Tuesday, 23 July

Central Banks’ profits and losses – Where do they come from?

Central Bank

The European Central Bank (ECB) in a podcast published on February 23, 2023, has explained the sources of central bank profits and losses, and whether it did matter whether central banks made a profit or loss. The release, which was done after the ECB had released its financial statement for the year ended 2022, stressed on the primacy of central bank’s mandate of keeping prices low, hence, are not expected to negate this role and avoid losses in order to report handsome profit.

“In today's difficult economic environment central banks across the world are either making or warning of losses. It's important to remember though that central banks are not like ordinary companies; they can lose money and still operate effectively” the podcast stated. Even though the conversation was on where profits and losses could come from in the context of the ECB and the central banks in the 20 countries using the Euro, it provided insightful information that explained how and why central banks globally incur losses.

“A central bank doesn't work towards making a profit. Its aim or its mandate is actually to keep prices stable”, the podcast revealed.

“We are a public institution and like an ordinary company we can make profits and losses but making profits or avoiding losses at all costs is not our aim, our aim is to keep prices stable”, the podcast explained, further stressing that profit is “basically a by-product of what we do, of our mandate”.

Analysing the composition of cost to the ECB, the podcast explained that “when banks deposit money with us, and banks do deposit money with us because they have accounts with us just like citizens have accounts with commercial Banks, commercial banks have accounts with the Euro system and we pay interest rate on these deposits and that's, I would say, the biggest source of costs”.

The ECB sets three interest rates, and one of them is the deposit facility rate, at which rate the ECB pays interest to the banks. This is similar to the cost of open market operations that some central banks use to mop excess liquidity from the economy.

“These losses that we've seen this year have been down to different things, some of them a little bit tricky to explain than others, but this last point that we talked about, the interest rates, this is key here because they're closely linked to some of those losses. I just want to zoom out a second to look at the economic environment that we're in right now because it's also important. Inflation is high and we are raising our key interest rates to tackle that including the deposit facility”, the ECB explained.

It may be recalled that the Bank of Ghana released its Annual Report and Financial Statements just a few weeks back, depicting a cost of GHc8.3 billion on its open market operations to tame inflation. This cost incurred has proved significant, as the mopping up exercise contributed to the reduction of inflation by more than 30 percentage points, from a high of 54.1% at the end of December 2022 to 23.2 % at the end of December 2023.

The Bank of Ghana has further explained that keeping inflation low and stable was a precondition for economic growth and that within a floating exchange rate regime it also contributes to exchange rate stability. The Bank of Ghana’s medium term inflation target is 8%, however, the central bank accepts fluctuations of plus/minus 2% of this target.

Source: ECB