The Bank of Canada reported a $522-million third-quarter loss on Tuesday, the first time the central bank has lost money in its 87-year history.
The bank has been caught in an unprofitable bind in recent months, as its dash to increase interest rates to fight inflation has created a mismatch between assets and liabilities on its enlarged balance sheet.
It is now paying out a higher interest rate on roughly $200-billion worth of commercial bank deposits at the central bank than it is earning in interest on bonds that it owns. This led to a net-interest revenue loss of $350-million in the third quarter, down from $814-million net interest revenue the previous quarter.
“The losses do not affect our ability to conduct monetary policy,” governor Tiff Macklem told the parliamentary finance committee last week. “I would also stress that our policy decisions are driven by our price and financial stability mandates. We do not make policy to maximize our income.”
The losses may not impact the bank’s ability to set interest rates, but they do create a political headache for both the central bank and the federal government.
Mr. Macklem told the committee that the losses are largely an “accounting issue.” Conservative Party leader Pierre Poilievre, by contrast, has begun warning of a “bailout” of the central bank.
Explainer: How does the Bank of Canada work?
The Bank of Canada is not allowed to retain its earnings, and it does not have a rainy day reserve fund. The Department of Finance needs to decide whether to cover the bank’s losses directly or come up with some other method that would allow the bank to make up for the losses once it returns to profitability.
Central bank spokesperson Paul Badertscher told Tausi Insider earlier this month that the bank expects to return to profitability in 2024 or 2025. It is forecasting losses of between $5-billion and $6-billion over the next few years, although the final amount will depend on the path of interest rates and other economic variables.
There are several options on the table for dealing with the losses. In New Zealand, the government is covering the losses directly. In the United States, the Federal Reserve is accounting for its losses by creating a deferred asset that will be paid off over time as the Fed starts making money again.
The Canadian government has already indemnified the central bank for any market losses it might make from buying or selling bonds. But this indemnity does not cover operating losses.
Until now, the Bank of Canada has always made a profit, which it has remitted to the federal government each year. After covering its own expenses, the bank typically sent around $1-billion in annual profit to the federal treasury in the years leading up to the pandemic. Over the past two years it sent around of $4.7-billion to government coffers.
The losses ultimately stem from the Bank of Canada’s decision to dramatically expand its balance sheet during the COVID-19 pandemic. It bought hundreds of billions worth of assets, first to stabilize markets in the spring of 2020, then as part of a Quantitative Easing program, also known as QE, aimed at holding down interest rates to support the economy through the pandemic.
The QE program, which ended last fall, saw the bank purchase more than $300-billion worth of government bonds from commercial banks and other investors. To pay for the bonds, it created a form of electronic money called a “settlement balance,” which is essentially a type of commercial bank deposit held at the central bank. The central bank pays interest on settlement balances equal to the benchmark overnight rate.
Settlement balances exploded from around $250-million to a peak of $394-billion in early 2021. There are roughly $200-billion worth of settlement balances still on the Bank of Canada’s balance sheet.
Because the bank pays the overnight rate on settlement balances, the interest rate it is paying on its largest liability has risen from 0.25 per cent at the start of the year to 3.75 per cent today. Its assets – mostly government bonds it bought during QE – pay a much lower rate. The weighted-average yield of government bonds the bank bought during the pandemic is only 0.65 per cent, according to Mr. Badertscher.
The Bank of Canada is not alone. In September, the Reserve Bank of Australia recorded an 36.7-billion Australian dollar accounting loss for the year, leaving it with a negative-equity position of 12.4-billion Australian dollars. In October, the British government earmarked more than £11-billion to transfer to the Bank of England, to cover its losses.
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