(Kitco News) With aggressive rate hikes the theme of the day, are central banks worldwide at risk of going bust? ING looked at the global monetary policy shift and its impact on central bank balance sheets.
"As central banks are moving into a more 'normal' world for monetary policy, this also means that bank reserves will again be remunerated at positive interest rates. Some market participants might have forgotten about this, but this new normal has always been the reality," said ING's global head of macro Carsten Brzeski. "The current situation is different from anything we have seen in the past as excess liquidity as a result of quantitative easing (QE) and negative interest rates is extremely high."
With the sudden increase in rates, potential losses for national central banks could come quickly and exceed existing buffers, noted Brzeski in a report.
"Eurozone central banks running down their buffers, and their equity turning negative, has now become a possible scenario for the years ahead," he said. "Central banks that can print money can never fall short of money. Central banks can make losses, but they don't go bust. Instead, central banks can roll over losses into the next year, have reserves or need to be 'bailed out' by the governments via capital injections or an increase in their own capital."
For example, European Central Bank's (ECB) potential losses would first be balanced out via strategic reserves and then paid by the national central banks based on their share in the ECB's capital.
"The ECB's capital can also be increased, as was the case during the euro crisis when it was increased from €5bn to €10bn. National central bank losses do eventually end up with taxpayers as they transfer their net profits to national Treasuries," Brzeski described.
When it comes to negative equity, the ECB's June 2022 Convergence Report revealed the Bank's thinking: "any situation should be avoided whereby for a prolonged period of time an NCB's net equity is below the level of its statutory capital or is even negative... Any such situation may negatively impact the NCB's ability to perform its European System of Central Bank (ESCB)-related tasks but also its national tasks. Moreover, such a situation may affect the credibility of the Eurosystem's monetary policy."
The option to print money to offset central bank losses translates into purchasing assets as monetary policy tightens, which is counterproductive and unlikely to work, Brzeski explained.
One solution ING proposed is reducing excess liquidity to avoid negative central bank equity.
The rapid transition from negative to positive interest rates comes with unwarranted side effects, particularly as it (intently) coincided with ample liquidity. These side effects are losses for central banks, which have triggered the first central banks to quickly withdraw excess liquidity and others are likely to follow," Brzeski said. "For the ECB, the easiest and least controversial way forward is a reversed tiering of the deposit facility. This option would not be as counterproductive to further rate hikes as offsetting potential losses by printing new money or asking governments for capital injections would be."
During the era of negative rates, the ECB introduced a reserve tiering system, with banks only required to put a fraction of their reserves in the ECB's deposit facility, while the rest could be placed at a zero interest rate in the ECB's current account facility. "A reversal of such reserve tiering makes sense as it allows central banks to not remunerate all reserves," Brzeski said.
