Why OMFIs are Growing in Importance

OMFIs are responsible for around $10 trillion worth of monetary and financial assets of greater or less liquidity (including gold holdings) – a potent force on world capital markets. This sum has risen nearly tenfold from around $1 trillion in 1990 - reflecting an explosion of world liquidity caused by rapid expansion of world capital and trade flows, interrupted by the 2008-09 recession These assets are held in a multiplicity of highly diverse institutions across five continents, ranging from old-established and predominantly conservative European central banks to the para-state investment arms of wealthy oil states and the trust corporations of state-owned companies across Asia.

Increasing signs of convergence

Sovereign wealth funds from the Middle East and Asia have made highly-publicised forays to purchase stakes in foreign companies, with a focus on the financial, manufacturing and natural resources sectors. They have also been hard-hit by losses on investments during the stock market downturn. Such funds now operate on long-term portfolio management lines akin to those of large private sector operators, albeit with very different governance structures. Among the central banks, traditional reserve asset behaviour has always emphasised lowering risk and maintaining liquidity. However, some old-established central banks in Europe and elsewhere are now investing a limited proportion of their portfolios in equities as part of a new emphasis on generating wealth over the longer term. This convergence with patterns among sovereign wealth funds and in the private sector partly reflects Economic and Monetary Union (EMU) in Europe, which has reduced central banks’ need to maintain sizeable foreign exchange reserves for intervention.

OMFIs and the new regulatory architecture

OMFIs will play a significant role in new regulatory structures built around greater cross-border information flows aimed at improving supervision of individual financial institutions as well as assessing and limiting overall risks to the system. Although national supervisory authorities and governments will remain essential building blocks, there will be a greater role for supranational authorities in providing early warning of threats to overall stability. In this context, central banks and sovereign wealth funds can benefit from informal exchanges with regulatory and supervisory authorities from different parts of the world as well as with private sector institutions with overlapping preoccupations and interests.

Shift in geographical balance

Along with fundamental changes in the nature of OMFIs’ operations, there has been a significant shift in the balance of geographical power among them. The varying and widespread repercussions of globalisation have led to a shakeup in traditional OMFI rankings. Many institutions from the emerging markets now possess considerably more financial clout than those from industrialised countries. Official holders of foreign currency assets are now concentrating on the oil-producing countries and Asia, with 60 percent of central banks’ published foreign currency reserves held by six countries – China, Japan, Taiwan, India, South Korea and Russia. The US and Europe have led the world monetary field for much of the past 100 years, but now Europe’s largest economy Germany - which during the 1970s had the world’s largest foreign exchange reserves - accounts for just 0.7 percent of total published official holdings.

Path to multi-currency monetary system

Reflecting fundamental changes in the world economy, OMFIs are at the forefront of practical steps towards a genuine global multi-currency system, where emerging market currencies are expected to play a much greater role than in the past. A gradual reduction in the dollar’s role as the premier reserve currency is likely to make the financial system more resilient to shocks. But it will take place in a series of ‘bottom-up’ advances rather than in any formal ‘top-down’ initiative to rebuild the world monetary system. This provides a practical example of how changes in public sector asset management behaviour can buttress overall efforts to improve financial stability.