Global financial turmoil has had a major impact on the reserve management policies of two thirds of central banks and almost all are rethinking diversification tactics, a survey showed on Wednesday.

The survey of 39 central banks who control reserve assets worth $3.2 trillion, just under 42 percent of the world's total, showed reserve managers were much more conservative and cautious last year than a year earlier.

Reserve managers expressed great concern about credit and liquidity risks, with over two thirds of respondents saying they experienced bouts of illiquidity in even the major bond markets.

Over 90 percent of respondents to the survey conducted by Central Banking Publications said they have been forced to reassess counterparty risk and most said the hunt for diversity and yield in recent years has been severely curtailed.

The majority of respondents in the survey, carried out late last year, also said they expect reserves to fall as the crisis unfolds before recovering to only marginally above current levels over the next four years.

The unprecedented changes to the financial landscape witnessed over the last (few) months have dramatically altered previous paradigms and beliefs, said a respondent from a central bank in the Americas.

These events have increased risk aversion and central banks have not been an exception.

This was in stark contrast to the findings in last year's survey, which showed reserve managers still inclined to seek yield and almost 60 percent of them saying derivatives were an attractive asset class in which to invest FX reserves.

This year's survey showed that as the financial turmoil ebbed and flowed reserve managers, like most other investors, opted for safety.

Less credit and more 'plain vanilla' instruments are preferred, said one European reserve manager.


Over two thirds said they had experienced illiquidity in important government bond markets, and the survey said reserve managers had expressed surprise that even these markets had frozen up as spreads widened and trades failed to settle.

Almost 80 percent of respondents said government bonds rated AA or higher were a more attractive investment than a year earlier, 61 percent said the same for agency paper and 57 percent said gold was a better investment.

Between roughly two thirds and all the respondents said virtually every other asset class was a less attractive investment than a year ago: equities, mortgage-backed securities, derivatives, lower-rated government bonds, commodities and hedge funds, amongst others.

In view of the coming recession in the world economy, almost all the listed instruments are considered too risky for central bank investments, said an Asian reserve manager.

The survey's findings also suggested there had been a loss of faith in credit rating agencies.

Just over half the respondents said they had altered the way they judge credit quality, with some of their comments noting a downgrading of agencies' assessments and an increasing recourse to other external indicators such as credit default swaps, share prices, and/or a strengthening of internal models.

In terms of reserves' currency composition, 74 percent of respondents said there was no change over the year in the number of currencies they invested in, and 94 percent of them said they didn't even consider investing in other currencies.

Central banks have refrained from diversifying their reserves in terms of currencies, the survey noted.

Whereas previous surveys had revealed interest or active allocation in non-traditional reserve currencies, that was not the case in 2008.

Reserve managers believe overall reserve levels will fall this year as countries draw down the cash needed to fund the huge financial and economic rescue packages needed to fight recession.

Most believe reserves will slowly accumulate again over the next four years but a significant minority -- almost a quarter -- believe the crisis will bring the build up in reserves over recent years to a shuddering halt.