Bud­get wind­fall from Cen­tral bank prof­its dry­ing up

The Irish Times - Business - - Front Page - John FitzGer­ald

An im­por­tant strate­gic con­sid­er­a­tion for Min­is­ter for Fi­nance Pas­cal Dono­hoe in fram­ing next week’s bud­get is the re­li­a­bil­ity of dif­fer­ent strands of rev­enue. Al­ready he has been warned of the dan­gers of re­ly­ing too heav­ily on cor­po­ra­tion tax, as de­ci­sions by a small num­ber of firms could have a big neg­a­tive ef­fect on fu­ture rev­enues.

The prof­its of the Cen­tral Bank have been an­other sig­nif­i­cant source of in­come for the gov­ern­ment over re­cent years. In 2010 and 2011, the bank con­trib­uted €700 mil­lion to gov­ern­ment cof­fers. In 2016 and 2017, it amounted to around €1.8 bil­lion. This has been a very im­por­tant source of fund­ing dur­ing very dif­fi­cult times. How­ever, the bank’s deputy gover­nor Sharon Don­nery, in a re­cent ar­ti­cle with col­leagues, pointed out that this par­tic­u­lar rev­enue source is likely to dry up as the euro zone econ­omy nor­malises.

Since 2010, the Cen­tral Bank has made sub­stan­tial an­nual prof­its, and has trans­ferred 80 per cent of these to the Depart­ment of Fi­nance. (For tech­ni­cal rea­sons, only two-thirds of this trans­fer is avail­able for use in the bud­get this year, the rest goes to re­duce the debt.)

In 2010 and 2011, a key fac­tor in the Cen­tral Bank’s prof­itabil­ity was that dis­tressed banks which needed emer­gency liq­uid­ity as­sis­tance had to pay a penalty rate of in­ter­est to re­ceive fund­ing from the Cen­tral Bank. As a re­sult, the bank made a profit that was re­mit­ted to the Depart­ment of Fi­nance, mak­ing a small but wel­come con­tri­bu­tion to the tax­payer to com­pen­sate for the mas­sive losses the trou­bled banks im­posed on so­ci­ety.

More re­cently, a key source of profit for the Cen­tral Bank has been from the sales of the port­fo­lio of as­sets it ac­quired from the liq­ui­da­tion of IBRC (for­merly An­glo Ir­ish).

Cost of fund­ing

The in­ter­est rate the Cen­tral Bank earns on these notes is much higher than the bank’s cost of fund­ing. As a re­sult, it makes a profit which, in turn, it passes on to the Depart­ment of Fi­nance.

How­ever, as con­di­tions have im­proved in terms of fi­nan­cial sta­bil­ity and the econ­omy more gen­er­ally, the gov­ern­ment bonds that are part of the port­fo­lio are be­ing sold off more rapidly than ex­pected. Once they are sold, the po­ten­tial profit of the Cen­tral Bank will also fall.

While the bank is sell­ing the bonds re­lated to the prom­is­sory notes, it is also, like other euro zone cen­tral banks, buy­ing a large quan­tity of nor­mal gov­ern­ment bonds in the sec­ondary mar­ket as part of the quan­ti­ta­tive eas­ing pro­gramme. These bonds will ma­ture many years hence. The yield on them is very low by his­tor­i­cal stan­dards, but it is cur­rently, on av­er­age, sig­nif­i­cantly more than the Cen­tral Bank’s cost of fund­ing. So the bank is cur­rently mak­ing a small profit on these bonds, even if the bond pur­chases are be­ing made for mon­e­tary pol­icy rea­sons.

Re­cov­ery in euro zone

How­ever, with a re­cov­ery in the euro zone econ­omy, it is ex­pected that by the end of this decade, the ECB will have raised sig­nif­i­cantly in­ter­est rates which are linked to the Cen­tral Bank’s cost of fund­ing. Mean­while, the in­ter­est rate that cen­tral banks re­ceive on their bond pur­chases has been fixed at a very low level. As a re­sult, cen­tral banks may at that time make a loss on the as­sets they bought to sup­port the mon­e­tary pol­icy ob­jec­tives

The ECB and its mem­ber cen­tral banks must pay a price for hav­ing done what Mario Draghi termed ‘what­ever it takes’ to re­turn the euro area econ­omy to work­ing or­der

of the ECB.

The par­tic­u­lar bond port­fo­lio held by Ire­land’s Cen­tral Bank lim­its the scale of po­ten­tial losses it is likely to face in fu­ture years. Other euro zone cen­tral banks that bought lower-yield­ing gov­ern­ment stock, such as Ger­man bonds, are likely to face larger losses.

The Fed­eral Re­serve, the US cen­tral bank, is likely to move from profit to loss for sim­i­lar rea­sons as it un­winds the pol­icy of ex­cep­tion­ally low in­ter­est rates. These losses may arise ear­lier for the Fed than for Euro­pean cen­tral banks, be­cause of the dif­fer­ent state of the US eco­nomic cy­cle.

To pre­pare for these fu­ture losses, the Cen­tral Bank this year made a pro­vi­sion in its ac­counts of €165 mil­lion. It would be pru­dent for the Min­is­ter for Fi­nance to take sim­i­larly pre­cau­tion­ary steps in the light of this pend­ing loss of rev­enue.

The ECB and its mem­ber cen­tral banks must pay a price for hav­ing done what Mario Draghi termed “what­ever it takes” to re­turn the euro area econ­omy to work­ing or­der.

And while gov­ern­ment rev­enue has been boosted in re­cent years by the re­sult­ing eco­nomic growth, we now need to plan for this loom­ing rev­enue ad­just­ment.

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