Reserve currency — Definition Explained Simply | Examples & Role
Reserve currency is a foreign currency held by governments and central banks to build up foreign exchange reserves, make international payments, and repay debts.
Reserve currency is a foreign currency that is globally recognized and used by central banks and governments to form currency reserves. It serves as a tool for international settlements, investments, repayment of external debts, and maintaining the stability of the national currency.
The presence of a reserve currency in a country increases confidence in its financial system and facilitates international trade. The larger the share of a currency in global reserves, the higher its status and influence on the world economy. According to the International Monetary Fund (IMF), the main reserve currencies today are the US dollar (USD), the euro (EUR), the Japanese yen (JPY), and the British pound sterling (GBP). Other currencies on the list include the Swiss franc (CHF), the Canadian dollar (CAD), the Australian dollar (AUD), and the Chinese yuan (CNY).
Functions of a reserve currency
- Building up foreign exchange reserves by central banks.
- Facilitating international payments between countries.
- Repaying sovereign external debt.
- Serving as a reliable investment asset.
Reserve currencies and the global economy
Reserve currencies form the backbone of the global financial system. For example, the majority of international payments are made in US dollars and euros. Their high liquidity and stability make them the primary instruments for saving and settlement in global trade.
Examples
- US dollar (USD) — the largest global reserve currency.
- Euro (EUR) — widely used in international reserves and settlements.
- Japanese yen (JPY) and British pound sterling (GBP) — part of the “big four” reserve currencies.
- Chinese yuan (CNY) — gradually strengthening its role as a reserve currency.