Photo: The Canadian Press
The Bank of Canada could lose as much as $8.8 billion over the next few years, according to a new report that warns the central bank may be facing a communication problem in the wake of the losses.
A report from the CD Howe Institute estimates that total losses will reach $3.6 billion to $8.8 billion over the next two to three years.
“A lot of what determines the size of the losses really depends on what interest rates are going to be in the next two to three years,” said Trevor Tombe, an economics professor at the University of Calgary and co-author of the report. .
In the fall, the Bank of Canada posted its first loss in its 87-year history, losing $522 million in the third quarter.
The central bank said in its financial report that interest income from its assets did not keep pace with interest from bank deposits, which rose as interest rates rose.
This problem is expected to persist as interest rates remain high.
Another factor affecting the size of losses is how large financial institutions’ deposits are with the central bank, Tombe said.
While the losses do not affect the Bank of Canada’s ability to conduct monetary policy, Tombe said they present a communication challenge for the central bank.
“A lot of people look at that and say, doesn’t that mean the bank is insolvent?” he said.
Historically, the Bank of Canada has always made a profit, which it sends to the federal government. According to the report, those profits over the entire history of the bank amount to roughly $160 billion in 2021 dollars.
However, the central bank’s policy decisions during the pandemic led to the current predicament.
In response to the economic crisis caused by COVID-19, the Bank of Canada has dramatically expanded its assets under the Government Bond Purchase Program. This policy, also known as quantitative easing, was part of the central bank’s efforts to stimulate the economy.
This asset expansion is now costing the central bank because it paid for the government bonds by creating settlement balances.
With interest rates now elevated, the interest charges the central bank pays on these settlement balances have exceeded the interest it earns on government bonds.
While the losses are the first for the Bank of Canada, other central banks that have also engaged in quantitative easing during the pandemic are also posting losses.
The Bank of Canada is now looking to the federal government for a solution to balance its books. But economists note that the solutions involve accounting, and the losses will inevitably be covered by the federal government.
Tombe said finding the right accounting solution is still important because of the central bank’s recent political attention.
“Any further potential reputational hits this entails could further erode public confidence in the institution,” he said.
Tombe and his co-author recommend that the Bank of Canada operate a deferred asset that would allow the central bank to offset currently incurred losses against future expected gains.
As the Bank of Canada returns to making money, it would keep the profits instead of funneling them into government coffers.
However, this solution would require an amendment to the Bank of Canada Act, which currently does not allow the central bank to retain profits.
Tombe said if the law is to be amended, it would be a good opportunity to prepare the Bank of Canada for the next time it could incur losses.
“We should expect to be in a situation like this again,” Tombe said. “And this is an opportunity to potentially think about larger reforms to the Bank of Canada Act to make sure we’re ready for the next one.”
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