The Foreign Exchange Market and Reserves

The functions of the Markets Department include, among other things, holding and managing the country's foreign exchange reserves, supporting the orderly activity of the foreign exchange market, and publishing representative exchange rates.
 
The country's foreign exchange reserves are the main reserves of foreign currency available to the economy. The Bank of Israel holds the foreign exchange reserves to provide liquidity in foreign currency when it is needed, such as to finance the repayments of the country's debt, to pay for exceptional government expenditure on imports at times of emergency, to provide liquidity in a financial crisis, or to be sold as necessary in the course of conducting monetary policy.
 
The appropriate level of foreign exchange reserves is also important from the aspect of the international standing of the economy. The proper level of reserves reduces economic risk and improves the country's international credit rating, helping it to obtain credit at a reasonable cost. In managing the reserves, the Bank of Israel, like other central banks, follows a cautious approach, directed towards three objectives: maintaining a high level of liquidity; minimizing the various financial and credit risks; and maintaining the purchasing power of the reserves and obtaining an adequate return on the investments. The reserves are therefore invested mainly in low risk tradable assets with a relatively short time horizon, subject to the limitations specified in the law. The currency mix of the foreign exchange reserves and their preferred level are determined in accordance with the policy rules, which are derived from the functions of the reserves.
 
The Bank of Israel's Markets Department monitors and analyzes current developments in the foreign exchange market, and carries out the Bank's exchange rate policy. Foreign exchange trading takes place primarily between banks and their customers both in Israel and abroad, and between the banks themselves. Every foreign exchange trading day, the Bank of Israel publishes the representative exchange rates of the shekel against foreign currencies. The representative rate is based on market prices around the time the rate is set.
 
Section 4(3) of the Bank of Israel Law establishes that one of the Bank's functions is, "Supporting the orderly activity of the Foreign Currency Market in Israel". As part of this role, the Markets Department monitors the market's functioning.
 
Exchange rate policy today is based on free movement of the shekel's exchange rate against other currencies. With that, the Bank maintains the option to intervene in foreign currency trading in situations of extraordinary movements in the exchange rate which are not in line with fundamental economic conditions, or when the foreign exchange market is not functioning appropriately. Since the beginning of the 1990s, foreign exchange control has been gradually lifted, in a process of liberalization. Today, there are no oversight limitations at all. The Bank of Israel analyzes developments in the foreign exchange market as well as in the domestic bond and securities markets. The Bank collates information on trading in these markets and constructs indices that enable it to examine whether the financial markets are operating properly.
 
Every foreign exchange trading day the Bank of Israel publishes representative exchange rates of the shekel against other currencies, based on the market rates around the time of they are set. It should be noted that the representative exchange rate is an indicator of the rate prevailing in the market, but it has no legally binding significance. The parties to a transaction indexed to foreign currency can therefore carry it out at any agreed upon exchange rate.