Central Bank Profits May Not Be Critical But Still a Good Sign

(Bloomberg) -- There are good reasons why central banks should think about profit as well as monetary policy, according to a new study.

Financial strength can help monetary institutions fulfill their mandates and indicate the success of individual policies, Francesco Chiacchio, Gregory Claeys and Francesco Papadia write in a paper published Thursday by Brussels-based think tank Bruegel. Central-bank income also presents a revenue source for governments, a factor that’s gained interest since the European Commission proposed earlier this year setting up a rainy-day fund using that money.

“While a central bank does not need to generate profits to fulfill its macroeconomic functions, it is better if it does,” the economists wrote. “Overall, the Eurosystem has so far respected this principle.”

At the European Central Bank, profits have been fairly stable over the years since its creation. At the same time, policy makers have stressed that their primary goal is and will remain price stability, whatever the bottom line may be at the end of the year.

Central Bank Profits May Not Be Critical But Still a Good Sign

The euro area’s 19 national central banks and the ECB rely on several layers of insurance to prevent losses, if they occur, from eroding the institutions’ capital. Profits on holdings such as gold and foreign exchange are retained in revaluation accounts, and provisions are made for any risks that may emerge in the future.

Those provisions may be drawn on when central banks have to pay interest again on banks’ deposits, while not making enough themselves on the bonds acquired under quantitative easing.

While the ECB says on its website that any losses not covered by previously accumulated reserves can be kept on the balance sheet and offset against future income, policy makers have expressed reservations about negative capital in the past.

Bruegel disputes the view that such a situation necessarily leads to impaired inflation control or less independence.

“There have been many examples of central banks with negative accounting capital -- resulting from sustained losses -- which have been nonetheless able to fulfill their macroeconomic mandates without major hurdles,” the economists wrote. “While one can question, in theory, the relevance of central bank profits, in practice it is preferable for the central bank to remain in a reasonably profitable situation.”

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