While central bank investment tranches are

While central bank investment tranches are in some ways comparable to sovereign portfolios, they are differentiated by the former's broader market functions While there are similarities in the approach taken to investment tranches (in terms of risk asset allocation and development of internal capability), central banks have a broader set of functions, including local market money supply, the role of lender of last resort and currency exchange rate regime management. These factors have considerable influence over investment strategy and capacity, and differentiate central banks from sovereign investors. In last year’s report, we focused on emerging market (EM) central banks due to their increasing use of investment tranches (reserves sub-portfolios which prioritise investment return over liquidity), which have similar allocations to sovereign investor portfolios. We noted that many of the respondent banks were moving up the risk spectrum in response to achieving capital preservation in the face of low and negative yields, and that reserve managers were allocating higher levels of reserves to the investment tranche. We explore how central banks in developed markets with low financial market exposure have followed emerging market reserve managers up the risk spectrum. Low banking sector exposure is accompanied by lesser build-up in the levels of reserves and a growing appetite for risk assets In this year’s report, we have expanded our central bank sample and segmented the central bank universe into developed and emerging markets to understand differences in strategy and pace of change with respect to investment tranches. Within developed market central banks, we further segmented them into two categories: those with high exposure to financial markets (DM High FME) and those with low exposure (DM Low FME?). We summarise these classifications in figure 27. While there are various means of calculating reserves adequacy (with import coverage and short- term debt coverage most frequently cited in figure 28), all measures link level of reserves to potential drawdown of funds. Following the Global Financial Crisis of 2008, DM High FME central banks increased estimates of the likelinood and size of potential drawdowns, increasing the level of reserves over the intervening years to better equip themselves as ‘lenders of last resort’. In 2016, this trend continued with DM High FME central banks increasing reserves more rapidly than DM Low FME and EM (figure 29). DM High FME reserve managers rely on these large net inflows to maintain high levels of liquidity (with 67% of respondents describing reserves as ‘ample’ in figure 30), and focus less on capital preservation and investment returns. Furthermore, reserve managers in High FME markets noted that they are unwilling to invest in risk assets such as equities or asset-backed securities as they are seeking to diversify (not correlate) their reserves from local financial market shocks. IMeasure of financial exposure based on World Bank Global Financial Development - Private credit by deposit money banks and other financial institutions to GDP (%), 24 June 2016. Medium/Low Medium/Low High/Medium Medium Ww 8 HOUSE_OVERSIGHT_026718