Central banks, by virtue of the duties and powers vested in them by law, operate within a framework that, unlike that of commercial banks, pursues the public interest and does not seek to make a profit. The structural difference between central banks and commercial banks is a topic studied in the economics literature. What must be underlined is the fact that central banks aim to achieve and maintain price stability and financial stability rather than focus on financial objectives such as a strong balance sheet or profitability (Long & Fisher, 2024). Studies that have shed light on the profit-or-loss nature of central banks reveal that:
- Central banks generally tend to profit due to their monopolistic status in printing and issuing domestic currency,
- Central banks will not be insolvent as they do not face fundamental banking problems such as liquidity mismatch and negative capital,
- However, they may incur losses in certain periods as a result of the steps they take to achieve their policy objectives.
Accordingly, exceptional circumstances may arise that cause central banks to incur temporary losses. The 2008 financial crisis and the Covid-19 pandemic are such examples.
What Does It Mean for Central Banks to Incur Losses?
Certain central banks that purchase domestic currency-denominated assets to strengthen macroeconomic and financial stability may report losses or low profits during periods of rising interest rates. Central banks that adopt an accounting standard that incorporates changes in market value of bonds in calculating net profits put pressures on their profitability (Bell et al., 2023). This is usually the case for advanced economy central banks that pursue asset purchase programs. However, many emerging market economy (EME) central banks have also previously reported losses. For example, the Central Bank of Chile, the Czech National Bank, and Banco de México continued to operate with negative equity for many years (Archer & Moser-Boehm, 2013).
Unlike advanced economy central banks, the profitability of EME central banks can be significantly affected by exchange rate swings. Since FX and gold reserves of EME central banks account for most of the assets on their balance sheets, exchange rate fluctuations can play a major role in their profitability (Bell et al., 2023).
Meanwhile, central banks' reported losses do not directly affect their ability to effectively continue their operations. After all, central banks can issue domestic currency to meet their obligations and are not subject to any capital requirements due to their nature.
Central Banks in Post-Pandemic Era
The pandemic, in addition to its direct and indirect effects on households, the real sector, and the financial sector, has gone down in history as a challenging time for central banks and regulatory authorities. As part of the expansionary/accommodative monetary policies adopted during the pandemic, the policy interest rates were lowered, credit growth in financial markets was allowed, and the securities item in the balance sheets of central banks grew due to quantitative easing.
During 2022 and 2023, the direct effects of the pandemic began to fade, but the fight against inflation, which surged during the pandemic, was one of the top policy priorities. The monetary tightening of advanced economies during these years impaired the securities - mostly long-term securities - accumulated in central bank assets during the pandemic, and increased central banks' interest expenses on their liabilities in many instances. Consequently, the number of central banks reporting losses has significantly increased in recent years (Table 1). [1]
An analysis of the profit and loss for the past five years of the 28 central banks, whose annual report details are readily available on a regular basis, reveals that four central banks posted losses in 2019 and 2020, 10 in 2021, and 12 in 2022. Nine out of 19 countries reporting for 2023 so far have reported losses.
The increase in interest expenses is the primary reason behind the losses incurred by the central banks of the US, Germany, Australia, Belgium, France, Switzerland, and Canada, as well as the European Central Bank in 2023. This is a natural outcome of the asset-liability maturity structure of central banks in a setting of rapidly rising interest rates. The recent losses of the Reserve Bank of Australia were also attributable to the impairment of securities along with rising interest rates. Likewise, the Central Bank of the Russian Federation, the Czech National Bank, the Monetary Authority of Singapore, and the Reserve Bank of New Zealand also posted losses in the previous period due to the impairment of their securities as well as the increase in interest expenses.
The Central Bank of the Republic of Türkiye also reported a loss of TRY 818.2 billion in its balance sheet for the 92nd accounting year ending on 31 December 2023. While this loss was mainly due to exchange rate differences paid to FX-protected deposit items, rising interest rates are observed to have reduced profits by means of interest expenses and impaired securities, even when excluding FX-protected deposit expenses.
Although this article will not delve into detail as it concentrates on the post-pandemic period, Banco de México, the National Bank of Ukraine, and the Bank of Thailand posted losses in 2019, and the Riksbank of Sweden posted losses in 2020 due to FX trading.
In sum
Periodic loss announcements by central banks during extraordinary times are temporary and exceptional, as the literature points out, and thus do not serve as an indicator for assessing the effectiveness of monetary policy. Given the extraordinary character of the losses that have lately been reported by a number of central banks, this circumstance is unlikely to have an impact on the upcoming activities of central banks to achieve price stability (García-Escudero & Romo González, 2024).
[1] The countries represented in this sample of central banks, for which annual reports are available for the last five years, account for 66% of world income.
References
Archer, D., & Moser-Boehm, P. (2013). Central bank finances. BIS papers.
Bell, S., Chui, M., Gomes, T., Moser-Boehm, P., & Tejada, A. P. (2023). Why are central banks reporting losses? Does it matter? (No. 68). Bank for International Settlements.
García-Escudero, E. E., & Romo González, L. A. (2024). Why a central bank’s bottom line doesn’t matter (that much). Banco de Espana Article, 1.
Long, J., & Fisher, P. (2024). Central bank profit distribution and recapitalisation (No. 1069). Bank of England.