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Central Bank losses: Potential impact on the economy
Dr Ernest Addison — BoG Governor

Central Bank losses: Potential impact on the economy

The possibility of central bank losses may look like a "science fiction story" in most developed countries.

It is indeed expected that a central bank carrying out traditional central banking functions in a stable macroeconomic environment will make profits. 

However, in the unstable macroeconomic environment of many developing countries like Ghana, central bank losses have emerged as a complex "real world drama: At times, central bank losses have created problems in the effective design and implementation of International Monetary Fund programs because of large and unexpected or unexplained movements in "other items net" in the balance sheet of central banks (Leone 1991). 

Dalton and Dziobek (2005) opined that under normal circumstances, a central bank should be able to operate at a profit with a core level of earnings derived from seignorage. 

Losses have, however, arisen in several central banks from a range of activities including: open market operations; sterilization of foreign currency inflows; domestic and foreign investments, credit, and guarantees; costs associated with financial sector restructuring; direct or implicit interest subsidies; and non-core activities of a fiscal or quasi-fiscal nature. 

Failure to address ongoing losses, or any ensuing negative net worth, will interfere with monetary management and may jeopardize a central bank's independence and credibility. 

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Transparency and accounting standards require net losses to be recorded as such in the income statement, charged against capital, and any resulting negative net worth to be properly disclosed in the equity section of the balance sheet. 

Net losses should not be presented in the balance sheet as assets unless they have been formally covered by the government.

According to Honohan (2023) also opine that central banks running with negative equity does not matter but however economic logic compels that functioning of central bank to have positive equity. 

However, some central banks over the years that ran on negative capital were Central Bank of Israel, the Czech National Bank and the Central Bank of Chile.

According to Honohon (2023) if the central banks’ losses persist with sizable net liabilities denominated foreign currency and restructured domestic debt could disable a financially weak central bank. 

Failure to address ongoing losses, or any ensuing negative net worth, will interfere with monetary management and may jeopardize a central bank's independence and credibility. 

Moreover, central banks are not subject to capital adequacy requirements or bankruptcy procedures and can operate effectively even with negative equity, as the central banks of Chile, the Czech Republic, Israel and Mexico have done over several years (Bell et al., 2023). 

However, losses or negative equity can pose communication challenges. For instance, some policy decisions, such as retaining rather than selling government bonds, could be misinterpreted as being motivated by a desire to contain losses rather than as actions to pursue specific policy mandates. 

Central bank credibility 

This would reduce central bank credibility. Likewise, financial flows from government, including actions to strengthen central bank capital positions, could be perceived as being inconsistent with central bank independence. 

This underscores the importance of clear communication about the reasons for losses and of a transparent framework for financial flows between the central bank and the government. 

Central bank losses are not an indication of a policy error and need not hamper the effectiveness of monetary and financial policies.

The policy mandates of central banks include price stability and financial stability, but not profit maximization.

Their current losses, as well as their earlier gains from QE, are a by-product of policy actions designed to help achieve their mandates. 

Moreover, central banks are not subject to capital adequacy requirements or bankruptcy procedures and can operate effectively even with negative equity, as the central banks of Chile, the Czech Republic, Israel and Mexico have done over several years (Bell et al., 2023). 

Central bank losses affect the public finances by reducing or ending central bank payments to the Treasury in the form of income taxes or remittances.  

Moreover, reverse cash flows (i.e., payments from the Treasury) may occur if central banks are entitled to be compensated by the government for certain losses, such as Quantitative Easing-related losses. 

For instance, in the United Kingdom, the Bank of England Asset Purchase Facility (APF), through which QE asset purchases were conducted, is fully indemnified by the Treasury.

Impact on economy 

The Bank of Ghana’s losses in 2022 is not the first in the past decade, in 2017 Bank of Ghana recorded loss of (US$ 347 million) GHC1.64 billion, according to its annual report announcing a pre-tax profit of (US$ 150 million) that was GHC 709.5 million 

However, the report showed an impairment loss of US$ 85.5 million in 2016 and rebound of 208% to US$275 million in 2017.

The analysis of the dismal financial performance showed that the situation was attributable to the regulator’s support to the insolvent local banks that operated between 2013-2016 as the biggest contributor to the central bank loss position. 

Bank of Ghana posted losses totaling GHC 60.81 billion (US$5.3 billion) for the 2022 financial year compared to a profit of GHC 1.21 billion for 2021. 

According to IMF Country report (23/168) opined that the Bank of Ghana’s balance sheet could be affected by the debt restructuring, and requested that the Government and the Bank of Ghana would be required to assess the impact and develop plans for its recapitalization with technical assistance support from IMF. 

Bank of Ghana engaging in quasi-fiscal activities has been responsible for most such losses because it increased the Bank of Ghana’s expenditures.

The Bank of Ghana reported a loss of GHC 60.8 billion as reported in the audited financial statement of the year end 2022.  

The main reason for this huge loss is the impairment of the holding of marketable Government stocks and non-marketable instruments of Government all being held in the books of the Bank of Ghana. 

In addition, the Bank of Ghana’s exposure to COCOBOD, which has been built over the years, was also impaired.

As we all know, the Government of Ghana embarked on both domestic and external debt restructuring.

The holdings of Government instruments and COCOBOD exposures were all part of the perimeter of the debt exchange. 

Whereas all other stakeholders that participated in the Domestic Debt Exchange (DDEP) did not have principal haircuts, but rather had new instruments with new tenors and coupon structure, the Bank of Ghana, served as the loss absorber to the entire debt exchange program, a key requirement that allowed the Government of Ghana to meet the threshold for the approval of the IMF program. 

As a result, the Bank of Ghana had to take on a 50 percent principal haircut on the total principal (which stood at GHC 64.6 billion at the time of the exchange). Consequently, Bank of Ghana had new instruments with extended tenor and significantly reduced coupon. 

IFRS 9 requirements

By applying the full requirements of IFRS 9, this means that from the principal alone, a 50% haircut on the non-marketable (government accommodation finance of GHC64.6 billion by Bank of Ghana) amounted to a loss of GHC32.3 billion. 

Restructuring of marketable instruments amounted to a loss of GHC16.1 billion. The impairment from exposure to COCOBOD also amounted to GHC4.7 billion. 

These three DDEP items (i.e. marketable, non-marketable and COCOBOD) accounted for GHC53.1 billion out of the total loss of GHC 60.8 billion for 2022.

In addition to these three items, price and exchange rate valuation effects accounted for GHC 5.2 billion of the total loss, whereas interest expense on cost of monetary policy operation accounted for GH3.3 billion. 

Bank of Ghana losses occurred for three main reasons. First, market securities valued GHC16.1 billion held by the central bank are sold at a value inferior to the one they were bought (DDEP). 

Second, losses occurred because of 50% haircut of non-market debt of GHC 64.5 billion in the form of accommodating finance of government in 2022. Third, there was a revaluation of foreign exchange holdings, i.e. that the domestic currency devalued against reserve currencies, this can lead to a loss. 

The central bank’s holdings of government debt were restructured. Non-marketable holdings of government of Ghana instruments including long-term stocks, a COVID-19 Bond and overdraft were subjected to a 50 per cent haircut. 

Bank of Ghana’s other claims (holdings of marketable instruments) were exchanged under similar terms as other financial institutions under the DDEP. This led to an impairment of GH¢48.40 billion in 2022. 

At the same time, the Bank incurred revaluation losses on its foreign assets and liabilities due to exchange rate depreciation. The impairments and revaluation losses led to a negative equity position of GH¢55.12 billion for 2022”

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