Article’s Purpose and Background

This short article highlights why central banks making losses on the business of money printing is unjustified and unethical even in common sense in modern monetary economies. Therefore, this article is in the following background.

• It has now become a general practice for many central banks led by the US Federal Reserve, the world’s largest and most influential central bank, to report massive losses.

• This is a puzzle why central banks make losses although they fund their operations through the monopoly printing of money or issuance of fiat money without any business rules and regulations. In contrast, banks who carry on business through the creation of money are required to make a sufficient profit if they are to stay in the business within rules stipulated by central banks as bank regulators.

• In economics, any business must make at least normal profit or be breakeven to escape the closure. However, central bank can continue with any amount of loss, irrespective of economic principles. 

• In fact, in the event a central bank goes bankrupt due to accumulated losses, the law requires that tax payers make the central bank solvent. However, if a state enterprise makes losses or becomes bankrupt due to its public welfare-based business, it is labelled as corruption, waste and inefficiency. In some cases, even criminal charges are framed against identified officials on the ground of loss to public funds. Instead, loss-making or bankrupt central banks are treated as having managed professionally by the cream of economists with divine knowledge.

• In conventional central banking topic, what students learn is the profit of central banking which is known as seigniorage that goes to the government as profit on the state monopoly of fiat money. Therefore, the government to receive negative seigniorage in modern central banking is a puzzle.

What is the business of central banks? Why should they make profit?

The primary role of central banks is to supply money called “reserves” to meet the demand of the economy. This is called money printing. Reserves so supplied consist of currency notes and coins in circulation and deposits held by banks and government in their current accounts at the central bank.

The source of the supply of reserves is the central bank’s lending and purchase of foreign currency. This is bluntly known as the monetary policy.

They lend to banks and governments without having any credit risk. Central banks in developing countries supply reserves by the purchase of surplus foreign currency from banks and governments. They all print money by book entries in the computers to respective bank and government accounts when they lend reserves or purchase foreign currency.

Therefore, central banks should make profit due to three fundamental reasons.

• First, they do not pay interest on currency in circulation and bank deposits of reserves at central banks which are the key financial liabilities of central banks. Therefore, the financial cost on money printing business is zero, other than the small amount of staff and currency printing cost.

• Second, they charge interest on loans granted to banks and governments and earn interest and profit on foreign assets acquired from foreign currency proceeds whereas they do not take business risks in these assets.

• Third, this money printing operation is exclusively licensed to central banks and, therefore, they do not confront any competition in producing reserves to the economy.

If so, why central banks make losses?

The nature of monetary policy-based business operations stated above is largely same for almost all central banks. Therefore, their profits/losses follow same reasons.

Financial highlights of the US central bank are given in the table below to understand central bank business and reasons for profit/loss.

• Accordingly, the excessive interest cost than the interest income on money printing operations is the cause for the Fed losses of US$ 114.3 bn and US$ 77.6 bn reported in the last two years.

• The loss of the Bank of England was £ 75 mn in 2023 and £ 111 mn in 2024 on total assets of £ 1,075 bn and £ 945 bn, respectively.

• The profit of the European Central Bank was zero in 2022 and a loss of EUR 1,266 mn in 2023 on total assets of EUR 698.9 mn and EUR 674.5 mn, respectively.

• However, some central banks like Indian Central Bank make significant profit and remit dividends to the government. In India, central bank dividend is an announced source of monetary financing of budget deficit. A Governor who resisted the profit transfer had to step down.

• Meanwhile, some central banks adopt creative accounting practices to hide actual profit and to prevent profit transfer to the government on the belief that such profit used by the government is inflationary.

Accordingly, following highlights are presented to understand the root causes of the losses of the Fed in special and of other central banks in general. However, creating accounting practices used by some central banks are not covered here.

• Printing money or supply of reserves primarily takes place on the purchase of government securities in the open market. Meanwhile, lending to banks is generally for the supply of reserves for inter-bank payments settlements on a daily basis.

• Therefore, interest income is driven primarily by market yield rates on government securities.

• Reserves so supplied roll over in the economy in two forms.

• Currency not earning any interest income from the central bank.
• Banks depositing and investing excess reserves in the accounts with the central bank for interest income. It is this portion of reserves that causes losses due to payment of interest depending on the central bank interest rate policy or monetary policy model.

• The reasons for unnecessary interest payments on such excess reserves are two-fold.

• First, inter-bank overnight interest rates targeted policy of reserve supply and monetary policy. Accordingly, central banks set a lower bound of inter-bank interest rates (policy interest rate) and pay interest to banks to absorb excess reserves to the central bank so that the lower bound interest rate is maintained. At present, Fed’s lower bound policy rate is 4.25% (upper bound of 4.50%). For this purpose, in addition to interest payment on bank reserve balances, central banks further absorb reserves from banks through repurchase agreements at higher interest rates than interest rates paid on reserve deposit balances.
• Second, the imbalance and time gap between money printing (supply of reserves) and its roll-back keep excess reserves continued in the economy forcing central banks to mop-up them on concerns over possible inflationary pressure. For example, the Fed’s balance sheet ballooned from around US$ 900 bn in 2007 to 4.5 trillion in 2014 consequent to the excessive supply of reserves to deal with the global financial crisis 2007/09 and then to 8.9 trillion in 2022 consequent to another round of the excessive supply of reserves to deal with financial stability concerns over the global Covid-19 pandemic. However, the Fed has no monetary policy to roll-back such excess reserves once concerns at the time of supply are resolved. For example, the Fed’s balance sheet is still at US$ 6.7 trillion at present even if the Fed has pursued a tightest monetary policy of the past two decades during the last two years. Therefore, central banks have to continue paying interest on excess reserves accumulated in the economy, given its policy interest rates corridor-based monetary policy model.
• Therefore, the excessive interest cost has been the root of the loss of the Fed and many other central banks.
• In addition, central banks in developing countries are involved in a huge cost on keeping foreign reserves and over-valued exchange rates as the major component of the monetary policy to please national leaders and general public. In some central banks, the major cause of loss is the cost involved in foreign reserve operations. 

Is central bank independence justified for losses?

During the past 2-3 decades, a concept of central bank independence has grown in line with the US central bank. The underlying assumption is that central banks have the ability to keep economies stable if they are allowed to operate independently from government policies. Its economic rationale prevails as monetary conditions are believed to drive economic activities. Therefore, central bank independence is advocated for maintenance of the price stability, financial stability and production activities as the central bank mandates are driven by their ability to control and drive monetary conditions of the economy as appropriate.

Therefore, the central bank independence has led the public not to question any operations of central banks. Even if questioned, nobody understands technical answers provided by central banks. Their typical answer is that, if they wish to operate for profit targets, they can change interest rates, exchange rates and money printing accordingly. However, the fact is they cannot do it in modern markets. 

Further, It has become customary for the public to confront high inflation or deflation, financial crises and high unemployment from time to time despite central bank stability mandates and independence. What central banks state in such instances is that the stability will reach in the medium and long-term which never starts or ends and they engage in supply of reserves on a day to day basis to banks by stating that the market liquidity is maintained at appropriate levels.

Therefore, no auditors or lawmakers or economists tend to question the rationale of central bank losses. In that context, economic principles are not applicable to monetary business of central banks and they can stay in business despite losses and accounting insolvencies.

However, banks also are engaged in a monetary business by creation of money through lending-deposit business while taking different risks. Unlike central banks, banks are required to manage risks and make profit if they are to stay in the monetary business. Therefore, banks who make losses and become insolvent have to get shut down. Therefore, this dichotomy of monetary business between central banks and banks is against economic principles.

Overall, the present policy interest rates and reserves based monetary policy model is singularly responsible for central bank losses and irregularities. The policy model used before was the monetary sector or money supply regulation in consolidation of money printing and bank business regulation on same page. Therefore, the cost and benefits of the monetary policy were shared by all participants. 

However, the present monetary policy model separates money printing (or supply of reserves) from banking business regulation and, it is the central bank’s supply of reserves that is used for all stability objectives of central banks. Therefore, it is now observed that even banks tend to fail because of the monetary policy. The fine example is the waive of the turmoil across mid-sized banks led by Silicon Valley bank in the US in March/April 2023 in response to rapid interest rate hikes by the Fed even though banks followed a model of investments in government securities. As a result, the Fed had to increase the supply of reserves by about US$ 200 bn in few weeks.

Therefore, banks and markets now gamble on policy interest rates and speculations drive even policy interest rates whereas central banks have no knowledge on interest sensitive economic activities to gage the policy effectiveness.

Therefore, it is now time to question the central bank independence and loss-making monetary policy in view of economic imbalances and uncertainties and economic principles, especially due to the new US trade disputes and new dollar policy. Country governments now desperately need a monetary policy coordinated with the fiscal policy to resolve trade disputes and rebalance economies as required by the US authorities if they are to survive. The US President Donald Trump also heavily criticizes the delay of the Fed to assist its new economic policy and prepares even to amend laws to intervene in the Fed.

Overall, this type of information and analyses shows how flawed is key elements of country governance systems that are expected to improve living standards. The trust in the system without periodically assessing its hidden risks is disastrous.

(This article is released in the interest of participating in the professional dialogue to find out solutions to economic issues affecting living standards. All are personal views of the author based on his research and knowledge on the subject and, therefore, the author has no intension to personally or maliciously discredit views and characters of any individuals or institutions.)

P Samarasiri

(BA (Hons) in Economics and MA in Economics)(Former Deputy Governor, Central Bank of Sri Lanka)

(Former  Deputy Governor, Assistant Governor, Secretary to the Monetary Board, Compliance Officer and Director of Bank Supervision of the Central Bank, Former Chairman of the Sri Lanka Accounting and Auditing Standards Board and Credit Information Bureau, Former Chairman and Vice Chairman of the Institute of Bankers of Sri Lanka, Former Member of the Securities and Exchange Commission and Insurance Regulatory Commission and the Author of 13 Economics and Banking Books and a large number of articles published.)

Source: Economy Forward

*The content in this article is of personal views of the author and does not reflect the opinion of LNW in any way.