Time to rethink Central Bank Money

In most jurisdictions today, two legacy conventions cause significant misperceptions of central bank money—the backbone of modern monetary systems. First, it is still commonly treated as a liability on central bank balance sheets. Second, its creation is not explicitly recognized in the law: central bank legislation authorizes lending, open market operations, and currency issuance, but the reserve-creation function remains implicit.

Both conventions hide the true nature of sovereign money, cloud balance-sheet transparency, and risk misleading policy design—especially in the digital age.

Based on our previous and more recent work,¹ we argue that central bank money—banknotes, reserves, or central bank digital currencies (CBDCs)—is not debt. It is better understood as equityfor the issuer and as custodial assets for the holders.

The liability illusion

A financial liability is a contractual obligation of the issuer to deliver an economic resource to the holder. But central bank reserves—the balances commercial banks hold in their accounts at the central bank—carry no such obligation.

Reserves are created out of nothing when the central bank credits a commercial bank’s account during monetary operations. When one bank sends reserves to another, the central bank simply reduces the balance in the sender’s account and increases the balance in the recipient’s account: the reserves held by the recipient are newly created entries, not transferred resources. At no point does the receiving bank “lend” reserves to the central bank—unlike what many central bank laws implicitly assume—nor does the central bank acquire any corresponding liability in the sense of a commitment to deliver an economic resource.

In addition, unlike debt, reserves are irredeemable: they cannot be converted into a higher-order asset. At most, they can be exchanged for banknotes, which—like reserves—represent value created, not borrowed, by the central bank and constitute a source of its financial strength.

So why are reserves still classified as liabilities? The answer is historical inertia. Under the gold and silver standards of the early twentieth century, reserves were redeemable for metals or foreign currency. The liability classification once made sense. But in today’s sovereign fiat systems, it persists as a legacy of a long-vanished monetary order.
 

The equity nature of sovereign money

When the central bank issues reserves, against securities or as loans, the value of those securities or loans should be recognized as revenue income and properly recorded as equity of the central bank. The central bank does not incur debt in creating money—it creates net worth.

Yet, under the current accounting convention, reserves appear as debts owed by the central bank and loans made by commercial banks (chart 1).

Chart 1. Current Accounting: Reserves as Liabilities

Central Bank Balance Sheet
	Resources (assets)	Claims (liabilities and equity)
	Government securities	Reserves (owed to banks)
	Loans to banks	+ Other liabilities
	Other assets	= Liabilities
		Equity
	= Assets	= Liabilities + equity
Consolidated Commercial Banking Sector Balance Sheet
	Resources (assets)	Claims (liabilities and equity)
	Reserves at the central bank (treated as loans to the central bank)	Deposits to clients
	Loans to firms and households	+ Other liabilities
	Other assets	= Liabilities
		Equity
	= Assets	= Liabilities + equity

Yet, treating reserves as debt perpetuates several deep misconceptions:

1. That commercial banks fund the central bank. They do not. Reserves are not loans from banks; they are banks’ monetary assets held in custody by the central bank.
2. That central banks owe reserves back to depositors. They do not. The only obligation is to ensure their transferability within the payments system.
3. That central bank balance sheets are fragile. They are not. Reporting reserves as liabilities artificially reduces apparent net worth, suggesting weakness where there is none—especially during large-scale asset purchases.

These misconceptions can have critical implications, especially for emerging markets, where credibility and institutional trust are vital. During crises, liability accounting can fuel misplaced fears of insolvency and erode public confidence precisely when monetary authority must remain unimpeachable.

Custodial reality and the digital frontier

Commercial banks hold reserves not because they have loaned funds to the central bank, but because the central bank holds their monetary assets in custody. Commercial banks retain full ownership and unqualified access to these balances, which exist solely through central bank creation. In an ongoing sequence, the central bank issues reserves against securities or as loans, and the commercial banks (and other authorized financial intermediaries) receiving them hold them with the central bank, which keeps them in custody and administers them on behalf of their holders.

This custodial interpretation is crucial in designing CBDCs. If retail CBDCs are treated as liabilities, the paradox that citizens “lend” their own sovereign currency to the state must be accepted. In reality, digital sovereign money belongs to its holders and is safeguarded—not borrowed—by the central bank.

For emerging economies, which are often at the forefront of digital transformation, this shift in legal and accounting perspective could enhance trust in digital money, simplify supervision, and reduce systemic risk.
 

Lessons from history

Throughout history, monetary transitions—from gold to gold certificates, from gold to fiat, or from bearer securities to dematerialized claims—have required legal reinvention. Each transition involved moments of reclassification: what was a warehouse receipt in one era became a legal tender note in another.

The move to fiat money was such a moment: monetary liabilities became pure instruments of sovereign authority. Yet accounting norms lagged, preserving outdated liability classifications even after redemption obligations were abandoned.

Today, we face a similar juncture. Digitalization demands new legal foundations. When value exists purely as digital records on a public ledger, the question “whose asset is this?” becomes existential—and the wrong answer invites legal ambiguity, operational difficulty, and loss of monetary trust.

Source: blogs.worldbank.org