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The high exposure of central banks’ balance sheet to interest rate risk does not jeopardise their ability to fulfill their mandate
The size of central banks’ balance sheets increased significantly over the past decade. The composition also shifted, including today more long-term fixed-rate securities on the asset side, financed by reserves remunerated at variable rates that depend on monetary policy decisions. This leaves central banks exposed to interest rate risk and hence vulnerable to income losses when interest rates increase.
However, this does not necessarily put at risk the ability of central banks to fulfil their mandate. The objective of central banks is not to maximise profits, but rather to ensure price stability and support the prosecution of other macroeconomic goals. Under extreme conditions, a weak financial situation could interfere with monetary policy objectives, but the literature suggests that the likelihood of such an event occurring in practice in an advanced economy is very low.
Central banks ability to issue legal tender at a negligible cost provide them with a significant and fairly certain stream of revenues (seignorage). While it is difficult to measure with precision the discounted net present value of these future revenues, the estimates available in the literature suggest that this is sufficient to cover any significant loss incurred by major central banks.
For further details see Cardoso da Costa (2022), “On the solvency and credibility of a central bank”, Banco de Portugal Economic Studies, Vol. VIII, No. 3, pp. 71-91.
Prepared by José Miguel Cardoso da Costa. The opinions expressed in the article are those of the author and do not necessarily coincide with those of Banco de Portugal or the Eurosystem.
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