FRANKFURT 29 November (Reuters) – As high inflation forces the European Central Bank to raise interest rate and pay for a decade of aggressively printing money, it warned that it could be in trouble.
The ECB has raised interest rates in an effort to combat rising prices. It must pay huge interest to commercial banks on 5 trillion euro worth of deposits that it has created via large bond purchases and low-interest loans.
Those stimulus instruments, which were deployed over many years when inflation was too low for most people, are now likely to drive the ECB and its shareholders, including the central banks of Germany and the Netherlands, into the red.
Some central banks might be forced to seek bailouts, which could raise questions about their independence as well as anger taxpayers.
On Tuesday, the ECB posted on its website that it must combat inflation by raising interest rates. This results in higher interest costs for banks. “In this instance our profit falls and we might even lose.”
Ironically, the most fiscally prudent countries’ central banks will be hardest hit because they hold a greater share of bank deposits and their bonds purchased on behalf of the ECB yield zero or lower.
The Dutch central bank openly admitted the possibility that it might be in need of a recapitalisation from its government. But, Sigridkaag, finance minister, cautioned that this was not yet on the table.
The ECB, which is mainly owned by the national banks of the 19 Eurosystem countries, accounts for 8%.
It could also deplete its reserves and tap any income national central banks receive from their monetary policy operations, such as bonds or loans.
The Bundesbank also suggested that it could defer any losses by writing them on its balance sheet, as a claim against future earnings – an option that was also mentioned last week by the Bundesbank.
The ECB stated that “Ultimately, the return of a positive interest environment supports Eurosystem profitability over the medium term.”
Even if they suffer losses that drain all their capital, central banks can still function normally. This has been the case in many countries in recent years, including Germany.
However, ECB doctrine states that it should be well capitalised to preserve its independence from governments as well as its credibility in fighting inflation.
The ECB’s easy policies have been a great help to governments in the Euro zone. They are able to borrow less and receive dividends from their central banks. It is possible that they will return some of this money.
The ECB stated that central banks are different from ordinary businesses in that they can lose money but still function effectively. “But, the principle financial independence requires that central banks of national importance should always have sufficient capital.”
Reporting By Francesco Canepa
Bernadette Baum edits
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