Profits and losses of the ECB and the euro area national central banks: where do they come from?
Updated on 23 February 2023 (first published on 16 February 2017)
When you think of the European Central Bank, do you think of a bank aiming to make a profit and avoid losses? It is certainly true that we publish annual accounts, so if there are profits or losses, they are there for all to see. But in fact, we are working towards a completely different goal: to keep prices stable in the euro area. For us profits or losses are side effects of our efforts to fulfil our primary mandate.
The same applies to the national central banks of the euro area countries which, together with the ECB, are collectively known as the Eurosystem. Below we explain where these profits and possible losses can come from.
So how does it all work?
Like other central banks, the ECB and the national central banks of the euro area countries earn income from a number of sources. This includes interest on loans to commercial banks, interest on bonds purchased as part of asset purchase programmes, and income on foreign currency reserves and investments. All these elements are assets held by the ECB and/or the national central banks.
On the other hand, the banknotes that you carry in your wallets are a big part of our liabilities, which do not bear interest and are the basis of our seigniorage income. Another big liability are the deposits that commercial banks keep with us, on which banks receive interest, which for us represents an expense. This is a key part of our monetary policy. For example, if we raise the interest rate that banks earn on their deposits with us, interest rates in financial markets increase too, which has an impact on financing conditions throughout the entire economy. This, in turn, boosts savings and dampens spending, thereby cooling the economy and reducing inflation.
It can happen that our interest expenses to banks are not matched in the short term by an equivalent increase in the income earned on the assets that we hold, in particular if those assets have fixed-rate coupons and a long duration. Like other major central banks, we purchased private and public sector bonds with longer-term maturities in order to lower interest rates at a time when our policy rates had come closer to their effective lower bound. This was necessary in order to support the return of inflation, which was too low for a protracted period of time, to our target. One of the channels through which asset purchases led to lower interest rates was by transferring part of the risk of future interest rate changes from the market to the central banks’ balance sheets. This risk starts materialising now across the world, as a series of unprecedented shocks has led to record-high inflation rates that we have to fight by raising interest rates, which results in higher interest expenses that we pay to banks. In this case our profit falls, and we might even make losses.
Over time, those losses will decline because the income earned by the central banks on the bonds and other assets they hold and the loans they make will also rise. Moreover, losses could also decline if we were to reduce our assets and commercial banks’ deposits with the national central banks fall. Ultimately, the return to a positive interest rate environment supports Eurosystem profitability in the medium term.
What happens if we make a profit?
If we record a profit, we may set aside some money as general provisions and reserves to protect against possible future losses. Any remaining profit is then shared among the national central banks of the euro area countries, who are the shareholders of the ECB.
The national central banks may also set aside some money, but their remaining profits usually go to the country’s government, thus contributing to its budget. This benefits euro area citizens.
And what if there is a loss?
The most important thing to us is our mandate to ensure price stability. That takes precedence over other considerations. We will implement the right policies to achieve our inflation target even if this results in lower profits or even losses. If we record a loss, we can first use the money set aside in previous years. The ECB and other euro area central banks have made sizeable profits for several years – profits before tax and general provisions were approximately EUR 300 billion between 2012 and 2021 – due in large part to the monetary policy pursued during these years, notably asset purchase programmes and negative interest paid – i.e. interest earned – on banks’ deposits. As we are conscious of financial risk-taking, we have used part of these profits to build up financial buffers such as general provisions and reserves, within our statutory limits. Furthermore, certain financial buffers are generated by the revaluation of some of the central banks’ assets. These are also part of our net equity and contribute to our financial soundness.
In the case of the ECB, if our general risk provision was not enough, the national central banks of the euro area countries might cover the remaining loss with their own income earned on monetary policy operations. Any further amount may be recorded on the ECB’s balance sheet, to be offset against any net income received in the future. You can find out more about profit and loss sharing procedures in this Occasional Paper.
It is important to remember that central banks are not like ordinary companies: they can lose money and still operate effectively. Still, the principle of financial independence implies that national central banks should be sufficiently capitalised.
To sum up, our available financial buffers, our risk management frameworks and other safeguards at our disposal ensure that any losses would not impair the Eurosystem’s ability to seek and maintain price stability.