Rising interest rates have created a gap between the income of Europe’s central banks and the interest they now have to pay to private financial institutions for their deposits. As a result, most of them will record losses in the coming years and may see their independence compromised.

Sharp interest rate hikes by the European Central Bank (ECB) will cause the central banks of the eurozone countries to record losses in the coming years. The cause of the red numbers is none other than the gap between what they earn and what they pay out.

The public debt acquired by these banks in recent years earns them hardly any interest. This was not a problem until July last year because until then they did not have to pay interest on the deposits entrusted to them by private financial institutions. The 0% rate set by the ECB allowed them to do so. In recent months, however, the interest rate has risen to 2.5%, which has upset the balance sheet equilibrium.

Bad times for central banks

Already in September, the Dutch central bank (DNB) warned in a letter to the Dutch prime minister that it was suffering from the financial consequences of the ECB’s change in monetary policy. In it, the DNB had to cope with increases in the rates it pays on deposits entrusted to it by banks, while the income from purchased bonds was not increasing accordingly. And it extended this problem to “all central banks that implement [debt] purchase programmes, both in the euro area and outside it”.

A few weeks later it was the governor of the Bank of Spain (BdE), Pablo Hernández de Cos, who acknowledged that this body, “like the vast majority of central banks in the Eurosystem”, would record losses in 2023. In an appearance in December, he added that this situation will last several years.

This will not entail a cost for the State in the short term, as the BdE has provisions of more than 30 billion euros to cover financial risks. However, it will eliminate the contribution made by this institution to the public coffers in recent years. Its profit in 2021 was already reduced by 16% in 2021 to 1,785 million euros. Of this amount, 925 million was paid into the Treasury, as required by Royal Decree 2059/2008. It has yet to publish its 2022 accounts.

Losses also for the ECB?

Reuters pointed out a few weeks ago that the European Central Bank itself is also exposed to going into the red, as it has to pay a huge amount of interest to commercial banks, whose deposits with the ECB amount to around five trillion euros globally.

The European banking regulator is largely owned by the national central banks of the countries that have adopted the euro. Therefore, some analysts point out that these losses could even force some of these central banks to request a bailout.

However, it should be borne in mind that the ECB has significant resources at its disposal to avoid such a scenario. In addition to exhausting its provisions, it could draw on any income that national central banks earn in their monetary policy operations, such as bonds and loans, to improve their accounts. It also has the possibility of deferring losses by booking them on its balance sheet as a credit against future profits.

Central banks can continue to operate despite incurring losses that exhaust their capital. However, as the ECB itself points out, “the principle of financial independence implies that, ultimately, national central banks should always be sufficiently capitalised“. This is the only way to guarantee their independence from the governments of the day.

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