Category: Irish Banking sytem

Irish Central Bank losses

One of the legacy issues stemming from the ECB’s QE operations is that national central banks across the euro area are reporting annual losses in their 2023 accounts, and flagging further losses to come. The Dutch central bank figure of €3.5bn was dwarfed by the Bundesbank’s €21.6bn , which wiped out its reserves. Against that backdrop the recently reported Irish central bank’s loss of €132m appears a very good result, although there are a number of factors at work which imply that the 2024 figure will be much higher.

In the ten years to 2023 the Central bank was recording large profits and transferring substantial sums to the Irish Exchequer , exceeding €2bn per annum on occasion, with a total of over €15bn.This in part reflected the negative interest rate the CB was paying on deposits from the Irish commercial banks but a key factor was the interest and capital gains on the €25bn Floating Rate Notes (FRN) issued by the Irish Government the CB had acquired as a result of its liquidity support for Anglo Irish Bank.The maturities varied , with an average interest rate of 6-month Euribor plus 2.63%, so the value of the notes soared in a period of very low and then negative rates.The CB sold the notes back to the NTMA over time, recording large capital gains, and that was also the case in 2023, with a gain of €1bn.

So absent that realised gain the loss would have been over €1.3bn, and as the notes have now all been sold that source of profit is no longer available, putting more emphasis on the CB’s net interest income. As a consequence of QE and the PEPP the CB held €60bn of securities for monetary purchases , receiving €379m in interest in 2023, implying an average coupon of only 0.63%. These asset purchase were funded by the CB creating deposits for the banks selling the bonds and the Deposit Facility Rate has of course climbed as a result of ECB monetary tightening, from -0.5% in mid 2022 to the current 4.0%. In 2023 the CB paid €2.8bn to Irish banks on these deposits, so giving a net interest loss of €2.4bn as a legacy effect of QE.

The deposit facility is likely to fall in 2024, so reducing the deposit interest paid, while the bonds held will gradually decline as they are no longer replaced as they mature. The CB also has other sources of income to offset its €300m in operating costs, including interest on positive Target balances at the the ECB (as a result of monetary inflows into Ireland) which are remunerated at the refinancing rate , which is currently 4.5%. The total interest earned last year was €3.4bn, but again this is likely to fall as the ECB moves to monetary easing.

The net loss of €132m loss last year was met by drawing down from the €3bn in provisions set aside for that purpose and as noted absent the gain from the FRN the loss would have been well over €1bn. Consequently the next few years may well see much higher headline losses, although the CB cannot go bankrupt as it has large reserves and can also print money. It does mean though that it may be some time before transfers to the Exchequer resume.

QE Legacy: big losses for Central Banks, big profits for commercial banks

Ben Bernanke one said that the problem with QE is it works in practice, but not in theory.The latter point, much debated in academic circles at the time, centres on the fact that QE was an asset swap -the Central Bank bought bonds, largely Government debt, which paid a fixed interest rate, and paid the commercial bank sellers a floating rate on the reserves created to finance the purchase. So, it was argued, it was a zero sum game, with either side of the swap gaining and losing at any one time depending on the interest rate cycle.

Central banks made large profits for years, because the rates paid on reserves were near zero and in the euro area were negative, falling to -0.5% at one stage. This allowed central banks in may cases to transfer a large portion of these profits to their respective governments.The flip side, for Euro banks in particular, was a big hit to their net interest margin, as they were effectively paying the ECB to deposit money , with reserves swollen by ongoing QE, then augmented by the PEPP operation.

The ECB initially argued that credit growth would offset the negative impact on NIM but eventually became concerned about the impact on banks , eventually introducing a long term loan to banks at a rate below the deposit facility rate (TLTRO III) ,amounting to a profit subsidy.

The onset of the tightening cycle has changed the profit/loss dynamic however. The ECB’s deposit rate, for example, has risen by 4.5%, to 4%, since July 2022, so Central Banks across the zone are now faced with paying out far more in interest than they receive on the bonds they hold, which in some cases carry a negative rate anyway. The Bundesbank’s annual results makes this starkly clear; their interest income in 2023 was €55bn against interest expense of €69bn and with staff costs and other expenses the loss would have been €21.6bn, had they not transferred €19bn from provisions and €2.4bn from reserves. So no transfer of profits to the German Government and another loss is expected this year, which will wipe out the remaining reserves, with losses carried forward until eventually offset by future profits.

The Irish Central Bank has already flagged the probability of losses, particularly as it was making large profits from the sales of its IBRC linked bonds but have now sold the full complement. The Bank still owns €67bn of Irish Government bonds acquired through PEPP and QE, receiving relatively low fixed rates, while currently paying 4% on the €90bn held by Irish banks in the deposit facility( or €3.6bn a year). In some years the Central Bank was transferring €2bn or more from its profits to the Exchequer (not much commented on, oddly enough) but that will be zero this year and no doubt for some time to come .