Risks to Central Bank balance sheets among economic research published in Third Quarterly Bulletin

• The future of interest rates – a risk to the Central Bank’s own balance sheet?
• How do large Irish funds manage potential liquidity and redemption risks?
• Following the money – Irish banks and their international exposures

The Central Bank of Ireland has published the series of signed articles from the third Quarterly Bulletin, due to be published on 28 July.

Non-standard monetary policy measures and the Balance Sheets of Eurosystem Central Banks

This article by Deputy Governor Sharon Donnery, David Doran, Ruth Gleeson and Konstantina Carroll (PDF 307.65KB) considers the ability of national central banks (NCBs) to generate income in an era of wide scale purchasing of longer term assets with low, and sometimes negative, yields.

The article finds:

• A central bank’s ability to generate income is key to its independence, yet recent monetary policy measures have left many central bank balance sheets with long-term assets fixed at low or even negative yields
• As economic conditions improve and inflation nears its target level, euro area interest rates are expected to rise over time. While this would indicate that the monetary policy measures implemented by the Eurosystem have been successful, an interest rate mismatch may arise from the cost of associated liabilities (deposits) being greater than the income from purchased assets, impacting the profitability of central banks
• Over the longer term, NCBs are expected to return to profitability. Nonetheless, accounting year losses is a plausible scenario and this raises questions around the speed and ability of a central bank to recapitalise and to remain fully independent when doing so
• Unlike commercial banks, a central bank cannot use the financial markets to hedge against any such expected loss – to do so would be to take a position against a publicly stated monetary policy stance
• In light of these developments, in 2016 the Central Bank of Ireland set aside a provision of €165m to mitigate against any potential future losses.

A short discussion on the findings of this research is available on our YouTube Channel.

Liquidity & Risk Management: Results of a Survey of Large Irish-Domiciled Funds

This article by Pierce Daly and Kitty Moloney (PDF 430.03KB) presents new data based on Irish submissions to a European Systemic Risk Board survey on liquidity. The survey focuses on European bond, mixed and money market funds with a total Net Asset Value greater than €500m as of Q2 2015. The investment fund sector is an important part of the credit intermediation chain and is recognised as a potential contagion channel of systemic risks. As such, this paper considers the investor profile, redemption policy and liquidity management practices of funds that are integral in the analysis of liquidity and redemption risks.

The article finds:

• Large funds generally consist of institutional (not retail) investors. This may affect behavioural dynamics during stressed market conditions
• Over 90 per cent of large funds offer daily redemptions, which may have implications for liquidity and maturity transformation
• While the use of liquidity management tools has increased since the crisis, this remains in the minority with 19 percent of the funds surveyed reporting use of such tools. Funds may use pre-emptive tools to manage the cost of large redemptions and liquidity
• Whilst there were mixed views on the impact of regulation on market liquidity, there is some evidence that regulatory change has reduced liquidity in some markets.

Consolidated Banking Data: Introducing Enhanced Statistics for Ireland

This article by Kenneth Devine, Jennifer Dooley, Ciaran Meehan and Aisling Menton (PDF 848.5KB) considers expanded Bank of International Settlements (BIS) consolidated banking data and how it provides a deeper understanding of the exposures of Irish headquartered banks. It provides a breakdown of data not previously published by the Central Bank of Ireland, including new information on trends in foreign claims by Irish headquartered banks and international claims on Ireland. A network analysis of the exposures of foreign and domestic banking sectors on vulnerable EU states and sovereigns is also presented.

The article finds:

• Irish banks’ foreign exposures have declined substantially since the onset of the financial crisis, from a peak of €217 billion in Q3 2008 to just €79 billion in Q4 2016
• Irish banks’ foreign claims as a proportion of total assets, at 31 per cent, are close to the average for all reporting countries, indicating that Irish banks are not overly exposed to foreign claims in comparison to their peers in other countries
• The scale of foreign claims against the UK highlights Irish banks’ vulnerability to any downturn in that economy
• Pre-crisis, British and German banks had the largest claim on Irish residents. Following the onset of the financial crisis, the US became an important player, with Japanese claims becoming more significant since early 2013
• Vulnerable EU country borrowings decreased substantially by €1.2 trillion from Q4 2008 to Q4 2016, bringing the outstanding amount of claims to €1.3 trillion. Nearly one quarter of this decline related to claims on Ireland, which stood at just €315 billion at Q4 2016.

Notes

The views expressed in these articles are not necessarily those held by the Central Bank of Ireland.