April 7, 2016    3 minute read

Why the ECB can’t go Bankrupt

   April 7, 2016    3 minute read

Why the ECB can’t go Bankrupt

The ECB recently published a paper titled “Profit Distribution and loss coverage rules for central banks.” The paper subtly outlines how central banks, including the ECB, account for profit and losses, and how those profit and losses are distributed to the shareholders of those central banks – usually, the state in which they are based or in the case of the ECB the member parties of EU. In the light of the ECB expanding its current quantitative easing program by engaging in a €80 billion per month asset purchase program, the issue of central bank profit distribution is both complex and politically controversial. Though the paper is useful, it also raises the question of what would happen if the ECB makes significant losses on its asset purchases.

As central banks apply divergent rules as regards profit distribution and loss coverage, in the case of the ECB loss is carried forward. The loss in a particular year, which cannot be covered from specific or general buffers, is carried over to subsequent year(s) and offset against future annual profits. This could result in negative equity pending completion of the process or possible bankruptcy if the central bank is persistently fails to fund its debt obligations.

In discussing the profitability of central banks, the paper states that it isn’t necessary for central banks to make money. This isn’t a central bank’s core objective but could be incorporated into a central bank’s corporate governance mandate as it is useful in determining its credibility and efficacy of the bank. In a footnote the ECB describes this by stating:

“Central banks are protected from insolvency due to their ability to create money and can therefore operate with negative equity.”

This insinuates that it is impossible for central banks to run out of money as they are the ones that create the money and are at the liberty to do so when deemed necessary. You cannot run out of something you create yourself and therefore the ECB has in theory an infinite supply of money. Fortunately, the case of the ECB, there is a ceiling for the ECB’s general financial buffers in place (i.e. the sum of the general reserve fund and the general risk provision of the ECB may not exceed the value of the ECB’s paid-up capital). On the other hand, stakeholders – in particular, governments –  could influence the distributable profit of the central bank and attempt to change the risk provisions of transactions undertaken in order to generate higher profits. Mario Draghi, President of the ECB, has been accused of implementing monetary policy with such above-the-line- risk provisions. Since no two central banks have identical balance sheet structures and therefore risk exposures, it is unclear which non-exhaustive set of principles the ECB has at its disposal in the case of significant losses from its asset purchase program.

Since no two central banks have identical balance sheet structures and therefore risk exposures, it is unclear which non-exhaustive set of principles the ECB has at its disposal in the case of significant losses from its asset purchase program. This also raises the debate whether central banks should be financially independent and whether society should force an established link between financial independence, institutional independence and the credibility of central banks’ monetary policy conduct. The issue at hand, however, is that the quantifiable/measurable outflow of economic benefits owed to quantitative easing are still unclear. As an individual with little power I can do no more but question the ECB’s policy and with regards to quantitative easing hope for the best.

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