Central Bank Use of Derivatives and Other Contingent Liabilities

Abstract

While central banks have frequently undertaken contingent commitments as part of thier regula operation in the economy, it is only recently, through central bank involvement in the derivative markets, that these transactions have drawn the attention of policy makers, market participants, and international agencies. This renewed interest and the fact that these contingent operations came to light in the aftermath of the Asian financial crisis, increased the interest in the analytics and the measurement of these commitments.

The goal of this paper is to explore the rationale for cental banks to undertake these types of commitments -- in particular to intervene in derivative markets -- and to assess the arguments that are commonly made in favor of and against this sort of involvement. In addition, the paper suggest a methodology to analyze the whole spectrum of central bank contingent liabilities. Specifically we aggregate all on and off-balance sheet transactions in a single framework so as to be able to draw meaningful conclusion on the consequences of these central bank operations on a number of important policy issues such as the volume of central banks' available reserves, the potential burden arising from instability in the banking sector and the overall solvency of the central bank.

Keywords: Central banks, contingent liabilities, derivative markets

JEL Classification: E58, E53