Abstract
Since the increases of policy interest rates in the years 2022-2023, a number of central banks are suffering significant losses from the materialisation of interest rate risk. These losses erode the capital buffers and raise questions about the cost-efficiency of monetary policy. This warrants a closer look at the topic of central bank profitability. What drives central bank profits? What is the problem with central bank losses exactly? And what possibilities do central banks have to influence their profits and manage public perception? In this paper we revisit these questions for central banks in general, with a particular focus on the Eurosystem and De Nederlandsche Bank.
Although central bank losses can be an accepted consequence of necessary monetary policy (risks), they are regrettable as they constitute public money that could have been otherwise used for public purposes such as education and healthcare. But even low (positive) profits are undesirable. In general, central bank profits contribute to maintaining a strong balance sheet and support financial independence from the government. A central bank should preferably generate sufficient income over time to grow its capital in line with GDP (Gross Domestic Product). Here, we use the concept of “capital” in a broad sense, i.e. shareholder capital and provisions, acting as risk buffer. This risk buffer should develop in line with GDP as that is roughly proportional to the underlying latent risks of the central bank from the economy and the banking sector.
Central bank profits are mainly driven by the monetary policy interest rates – which have little room for including “efficiency” considerations. However, central banks should understand the outlook of their profits under different (interest rate) scenarios. This is also important for Eurosystem national central banks and the ECB which are exposed to the financial consequences of the ECB’s monetary policy decisions via income and cost sharing arrangements. Some of the balance sheet items allow for profitability considerations to be included in their management. The central bank’s own investment portfolio is the most prominent example. With the significant losses of a number of central banks, it may be wise to consider profitability more explicitly in the central bank policies. This paper attempts to offer input on that question.