Central banks are not here to make profits

Op-ed by Mr Agustín Carstens, General Manager of the BIS, published by the Financial Times (for subcribers only), 7 February 2023.

Unlike businesses, central banks are designed to make money only in the most literal sense. They have a mandate to act in the public interest: to safeguard the value of the money they issue so that people can make financial decisions with confidence. The bottom line for central banks is not profit, but the public good.

Today, following an extraordinary period in economic history, some central banks are facing losses. This is particularly true if they bought assets such as bonds and other securities to stabilise their economies in response to recent crises. Many will not contribute to government coffers for years to come.

Does this mean that central banks are unsound? The answer is "no". Losses do not jeopardise the vital role played by these institutions, which can and have operated effectively with losses and negative equity. And the unique nature of central bank tools means that sometimes losses are the price to pay for meeting their objectives - to support growth and jobs, ensure stable prices and help keep the financial system safe and stable.

In normal times, it is possible for central banks to both fulfil their mandates and earn profits without taking on significant financial risk. Traditionally, being the unique issuer of money provides a reliable revenue stream. But central banks with large foreign exchange reserves, built to cushion external shocks, will often experience ups and downs in income from exchange rate fluctuations. This means they sometimes make losses when pursuing their goal of a stable currency.

In times of crisis, central banks may also need to take on additional risks. And they do so with their eyes wide open. One example is the purchases of government bonds, including those made during the great financial crisis and more recently during the Covid-19 pandemic, in order to avert economic disaster by supporting financial stability, keeping credit flowing and boosting economic activity.

In the last decade, with inflation and interest rates low for a long period, these bond purchases boosted income. In fact, some central banks were able to transfer unusually large profits to governments. But in the wake of the pandemic and given the invasion of Ukraine by Russia, inflation has returned. This requires higher interest rates to contain spiralling prices - and exposes central banks to losses related to assets purchased in past successful rescue efforts.

Central banks should put purpose above profits. Would it make sense for a central bank with large foreign currency reserves to increase their value by haphazardly triggering a devaluation of its own currency just to generate a windfall? Or for a central bank with domestic currency assets to keep interest rates low, even in the face of high inflation, just to preserve low-cost funding and generate profits? Such actions would be wildly inappropriate, violate their mandates and destabilise the economy.

The soul of money is trust. To operate effectively, business must maintain the trust of investors. And central banks must maintain the trust of the public.

Governments also have a role to play in the face of today's central banks' losses. Because these institutions are ultimately backed by the state, trust in money requires sound government finances and good financial management.

Losses matter because they may inflict a bruise on public finances but a far greater injury would result from central banks neglecting their mandates in order to avoid a loss. The public, via elected officials, have given central banks the job of price and financial stability because of their enormous societal benefits. Now, and in the long term, the costs from central bank losses are insignificant compared to the costs of runaway inflation and prolonged economic crisis.