Bank of Canadas Q3 loss spurs government to fix central bank equity problem

Bank of Canada's Q3 loss spurs government to fix central bank equity problem

By Fergal Smith

TORONTO (Reuters) – After the Bank of Canada posted its first ever quarterly loss, the federal government plans to introduce legislation enabling the central bank to retain profits rather than remit them to the government, BoC Governor Tiff Macklem said.

The new legislation would give the Canadian central bank the means to restore positive equity on its balance sheet.

The BoCs balance sheet is likely to slip into negative equity in the coming years, a position in which liabilities exceed assets, as it pays out a higher interest rate on settlement balances than it earns on the government bonds it bought to support the economy during the COVID-19 crisis.

Settlement balances, which stood at about C$200 billion ($149 billion) in December, are deposits at the central bank held by financial institutions. The rate on those deposits has climbed in lockstep with the BoCs benchmark interest rate, which is up 425 basis points since March.

Several other major central banks that expanded their balance sheets, such as the Federal Reserve, also face negative equity issues.

“The Minister of Finance has recently communicated to me that the government intends to introduce legislative amendments that will allow the bank to retain earnings to offset losses,” Macklem said in a news conference on Wednesday following the central banks decision to raise interest rates by a quarter of a percentage point, adding that the losses have no impact on monetary policy.

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

Unlike a commercial bank, a central bank issues currency as well as settlement balances, so there is no indication that a move into negative equity would be a threat to the BoCs solvency.

The central bank reported a net loss of C$511 million in the third quarter of 2022, while its equity stood at C$954 million. The C.D. Howe Institute, a Canadian think tank, estimates cumulative losses of between C$3.6 billion and C$8.8 billion over the next two to three years.

Canadas central bank typically earns more income on its assets than it pays on its liabilities and then remits its net income to the government. In 2021, its remittance was C$2.7 billion.

Before the pandemic, the Bank of Canadas liabilities consisted largely of banknotes in circulation, on which it pays no interest, but settlement balances have since surged to finance the balance sheet expansion.

Last April, the central bank began the process of shrinking the size of its balance sheet, a move known as quantitative tightening.

($1 = 1.3387 Canadian dollars)