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Informist, Wednesday, Jul. 15, 2026

 

MUMBAI – The large reserves of gold accumulated by global central banks in the past few years for diversification, risk management, and other purposes have spawned a degree of confidence among other classes of buyers of the yellow metal. However, the buying of gold and its treatment as reserve by central banks is not free of risk. A recent paper by staffers of the International Monetary Fund has argued that central banks should treat gold as a high-risk reserve asset, confine it mainly to investment tranches, and assess it through liquidity-adjusted and risk-based frameworks.

 

"Domestic gold purchase programs--especially involving nonmonetary gold--can create governance, financial integrity, balance sheet, operational, and monetary policy risks and should generally be avoided or assigned outside the central bank," according to the note, titled "Gold in Central Bank Reserves: Strategic Considerations, Market Risks, and Practical Guidance" and authored by Istvan Mak and Etienne Vaccaro-Grange.

 

Pointing out that gold has emerged as a prominent component of central bank reserves and its share has risen sharply in recent years, the authors said the increase has been driven overwhelmingly by valuation effects stemming from the surge in global gold prices rather than by large-scale accumulation of physical gold.

 

From the perspective of reserve management, gold differs fundamentally from traditional reserve assets. Although it carries no credit risk and can act as a protection against sanctions, it is highly volatile and has hedging, safe-haven, and diversification properties that are both regime- and shock-dependent.

 

Gold acts most consistently as a hedge against interest rate risk and as a partial hedge against dollar depreciation. It can also provide diversification benefits in long-duration reserve portfolios. However, its protection against equity downturns, inflation surprises, and geopolitical shocks has weakened considerably after the pandemic, alongside a broader breakdown of the stock–bond hedge, as per the paper.

 

"Moreover, empirical evidence shows that gold does not exhibit reliable safe haven properties in tail events. These conditional and regime-dependent properties imply that gold can enhance long-term balance sheet resilience, but it may undermine the self-insurance function of reserves if over-allocated or treated as a substitute for liquid foreign assets," according to the paper.

 

Acknowledging liquidity risk to gold, the authors said it is important for central banks to address this risk "either through separating liquidity and investment tranches or, in the absence of tranching, by incorporating liquidity risk metrics directly into asset allocation decisions."

 

How do central banks decide on the purchase of gold? The evidence suggests the expansion of gold holdings has not generally been guided by formal quantitative allocation frameworks, according to the paper. "Most central banks report that the size of their gold position is determined primarily by legacy holdings or qualitative diversification considerations, rather than by strategic asset allocation (SAA) models."

 

According to an interesting observation in the IMF note, the recent surge in gold prices has had a dual impact on central bank reserve portfolios. On the one hand, all else being equal, higher gold valuations have contributed to improved reserve adequacy ratios. On the other hand, increased price volatility and a stronger positive correlation with traditional reserve assets have heightened the overall market risk exposure within the reserve portfolios.

 

This pronounced volatility in gold prices poses important challenges from the perspective of reserve accumulation. Although central banks have benefited from the recent surge in gold prices--which has mechanically boosted the market value of their gold holdings and, in many cases, lifted total reserves--such improvements are not the result of underlying policy adjustments and may prove temporary.

 

How can central banks manage gold market risks? Hedging instruments to manage such risks exist, but their availability is limited and they would add to the cost of gold, on top of storage and insurance costs. Central banks and reserve managers can use financial derivatives such as forwards, futures, and especially options to hedge against adverse movements in gold price. "However, it is important to note that the practical implementation of these strategies is often constrained by the limited size and liquidity of the gold derivatives market relative to the scale of central banks' physical gold holdings," the authors of the note said. "As a result, although hedging can mitigate gold price risk for a portion of reserves at a predictable, albeit, at times, high cost, the available market depth may not be sufficient to fully hedge large official sector positions without incurring significant transaction costs or market impact."

 

An important question in this context is how much gold should a central bank hold. According to the IMF paper, "determining the appropriate share of gold requires a holistic, risk-based assessment of external vulnerabilities, economic structure, and policy frameworks. Decisions on gold accumulation... should be firmly anchored in SAA and sound policy analysis, rather than operational convenience or short-term considerations."  End

 

Reported by Abhijit Doshi

Edited by Rajeev Pai

 

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