IMF Cautions Central Banks May Have to Rethink What Constitutes Reserves

The IMF warns that central banks may have to rethink what constitutes their reserve currency holdings. In a recent study, the global lender points to the changing geopolitical landscape, technological advances and the impact of the Covid-19 pandemic as events likely to influence the composition of reserves.

Advances in Financial Technologies

In addition to the US dollar, other currencies like the Euro, the Japanese and the British pound act as settlement currencies in global trade. Still, the US dollar dominates when it comes to its status as the world’s reserve currency.

However, in a study, whose findings are shared via the global institution’s blog, the IMF does say that the pandemic inspired “advances in financial and payment technologies” will likely “impact the future composition of reserve holdings.”

According to the authors of the blog, many central bankers are now aware of threats from private issuers of digital money, like the Facebook backed Diem. Consequently, some central banks may be attempting to counter this threat by issuing their own digital currencies. The authors write:

(The) potential competition from private issuers such as Diem – Facebook’s blockchain-based payment system – has spurred major central banks to accelerate work on central bank digital currencies and cross-border payments.

Diem Association is an independent organization governing the blockchain payment and Facebook is one of 27 member companies.

Institutions like the European Central Bank and the People’s Bank of China, which are already “exploring the issuance of central bank digital currencies,” believe that their ultimate success on this front “could increase demand for their currencies.” In turn, this increased demand will accelerate the dumping of the US dollar as the preferred global reserve currency.

Superior Technology Prevails

Still, the IMF blog post reminds central bankers that simply issuing a digital currency is no guarantee of its acceptance as another reserve currency. Instead, only “superior technology platforms” can help new currencies “overcome some of the advantages of incumbent currencies.” The authors conclude their sentiments on this reserve currency subject saying:

Depending on the adoption and use of public or private digital money, central banks might have to rethink what constitutes, and how to hold, reserves going forward.

Meanwhile, the blog also identifies the shifts in international finance, the changing trade links and invoicing practices as other factors that could propel the accelerated transformation of the reserve currency status quo.

Editor’s note: This article has been updated to reflect that Facebook is one of Diem Association’s 27 member companies.