It is noticeable that countries, such as Korea, which possessed very important amounts of  BIS Review 76/2010  7  reserves prior to the crisis and has a flexible exchange rate regime, nevertheless felt the need to enter into currency swaps with the Federal Reserve. Financial openness and integration means that domestic banks will engage more and more into foreign currency operations. In turn, the expansion of international balance sheets will increase the potential demand for liquidity support in case of shocks. This trend should be accepted as a normal consequence of open capital markets and international banking, together with the predominance of a very limited number of currencies in international finance. As a consequence, past benchmarks used to assess the adequacy of reserves are no longer valid. Current research (Obstfeld et al. 2009) shows that broad domestic money aggregates may be the best explanatory factors for the amount of reserves. Internationalisation of finance has created a fundamental indeterminacy in the demand for reserves, which reflects the indeterminacy in the demand for liquidity. Multilateral provision of international liquidity: the search for financial safety nets The rationale for a multilateral source of liquidity provision is straightforward: stabilizing the demand for international reserves would bring huge benefits in terms of world welfare. At the moment, reserve accumulation can only occur through a conjunction of balance of payment surplus and some degree of exchange rate intervention. In addition, if sterilization proves difficult or impossible, it also leads to unwanted changes in monetary policy.

  as precaution against possible abrupt capital outflows (the “sudden stop” syndrome)    and, finally, to provide liquidity to domestic financial institutions. (Obstfeld et al. 2009). That use of foreign exchange reserves was especially apparent in 2008 when Central Banks in many emerging (and some industrialized) countries put those reserves at work to ease domestic tensions created by dollar liquidity shortages. The costs of holding reserves are also well identified:   intermediation of national savings by a public entity is never neutral. By nature, those entities don’t have the same risk appetite and liquidity preference as private agents. A significant part of national savings (up to 30% in some countries) might find itself subject to a “directed” allocation towards liquid instruments denominated in foreign currency.   as a consequence, there is a direct opportunity cost because foreign exchange reserves’ risk / return profile may be lower than for other, alternative, investments.   finally, as reserves accumulate, countries are getting increasingly exposed to exchange rate risk and face the possibility of significant valuation losses. This kind of cost / benefit analysis seems less and less able, however, to account for the true behavior of reserve holders. First there may be immeasurable, but very powerful, benefits such as increased security, lower external interest rates and lower exchange rate variability over the long run. Second, part of the costs may be borne by the system itself and not fully internalized by each individual country.