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 normally profitable Crown corporation has been caught in a loss-making bind in recent months. After massively expanding its balance sheet during the pandemic, then racing to increase interest rates to fight inflation, the central bank is now paying more interest on its liabilities than it’s earning on its assets.
This led to a net-interest expense of $350-million in the third quarter, compared to net interest revenue of $814-million in the same quarter last year. This is the first in what is expected to be a stretch of quarterly losses, as the bank does not anticipate returning to profitability until 2024 or 2025.
The losses won’t affect the central bank’s ability to conduct monetary policy. It can’t run out of money like a normal corporation. But it will affect public finances, as the bank stops sending profits – typically around $1-billion a year – to federal government coffers for a period of time.
“Our policy decisions are driven by our price and financial stability mandates. We do not make policy to maximize our income,” Governor Tiff Macklem told the parliamentary finance committee last week, explaining the bank’s position on the losses.
The situation is also a political headache for the federal government, which has to figure out how to deal with the losses, and for the central bank, which has come under fire from opposition politicians for its handling of monetary policy during the COVID-19 pandemic.
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.
The Bank of Canada is not allowed to retain its earnings, and it does not have a rainy day reserve fund. That means 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. This may require changing the Bank of Canada Act.
The government has already indemnified the bank for any market losses it might make from selling bonds. But this indemnity does not cover operating losses.
“Whatever solution is chosen, it’s not going to affect how we run monetary policy,” Mr. Macklem said. “We are a going concern, we have liquidity, and we will continue to run monetary policy guided by our mandate.”
The Bank of Canada is not alone. Central banks around the world are reporting huge losses as they raise interest rates while winding down unconventional monetary policy measures used during and after the 2008 financial crisis, and again during the pandemic.
In September, the Reserve Bank of Australia recorded a 36.7 billion Australian dollar ($33.3-billion) 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 ($17.9-billion) to transfer to the Bank of England, to cover its losses.
The Bank of Canada’s loss ultimately stems from its decision to dramatically expand its balance sheet during the pandemic. It bought hundreds of billions worth of assets, first to stabilize financial 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.
During the QE program, which ended last fall, the bank purchased more than $300-billion worth of government bonds from Bay Street 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 to commercial banks on their settlement balances equal to the benchmark overnight rate.
The central bank has increased the overnight rate, its main monetary policy lever, to 3.75 per cent today from 0.25 per cent at the start of the year in a bid to get inflation under control. But that also means it is now paying far more on its liabilities – around $200-billion worth of settlement balances – than it’s earning on the bonds it bought in the QE program.
Mr. Macklem has long defended the use of QE as a key part of the bank’s monetary policy response to COVID-19. But he said last week that once the bank gets inflation under control, “we are going to have to have a thorough review of how all our tools worked through this pandemic.”