason.

How Foreign Exchange Reserves Work?

Foreign currency is deposited into the banks of the country’s exporters. From there, the currency is made available to the central bank. Trade partners pay exporters in dollars, euros, and other currencies. Exporters convert those currencies into local currency. The currency is used to pay their employees and local suppliers.

Since sovereign debt pays a small interest rate, banks prefer to buy it with the cash. Due to the dollar’s status as a world currency, Treasury bills are the most popular because most foreign trade takes place in the U.S. dollar.

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Increasingly, banks are holding assets denominated in euros, including corporate bonds of high quality. However, this has not changed during the eurozone crisis. Similarly, special drawing rights are also included. In addition, their reserve balance with the International Monetary Fund is a third asset. In addition, their reserve balance with the International Monetary Fund is a third asset.

What Are FER?

Reserves of foreign currencies held by a central bank constitute foreign exchange reserves. This information is used to back liabilities and to influence monetary policy. A central bank’s foreign funds include foreign currency held by the Federal Reserve Bank.

How Does FER Works?

In addition to banknotes, deposits, bonds, and Treasury bills, it can also include government securities. Assets of this type are held for a variety of reasons, but their most important function is to provide a central government agency with emergency funds in the event of a rapid currency loss or total insolvency.

Globally, many central banks hold significant foreign exchange reserves. The United States dollar is the most traded currency in the world, so most of these reserves are held in the United States. The FER occasionally made up of British pounds, euros, Chinese yuan and Japanese yen.

The theory holds that holding the FER in a currency that is not directly associated with the country’s own currency is more beneficial since it provides a buffer against a market shock. Due to the ease of global trading and currency intertwining, this practice has become more difficult.

How do Foreign Exchange Reserves or Forex Reserves work?

A country’s central bank or monetary agency keeps forex reserves (FER) as assets. US Dollars, Euros, Japanese Yen, and British Pounds sterling are usually used as reserve currencies. It is used to back its liabilities – including native currency issued by the government and reserves deposited by financial institutions and governments with the central bank.

Objectives Behind Holding Forex Reserves

  • The support and maintenance of confidence in the monetary and exchange rate policy.
  • Maintaining confidence in monetary and exchange rate management policies vulnerability by maintaining foreign currency liquidity.


Depending on your viewpoint, forex should only consist of foreign banknotes, foreign Treasury bills, foreign bank deposits, and long and short-term foreign government securities. In practice it would also include gold reserves, IMF reserve positions, and SDRs, or special drawing rights. It is easier to access the latter figure, which is officially known as the international reserves.

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