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QuestionWhy are banknotes on the liability side of the Bank's balance sheet?
The Bank started to issue banknotes in 1885. At that time, the banknotes were convertible notes whose convertibility to silver was guaranteed. Thereafter, when the gold standard was adopted, the banknotes became convertible to gold. Under these systems, the Bank was required to hold gold or silver equivalent to the amount of banknotes issued so as to meet the demand to exchange banknotes for gold or silver at any time. In this sense, it can be said that the banknotes represented the liability certificate issued by the Bank. Given this, the Bank recorded gold and silver as assets and banknotes as liabilities on its balance sheet.
These reserve requirements were later abolished. In the meantime, a view began to take hold that the stability of the value of banknotes should be maintained through the appropriate conduct of monetary policy by the Bank, rather than through a direct link with the value of assets held by the Bank. In this regard, banknotes continue to represent the liability certificate -- of which the credibility must be ensured by the Bank -- and are still on the liability side of the Bank's balance sheet. Such accounting treatment of banknotes is commonly applied among other major central banks.