Losses: Central banks versus commercial banks

A central bank or monetary authority is an organisation that manages a country's currency, interest rates and money supply. Central banks are usually held with the responsibility of overseeing functions of the scheduled banks of their respective countries. The central bank in any country is the apex body of monetary decisions with objectives of controlling inflation, maintaining price stability, performing functions of monopoly in note issue, banker to the government, bankers' bank, lender of the last resort, controller of credit and maintaining stable exchange rate etc.
The main distinction between central bank and commercial bank is the sustainability of the former even after the incurred losses. To be an efficient institution central bank doesn't need to make profits. Even making profits by the central banks don't guarantee their success. As Professor Sirimevan Colombage in an interview with Colombo Telegraph stated "A profit-making central bank is not necessarily better than a loss-making one, as the success of both institutions depends on the way in which monetary policy is conducted by each of them, but not by the levels of their profits or losses per se."
The success of central banks depends on their ability to maintain the targeted level of inflation, price stability, economic growth and employment. Although the success is not eroded in any way by the incurred losses of central banks, care should  be taken so that their repeated losses can't endanger their image and credibility. According to a report published by The Economist on August 01, 2015, "The Swiss National Bank (SNB), Switzerland's central bank, reported second quarter losses of SFr20 billion ($20 billion). Following an equally bad first three months of the year, the SNB's losses so far for 2015 now stand to a whopping SFr 50.1 billion, equivalent to 7.5% of Switzerland's GDP." The losses of The Swiss National Bank (SNB) were due to the nasty consequences of the currency peg.  First, the appreciation of the franc made Swiss exports more expensive for foreigners, prompting the Swiss economy to start shrinking in the first quarter of 2015. Second, the depreciation of the euro against the franc led to significant currency losses on the SNB's $550 billion foreign-exchange reserves, of which some $230 billion is held in the single currency.
It doesn't matter for losses by the central banks if their footprint is kept on the track for the accumulated well-being of the economy. In occasional paper series the European Central Bank (ECB) has stated that by introducing a number of non-standard monetary policy operations, a number of central banks during the global financial crisis expanded their balance sheets considerably. These new programmes increased the risk of incurring losses.  However, if losses are incurred by the operation of central banks they have so many ways to cover losses:
i) The utilisation of accumulated reserves and, where these are exhausted
ii) Offsetting carried losses against future profits. Failing this, the central bank must be recapitalised by the state, normally through transfers of marketable government debt - a situation that is not politically palatable to most governments most of the time, and which is likely to occur at a time when governments have their own economic difficulties.
The central banks don't need to incur profits to show its financial robustness and efficiency. Even central banks should not have any limit to the losses they can make at any point in time. Paul De Grauwe, Professor of International Economics, London School of Economics, and former member of the Belgian parliament, and YuemeiJi, Economist, LICOS, University of Leuven, stated at VoxEU "It is not correct to claim that the central bank needs to hold positive equity 'to remain solvent'. A central bank needs no equity. As a result, the claim that is sometimes made that a central bank with negative equity needs to be recapitalised by the treasury is senseless. To be clear:
o The central bank (that cannot default) needs no fiscal backing from the government (who can default).
o The only backing the central bank needs from the government is that it can keep its monopoly power to issue money in the territory over which the sovereign has jurisdiction."
Thus the central banks need not worry about making losses as they are freed from solvency constraint granted with the power by the sovereign authority.
RabiulHossain
The writer is Assistant Director, Bangladesh Bank.
rabiulhossain448@gmail.com