Where do Bank of Canada profits come from?
The Bank of Canada, like all other central banks, is generally a very profitable business. Its profits come from issuing money, called seigniorage rights, a right that belongs exclusively to central banks. The Bank of Canada also receives interest income on the federal government debt securities it purchases. These revenues, less interest paid on the reserves of the commercial banks it houses, are enough to pay their operating expenses and generate surpluses year after year that are paid to the federal government. These profits reach approximately $1 billion annually.
How can a central bank lose money?
The short answer is quantitative easing that the Bank of Canada has undertaken to reduce the impact of the pandemic on the Canadian economy, explains David Dupuis, an economist and professor at the University of Sherbrooke.
Like other central banks, the Bank of Canada massively bought up federal government debt to put oil into the engine of the economy. Its balance thus went from 120 billion to 575 billion in the space of 12 months. The bank has stopped these purchases, but it still has $415 billion in securities that pay a very low interest rate, while it must remunerate the reserves deposited by commercial banks at the key rate, a rate that has increased rapidly and is now it keeps. at 3.75%.
The interest income of the central bank is, therefore, lower than its interest expenses, hence the appearance of a deficit, the first in its history.
It’s unheard of, but the Bank of Canada isn’t the only one to post losses this year. The US Federal Reserve and the Central Bank of Australia, among others, are in the same situation.
Does that mean that the Bank of Canada has done too much to stimulate the economy?
It is not in the central bank’s balance sheet that we can see if there has been too much or not enough quantitative easing, but in inflation, David Dupuis specifies. The rising inflation rate is the combined result of monetary policy and aid measures by the federal government, but also external factors such as supply chain problems and the war in Ukraine. Canada is one of the countries that has had to reduce the impact of the pandemic on the economy the most, and part of the inflation is certainly attributable to fiscal and monetary policies. These policies have also enabled a rapid recovery of the economy, stresses the professor.
When will the profits come back?
The Bank of Canada ended quantitative easing and began trimming its Canadian Government bond portfolio in October 2021. Since then, its balance sheet has shrunk by 28%, from $575 billion to $415 billion . The bank’s financial situation should improve as this balance sheet becomes thinner, which could take a few years.
“The Bank will experience losses for a period and then return to positive net profit,” Governor Tiff Macklem told the House of Commons Finance Committee on Wednesday.
The losses could reach 5,000 million, according to the figures that circulate, but that the central bank does not confirm. The magnitude of those losses will depend on the path of interest rates and how the economy performs, the governor said.
“If inflation continues to decline and interest rates stop rising, it could take two years to get back on track,” said Steve Ambler, David Dodge Chair in Monetary Policy at the CD Howe Institute and a professor at the University of Quebec in Montreal. .
How will these shortfalls be covered?
The deficit does not change the functioning of the central bank. As it had never happened before, a solution will have to be found to absorb the losses, as long as its balance is normalized. One solution being considered would be for the central bank’s shareholder, the federal government, to simply write a check to the central bank. According to Steve Ambler, this solution could give the impression that the federal government is coming to the rescue of the central bank and can therefore influence monetary policy. “That wouldn’t be the case, but you have to think about appearances,” he observes.
In order not to damage the credibility of the central bank, a better solution would be to allow the Bank of Canada to create a deferral account for its losses, which would allow it to repay its deficit when it recovers its profits, especially the payment to the government.
An amendment to the Bank of Canada Act Such an account would need to be created, believes Steve Amber who, with two colleagues, details this pathway in a CD Howe Institute publication.
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