Signed Article: Assessing the Financial Risks and Buffers of the Central Bank

The Central Bank of Ireland has published a signed article from the fourth Quarterly Bulletin of 2018, due to be published on 12 October 2018.

The article Assessing the Financial Risks and Buffers of the Central Bank (PDF 219.98KB), by David Doran, Ruth Gleeson, Steve Kilkenny and Šarūnas Ramanauskas, examines how risks to the Central Bank of Ireland’s balance sheet and financial buffers are managed.  In doing so, the article considers the changes to euro area national central banks’ (NCBs) balance sheets in recent years and the role of capital and financial buffers for central banks.

The key findings are:

• There are clear arguments for managing financial risks and maintaining positive financial buffers in central banks: to preserve financial independence, to help ensure policy effectiveness and to retain credibility.
• NCBs’ balance sheets and risks have increased substantially in recent years, which requires enhanced risk measurement tools. The Central Bank of Ireland has similarly developed its risk measurement tools during this period, including a new internal framework which incorporates a multi-year risk-based assessment of the Central Bank’s financial buffers position.
• As the sizeable profits seen recently at the Central Bank of Ireland normalise in the coming years, the Central Bank will be constrained in its ability to materially increase its capital and reserves. The recent practice of retaining the maximum allowable percentage of profits (20%) under domestic regulations, along with other provisioning measures, will help ensure an appropriate level of overall financial buffers. These measures will contribute to the Central Bank’s financial resilience and protect its continued independence in the years ahead.

Notes

• The views expressed in this article are not necessarily those held by the Central Bank of Ireland.
• Central banks generate income through seigniorage income, which can narrowly be defined as the difference between the income or value of currency issued, less the cost of issuing or minting the currency. More broadly, however, seigniorage income can be extended to include the income that central banks make from investing the proceeds of currency issuance – i.e. through managing a portfolio of investment assets. In the case of the Central Bank of Ireland, income has also been supplemented on an exceptional basis in recent years, as the Floating Rate Notes (FRNs, held under the Special Portfolio of assets acquired following the liquidation of IBRC) are disposed. Once the remaining FRNs are disposed, the Central Bank’s income is expected to normalize.
• The policy response to the recent financial crisis has had a significant effect on the size, composition and risks of euro area NCB balance sheets. Initially, balance sheets expanded through increased monetary policy lending to euro area counterparties and in some cases Emergency Liquidity Assistance. More recent large-scale asset purchases have resulted in further expansion of the balance sheet and the emergence of a risk of a significant interest rate mismatch. The Central Bank is exposed to various degrees of market and credit risks through monetary policy operations, investment portfolio holdings and through any holdings of securities purchased for monetary policy purposes.

• See also “Non-standard monetary policy measures and the Balance Sheets of Eurosystem Central Banks”, Signed Article, July 2017.