The South African Reserve Bank (SARB) oversees the management of South Africa's foreign exchange reserves and plays a crucial role in regulating cross-border transactions. The SARB engages in the foreign exchange market to enhance reserves while maintaining a stable rand exchange rate.
Its responsibilities include the management of South Africa's gold and foreign exchange reserves. The SARB plays a crucial role in overseeing cross-border transactions, safeguarding against the misuse of the financial system, and facilitating the regulation of financial institutions.
This article explores the role of the South African Reserve Bank in forex trading, examining its influence on market stability, monetary policy, and the economy.
What is Forex Trading?
The foreign exchange market is essentially a group of people who buy and sell currencies on an international scale at predetermined prices. If you have ever been overseas, you have probably made a forex transaction, as it is the way that individuals, companies, and central banks convert one currency into another.
Although many people engage in foreign exchange for more pragmatic reasons, the vast majority of currency conversions are done so to make a profit. The daily volume of currency conversions might cause some currencies' prices to fluctuate wildly. Forex traders are drawn to its volatility, which increases the potential for huge rewards but also the risk.
What is the South African Reserve Bank?
In South Africa, the national bank is known as the South African Reserve Bank, or SARB. In response to the unprecedented monetary and financial crises caused by World War I, Parliament enacted the "Currency and Bank Act of 10 August 1920" in 1921, officially establishing the institution. It was then just one of four central banks in the world. The other being—the Federal Reserve, the Bank of Japan, and the Bank of Java.
The first proposals for a South African central bank appeared in 1879. On March 31, 1920, eleven members of Parliament were appointed to a select committee that would investigate whether or not the creation of the central bank would serve the national interest.
On 30 June 1921, the South African Reserve Bank became the oldest central bank in Africa after opening for operation in accordance with the committee's recommendations. The bank released the first banknotes to the public on 19 April 1922. The SARB is privately held, in contrast to the publicly owned Bank of England that served as its model.
The South African Reserve Bank and Foreign Exchange Operations
Market forces determine the nominal exchange rate in South Africa due to the country's floating exchange rate policy. Nevertheless, the SARB is not oblivious to the difficulties presented by currency rate volatility and sudden changes.
To ensure financial stability, promote orderly market functioning, and mitigate the effects of extreme fluctuations in currency rates, the bank may intervene in the foreign exchange market.
Spot purchases help the SARB build reserves and meet the foreign exchange demands of its clients, while foreign exchange swaps help control the liquidity of the local money market. Gold and foreign exchange reserves are the official foreign assets of the South African government, typically denominated in major currencies. These assets are kept to do three things: to cover the country's foreign exchange liabilities, to keep people confident in the country's monetary and financial policies, and to safeguard the economy from outside shocks.
Keeping sufficient reserves on hand reduces the likelihood of capital outflows and boosts investor trust.
When the market permits, that is, when buying doesn't cause the exchange rate to fluctuate too much or add to market volatility, foreign exchange reserves are amassed through open market transactions. In extraordinary circumstances, the SARB purchases a portion of FDI, merger and acquisition funds, and government foreign currency issuance proceeds directly.
How Does the Reserve Bank Manage Its Gold and Foreign Exchange Reserves?
The SARB's Investment Policy on Gold and Foreign Exchange Reserves governs reserve management. The SARB uses its overall risk tolerance framework to manage reserves, while Strategic Asset Allocation encapsulates the relevant strategic benchmarks and objectives.
The responsibility for executive authority is explicitly divided among the Governors' Executive Committee, the Reserves Management Committee, and the Financial Markets Department in a three-tier governance system. To improve the internal reserves management capabilities and diversify risk and return, external fund managers oversee a portion of the foreign exchange reserves.
In addition to buying almost all of the gold produced in the country, the SARB has been in charge of managing and storing gold reserves since 1925. Of course, this gold-related activity has progressed. At the moment, the SARB's gold-related operations are intentionally more similar to other central banks'.
South African gold producers had the option to sell their entire output to recognised counterparties when the Minister of Finance announced it on December 12, 1997. To qualify for this exception, the SARB had to provide an exemption from the Exchange Control Regulations, which the Minister of Finance did.
After carefully reviewing its contents, the South African Reserve Bank (SARB) has acknowledged that the Precious Metals Global Code (Code) stands as a collection of principles widely acknowledged as best practices in the precious metals wholesale market. A participant in the market as defined in the Code, the SARB promises to operate in accordance with the Code's principles. Therefore, SARB has taken the necessary measures, considering its size, complexity, and market engagement, to ensure that it operates in accordance with the principles outlined in the code that established it.
Official Gold and Foreign Exchange Reserves Management Investment Policy
The investment objectives are:
- Capital preservation
An investor's first priority should be the security of their initial investment. Subject to the approved risk tolerances establishing the SARB, investments will be made in a way that tries to protect the capital value of the entire portfolio over the investment horizon.
- Liquidity
The goal of investment management should be to set aside sufficient funds to cover a set of specified objectives. An adequate level of liquidity can be maintained by investing reserves primarily in securities that have a vibrant secondary market.
- Returns
The goal of investing the reserves is to get an acceptable return that is in line with the investment objectives and risk restrictions, while also preserving capital and meeting liquidity constraints.
Investment horizons and liquidity needs are different for each of these goals. In order to facilitate investment management, the reserves are then operationally divided into sub-portfolios called tranches.
Strategic Asset Allocation
There are two parts to the reserves: the liquidity portion and the investment portion. Once the reserves are sufficient, we can establish the size of the liquidity tranche. The Investment Tranche will receive any excess amount.
To guarantee that reserves are available when needed and that capital is preserved, the Liquidity Tranche is invested in highly liquid securities. We further divide each of its four sections—Special Drawing Rights (SDR), Gold, Working Capital, and Buffer—into smaller parts.
In light of South Africa's status as an IMF member, the Special Drawing Rights (SDR) Sub-tranche addresses the specific requirements of the SARB. In times of crisis, SDRs can be swapped for the currencies of member countries of the International Monetary Fund (IMF), acting as a form of insurance against uncertainty.
It is because South Africa is prepared to keep gold as a unique reserve instrument that the Gold Sub-tranche exists. Due to its high liquidity, diversification advantages, and monetary function, gold serves as a hedge against potential economic downturns.
The Working Capital Sub-tranche provides liquidity for short-term obligations and cash management requirements.
When the Working Capital Sub-tranche runs low on funds, the Buffer Sub-tranche can step in and cover the shortfall.
In line with South Africa's broader plans for macroeconomic and financial stability, the Investment Tranche seeks to cover longer-term eventualities and increase returns on the reserves portfolio. While keeping in mind the need to preserve capital and maintain liquidity, it is invested in securities with greater yields in order to boost the portfolio's return.
External Fund Management
Like other central banks, the SARB has a well-structured program to manage external funds in addition to its internal reserves. Improving and expanding internal capacity and spreading out the reserves' risk and return characteristics are the primary goals of this initiative.
The program, which has been in place since 1999, is regularly assessed and adjusted to meet the needs of the SARB, namely regarding the deployment of its reserves strategically. The staff members of the SARB have been able to handle more complicated portfolios because of the skills and knowledge transfer efforts that have helped them immensely throughout the years. Nevertheless, the SARB's goals in managing external funds have evolved over time, and diversification is now their primary emphasis. Therefore, the SARB gives external fund managers more freedom to invest in a wider variety of asset classes and take more risks due to their greater degree of professional competence.
A strict legal process is used to draft the Investment Management Agreements and Investment Guidelines. This is to make sure that the SARB's funds will be generally safe while the external fund managers are in charge. Furthermore, at in-person meetings, the Reserves Management Committee of the SARB receives formal portfolio performance evaluations that acknowledge liquidity and capital preservation goals.
Governance of the Reserve Bank
Effectively managing domestic operations and reserves requires good governance and functional organisational structures. Properly defining, adopting, and institutionalising roles and responsibilities is essential when constructing such institutions.
The Bank's Board, the Board Risk and Ethics Committee (BREC), the Governors' Executive Committee (GEC), the Risk Management Committee (RMC), and the Reserves Management Committee (Resmanco) are in charge of independent risk control and compliance. They are assisted by the relevant functional divisions. Managing risk is an ongoing activity that must be overseen by the bank's board.
Conclusion
Accumulating foreign exchange reserves is the primary motivation for the bank's participation in the foreign currency market. Following a policy of a flexible or floating exchange rate, the bank does not attempt to manipulate the level of the exchange rate. This does not, however, imply that the bank does not care about the difficulties caused by exchange rate fluctuation. In order to prevent financial instability, smooth out sudden changes, and promote the foreign currency market's orderly functioning, the bank is prepared to intervene in the market.
It will be difficult for the bank to influence the exchange rate level due to the microstructure and complicated dynamics of the domestic foreign exchange markets. Do not mistake the high volatility for inefficiencies or structural flaws in the foreign currency market; rather, it may be due to the market's depth and liquidity relative to an emerging market economy.
On a national scale, an exchange rate system that is open to negotiation lets the central bank pursue inflation-targeting strategies that are best suited to the current economic climate. South Africa's nominal exchange rate fluctuates to maintain a balanced external account, while the country's monetary policy strives for price stability.
