bank of canada Up to $8.8 billion could be lost over the next few years, according to a new report warning that the central bank could face a communications challenge as a result of the deficit.
The CD Howe Institute report estimated total losses over the next two to three years to be between $3.6 and $8.8 billion.
“A lot of what determines the size of a loss really comes down to Rate of interest are going to happen over the next two to three years,” said Trevor Tombe, professor of economics at the University of Calgary and co-author of the report.
In the fall, the Bank of Canada posted its first loss in its 87-year history, losing $522 million in its third quarter.
The central bank said in its financial report that its revenue from interest on assets has not kept pace with interest charges on bank deposits, which have gone up amid rising interest rates.
This problem is expected to persist as interest rates remain high.
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Tombe said another factor affecting the size of the deficit is the deposits of large financial institutions with the central bank.
While the losses do not affect the Bank of Canada’s ability to conduct monetary policy, Tombey said they present a communication challenge for the central bank.
“Many people will look at this and say, ‘Well, doesn’t that mean the bank is insolvent?'” he said.
Historically, the Bank of Canada has always made a profit, which it remits to the federal government. According to the report, in 2021 dollars, the total profit of the entire history of the bank is about 160 billion dollars.
However, the central bank’s policy decisions during the pandemic have led to the current predicament.
In response to the economic crisis brought on by COVID-19, the Bank of Canada dramatically expanded its assets as part of a government bond purchase program. Also known as quantitative easing, the policy was part of the central bank’s efforts to stimulate the economy.
This expansion in assets is now costing the central bank, as it has paid for government bonds with a build-up of settlement balances.
Now with the rise in interest rates, the interest charge paid by the central bank on these settlement balances has become more than the interest earned on government bonds.
While the loss is a first for the Bank of Canada, other central banks that have engaged in quantitative easing during the pandemic are also posting losses.
The Bank of Canada is now looking to the federal government for a solution to balance its books. However, economists note that the solutions are about accounting and that losses will essentially be covered by the federal government.
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Tombe said that finding a solution that finds a suitable accounting solution still matters because of the recent political focus on the central bank.
“Any other potential reputational hit that could further undermine public confidence in the institution,” he added.
Tombe and his co-authors advised the Bank of Canada to run a deferred asset that would allow the central bank to record losses in the present against potential future profits.
As the Bank of Canada goes back to making money, it will hold onto profits instead of sending them to government coffers.
However, this solution would require an amendment to the Bank of Canada Act, which currently does not allow the central bank to withhold profits.
Tombe said that if the Act were to be amended, it would be a good opportunity to prepare the Bank of Canada for the next loss.
“We must anticipate that we may find ourselves in that position again,” Tombe said. “And so this is an opportunity to potentially think about major reforms to the Bank of Canada Act to make sure we are ready for what’s next.”
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