A tough time for central banks

This week we’ve heard the Swiss National Bank announce that it will no longer pay interest on the minimum reserves that commercial banks hold with the SNB. 

>> Major central banks are close to end tightening cycle

We are not talking about the widely-unanticipated surge in inflation in recent years that has forced G10 central banks to play catch-up with dramatic rate hikes. Instead, what we are talking about is the losses that many are making. The conventional view is that central banks losses don’t matter as they can’t go bust. But while that might be technically true, at least in the G10 space, the fact that many are taking steps to deal with the problem suggests that there might be a problem here.

This week we’ve heard the Swiss National Bank announce that it will no longer pay interest on the minimum reserves that commercial banks hold with the SNB. While some may argue that this move represents a political payback to deny banks interest earnings, especially following the collapse of Credit Suisse, many others will say that it is an effort to save more than CHF600bn per year at current rates as the SNB fights back against huge losses. Clearly the SNB is not the only central bank to make big losses as all central banks that have engaged in QE and accumulated large amounts of bonds are haemorrhaging money as bonds collapse.

Central banks have different ways of dealing with this. The Swedish Riksbank said recently that its SEK80bn loss last year means that it has a negative equity position of SEK18bn and is asking the government to stump up the cash to lift this back to the ‘basic’ level of SEK40bn. The Bank of England has an indemnity from the government which lets it off the hook when it comes to QE-related losses.

As for the Fed, it can conveniently ‘park’ the losses under the heading of “deferred assets” and pay the losses down as profits (presumably) recover in the future. And in many senses this is the key point; future profits. For unlike a regular company, a central bank can count the present value of future profits as a definitive ‘asset’ because it is unique in being able to print money. The seigniorage revenues from this are theoretically at least an asset that prevents the central bank going bust.

The only problem arises is if central banks abuse this power by essentially printing so much money, in order to raise revenue, that the public will no longer accept the cash and will choose another currency instead, such as the dollar. If the government refuses to bail out the central bank, then this can conceivably lead to insolvency and there have been some rare instances when central banks have gone bust.

>> Any risks from an easing cycle ahead of major central banks?

But clearly when it comes to major developed-country central banks we are not talking about any such outcome. The banks will not subjugate monetary and inflation control just to make a quick buck to try to stave off bankruptcy by printing huge amounts of cash. However, this is not really what we are talking about. Instead, there is a potential problem if efforts to resolve financial difficulties impinge on the banks’ work.

For instance, the SNB, like the ECB before it, said that its decision to reduce its pay-out to banks on their reserve holdings does not impinge on the operation of monetary policy. But the Bank of England, for instance, has eschewed any such action on the basis that it does believe that it could impinge on its ability to set policy. And then there’s the question of central banks adhering to their strict independence mandate if, like the Riksbank, they are theoretically bailed out by the government.

But is it likely that any of these sorts of question marks over central bank solvency and its policy implications impact market psyche? At this stage it seems very unlikely. But who is to say whether it could happen in the future if central banks rack up large losses year after year? The Standard Bank said that it certainly has a fiscal consequence as governments are denied central bank profits even if they don’t have to cover losses. In short, it might not be an issue now, even if it is gaining a bit in severity, but it could easily become something financial markets focus on a bit more in the future should the difficulties that many central banks have had up to now continue and intensify in the future.