Ottawa poised to address Bank of Canada losses with legislative amendments

The federal government will allow the Bank of Canada to retain earnings to help it recoup billions of dollars in losses that the central bank expects to report over the coming years as a result of its pandemic-era bond-buying program.

The central bank reported a $522-million loss in the third-quarter of 2022, the first time it has lost money in its nine-decade history. It expects to be in the red for several years, as it pays out a higher rate of interest on its liabilities, mainly commercial bank deposits at the central bank, than it earns on its assets, mostly government bonds it acquired during the COVID-19 pandemic.

Bank of Canada Governor Tiff Macklem said Wednesday that the Department of Finance is preparing legislative amendments to address these losses.

Beyond the Bank of Canada’s rate hikes: The era of low interest rates is over

There’s no risk of the central bank going bankrupt, and losses won’t affect its ability to conduct monetary policy. But they do present a conundrum as the Bank of Canada Act does not currently give the central bank a way to manage a negative equity position.

The legislative changes “will allow, on a temporary basis, the Bank of Canada to retain earnings rather than remit them to the government, for the purpose of covering losses,” Mr. Macklem told reporters at a news conference after the bank’s latest interest-rate decision.

“Once positive equity is restored, we would resume our normal remittances to the Government of Canada,” he said.

Adrienne Vaupshas, press secretary to Finance Minister Chrystia Freeland, confirmed the planned amendments, although she offered no timeline for when they will be introduced.

Up until last year, the Bank of Canada always earned a profit. In normal times, its main liability is the physical cash that circulates through the Canadian economy. On the asset side of its balance sheet, it holds government bonds.

Because it pays no interest on physical cash, and earns interest on its bond holdings, the bank usually makes a tidy profit, which it sends to federal coffers. In the years leading up to the pandemic, it typically remitted around $1-billion to the treasury each year.

This changed during the pandemic as a result of the central bank’s massive bond-buying program, known as quantitative easing. The bank acquired hundreds of billions of dollars’ worth of government bonds in an effort to hold down interest rates and boost the economy through the COVID-19 downturn.

The bank paid for the bonds by creating deposits for commercial banks, known as settlement balances. These are essentially reserves that commercial banks keep at the central bank, and they ballooned from around $250-million before the pandemic to a peak of around $390-billion in 2021.

Unlike physical cash, the Bank of Canada has to pay interest on settlement balances equal to its overnight policy rate. As the policy rate has risen to 4.5 per cent from 0.25 per cent over the past year, the bank has started paying out far more in interest on these settlement balances than it is taking in on the bonds it owns, leading to large net interest margin losses.

The bank has estimated that cumulative losses could amount to $5-billion to $6-billion over the next few years – although this forecast is conditional on the trajectory of interest rates. University of Calgary economics professors Trevor Tombe and Yu Chen estimate that losses could range from $3.6-billion to $8.8-billion.

Mr. Macklem has played down the situation, referring to it as mostly an accounting issue. “None of this has any impact on monetary policy, we don’t run monetary policy with a profit motive in mind,” he said on Wednesday.

But the losses do create novel reputational and communication challenges for the central bank, Prof. Tombe and Prof. Chen argued in a paper published by the C.D. Howe Institute this month.

The issue is becoming politically charged. Conservative Party Leader Pierre Poilievre has warned of a Bank of Canada “bailout.” Ms. Vaupshas, the Finance Minister’s press secretary, noted in an e-mail that the Bank of Canada is not alone in experiencing losses.

“Many central banks globally – including the U.S. Federal Reserve, the Bank of England, the Reserve Bank of Australia, the Bank of Japan, and the European Central Bank – are facing similar circumstances following the extraordinary measures employed to ensure a strong economic recovery following the COVID-19 pandemic,” she said.