The Safe Assets Under Central Bankers’ Pillows

By Marina Zucker-Marques and Kevin P. Gallagher

Last month, the world’s major central bankers converged upon Jackson Hole during a period of unprecedented uncertainty. Constantly shifting policy priorities, tariffs, the conflict in Iran, rising debt levels, inflation fears and climate change have been keeping central bankers up all year. In past crises, central bankers could sleep relatively well knowing that they had access to the safe reserve asset of the United States dollar. But times have changed. Amid the uncertainty, central banks have started to reduce their exposure to the United States dollar rather than accumulate it.

A survey by the Official Monetary and Financial Institutions Forum (OMFIF) released in June reported that 74 percent of the 90 central banks surveyed said they anticipate the US dollar’s share of global reserves to decline. In light of this, banks have increased their gold purchases since 2022 as compared to the period from 2010-2021. While central banks won’t completely ditch the dollar, according to the survey, asset diversification is the new normal.

Thus far gold, the euro and even some renminbi have been the beneficiaries of central bank diversification strategies, but each has its limits. Gold doesn’t yield interest income and is hard to physically store. The euro could potentially be more dominant, but fragmented capital markets, limited common safe assets, incomplete fiscal and banking integration and lower global trade invoicing keep its international use limited. Meanwhile, the RMB has limited convertibility and less-developed financial markets, and concerns about policy transparency and geopolitical risk constrain its international use.

But while central bankers twist and turn at night, there are actually immense levels of safe international assets right under their pillows—ones that could also advance sustainable development. Multilateral development banks (MDBs) such as the World Bank have base capital from their member countries and use that capital as collateral to issue in global markets and then on-lend to member countries at interest rates and maturities far more favorable than the member country could enjoy if they went to markets on their own. Many central banks already hold MDB bonds as safe collateral given their high credit ratings and preferred creditor status.

Now MDBs are working to create various “hybrid capital” instruments that combine features of both debt and equity, giving the issuer financing that is partly loan-like and partly ownership-like. These instruments may be even more attractive to central banks than standard MDB bonds. The African Development Bank, World Bank and the Inter-American Development Bank have each issued or proposed such instruments already.

Prior research from the Boston University Global Development Policy Center has proposed a simple hybrid instrument called the Sustainable Future Bond—a perpetual, fixed-income hybrid capital instrument issued by MDBs. Central banks could purchase them using a small portion of their foreign-exchange reserves and hold them as equity. Because the bonds would be treated as equity, MDBs could leverage the new capital to issue additional conventional debt and expand lending to make the world economy more resilient and growth enhancing.

Sustainable Future Bonds would serve as a relatively safe international reserve asset because MDBs generally have high credit ratings and preferred creditor status, while the bonds would provide a return comparable to existing MDB bond instruments. Their liquidity would be supported by agreements allowing central banks to use them to settle claims with one another or exchange them for hard currencies on demand. This would give central banks another reserve asset alongside dollar-denominated holdings, while directing a small share of reserves toward development finance.

If central banks held Sustainable Future Bonds, they would gain a high-quality international reserve asset while strengthening the institutions best positioned to finance global resilience. Unlike conventional reserves that mainly insure against instability, these holdings would help fund adaptation, infrastructure, health and development in general—reducing the vulnerabilities that generate uncertainty in the first place. The result would be reserve management that not only protects against global shocks but helps prevent and absorb them.

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