Even central banks suffer from negative rates

The FT reports today that central banks also suffer from negative interest rates. It couldn’t be more ironic.

Investors ranging from small German savers to global life insurers have long complained about central banks’ use of negative interest rates.

Now, however, another group is feeling the pain from negative rates — central banks themselves.

European and Japanese rate cuts are putting pressure on many central banks’ returns — a source of income used to cover running costs and to provide finance ministries with profits on which they have come to rely.

A poll of reserve managers from 77 central banks, entrusted with reserves worth $6tn last August, found a clear majority were changing their portfolio management strategy as a result — including taking steps such as buying riskier assets.

Central banks are indeed big players on the market due to their OMO and related policies that involve purchasing and selling billions of assets in order to influence market prices, aggregate amount of high-powered money and interest rates. They also invest in other currencies and commodities and place cash with other central banks.

Unfortunately, a number of their placements are now generating negative returns and yields on their fixed income investments (often government bonds) are now very low, if not negative.

The irony of the whole situation is that central banks initiated their conventional and unconventional policies partly in order to help (i.e. force) the private sector to take more risks (‘search for yield’). What goes around comes around, and it is now central banks’ turn to follow the same route. In short, they are now turning into vulgar commercial banks that attempt to please their shareholders (i.e. budget-constrained governments who need this cash).

But in doing so, they also potentially endanger their capital base. While it isn’t clear whether or not central banks can fall into bankruptcy and what happens afterwards, I guess we’d all be better off not to reach a point from which we start asking this question.

PS: A French newspaper highlights the very close links between the French government and its domestic financial sector. Many government appointees were formerly financial executives, and many current executives used to work in government. This reminds me of this.

PPS: A few weeks ago, Huw van Steenis, bank analyst at Morgan Stanley, published a good article in the FT about the effects of negative rates on banks. His views are very similar to mine.

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5 responses to “Even central banks suffer from negative rates”

  1. Domenico Ghirlandaio says :

    I feel like I have gone through the looking glass! Is the FT really writing an article inviting us to fret about returns at central banks in the post Bretton Woods global monetary system? A fiat system! This is coo-coo talk.

    Since 1971(when all sovereign currencies were wholly and completely severed from gold) all of the worlds central banks create their own currency by simple book entry. They all, each and every one of them, can create base money ex nihilo instantaneously, at whichever quantity is required to meet the liquidity needs of the clearing system. To wit: There was no extraordinary tax levied to finance TARP, or the trillions in QE. You work in the biz M. Noizet….you know this.

    And while I am at it……

    Worrying about whether or not a modern central bank can go bankrupt or be insolvent is probably the silliest thing I have heard in the last, uh I dunno…. decade. Two decades….it’s silly like a grown man talking about the tooth fairy. It’s WWF silly.

    They can’t run out of money, they are the ones who make the base money, down in the basement of Maiden Lane…. on a computer. Period.

    Just let me ask you this: You go to a knicks game and the score is expected to be, say, 110 to 116. Let’s say some of the players are really doing well and after the third quarter the score is already 114 to 119. Is there a panic in the Garden ? OMG!!! Will the scorekeeper be able to finish the game?? If it goes much higher….oh lord…I don’t know what we’ll do !!!! Where will we get the extra points to handle this unforeseen rise in scoring ??? Get Adam Silver on the line!

    Willem Buiter: Should the credit risk attached to these assets materialise ex post, the balance sheet of the central banks involved would show a large hole. THEIR CAPITAL COULD EASILY BE WIPED OUT.

    WTF???

    No. It. Could. Not.

    The only exceptions to my point are the smaller nations like Iceland and Hungary who could have obligations to deliver Pounds, Euros and Dollars, then you could easily have the kind of calamitous insolvency Buiter is warning of.

    • Julien Noizet says :

      I used to agree with your view but I am now uncertain. I think it’s trickier than that and that we need to differentiate liquidity from capital. Certainly, a central bank can operate with negative equity. But I’m not sure what the implications of this would be in the end. Although to be honest I haven’t much looked into this topic.

  2. Jasmine says :

    Keep up the great posts.

  3. Jake says :

    In terms of Central banks becoming impossible;that is not possible according to ECB http://www.bloomberg.com/news/articles/2016-04-05/the-ecb-explains-why-central-banks-can-t-go-bankrupt-in-a-footnote

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