Central Banks of the Eurozone in Trouble, A Series of Poor Annual Reports Expected

Central banks of the eurozone will announce their first significant losses in the coming weeks, heralding a new era of oversight and prospects for taxpayer bailouts.

The European Central Bank will release its annual results on Thursday, and it is expected to likely hint at a series of uncomfortable national reports, with the German Bundesbank potentially facing the largest hit of all.

‒ Results will turn negative for many banks as early as 2022 due to mismatched interest rates on assets and liabilities ‒ stated Mario Centeno, Governor of the Central Bank of Portugal, in an interview.

Losses in the eurozone would add to the list of examples on the global stage, and the current outlook has some officials nervous about the financial state of the region and potential fiscal implications.

The Bank for International Settlements (BIS) has indicated that such outcomes are not significant, that central banks can operate with negative capital, and that they cannot go bankrupt. Above all, officials assert that losses do not impact monetary policy.

Problems in Germany

Furthermore, the Bundesbank is likely to record small losses in 2022 that could rise to €26 billion in 2023 if ECB rates remain at current levels. This would wipe out €20 billion reserved for losses as well as €5 billion in capital.

Other eurozone partners are also facing significant losses, but not enough to wipe out capital. It is expected to total €17 billion in France, €9 billion in Italy, and €5 billion in the Netherlands. If rates remain high in 2024, the Dutch and French central banks could also be at risk of negative capital.

The head of the Dutch central bank, Klaas Knot, warned his government in September of ‘cumulative losses that will be significant’ in the coming years.

Jerome Haegeli, Chief Economist at Swiss Re and former SNB official, stated that losses are likely to expose central banks and their money-printing programs to stricter political and public scrutiny.

The combination of high inflation and any taxpayer transfers needed to offset negative capital positions can be seen as a ‘super tax on economies,’ he remarked.

‒ Together with central banks no longer providing unexpected profits means that the public deficit is increasing ‒ he said, adding that in the worst-case scenario, filling financial gaps in central banks could mean that governments ‘will need even higher taxes.’

Haegeli also stated that the dual effect jeopardizes ‘the most important asset of central banks, which is their de facto independence.’

The Problem of Government Bonds

As reported by Bloomberg, losses arise because the ECB created liquidity by purchasing €5 trillion in predominantly government bonds to stimulate inflation and stabilize financial markets during the pandemic. A large portion of those funds has been returned as deposits.

National central banks pay interest on them at the ECB rate, which is currently 2.5 percent, and according to data presented by Bloomberg, their corresponding assets are fixed coupon bonds that pay on average only 0.5 percent.

Although monetary decisions are made by the ECB, operations are conducted at the national level. The Bundesbank is the most affected as German government bonds are considered a safe haven, with low or even negative yields. The Bank of Greece, whose purchases were much smaller, is unlikely to remain profitable.

Eurozone institutions have indeed anticipated a deficit, and as Centeno stated, central banks made a huge amount of provisions during the last cycle of good results. For years, that profit helped finance government spending, and the turnaround now means that public funds may be needed to restore balance sheets.

For example, the United Kingdom has already approved a transfer of £11 billion to the Bank of England as part of a pre-agreed compensation.

A loss of AUD 36.7 billion at the Reserve Bank of Australia has left it with negative capital of AUD 12.4 billion. In June, bank officials stated that they hope to restore reserves by retaining future profits and that no state cash has been requested.

According to the head of the BIS, Agustin Carstens, this is perfectly fine. Earlier this month, he stated that central banks ‘can and do operate effectively’ even with negative capital. He argues that the essence of central banks is not profit, but public good.