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Sweden’s Riksbank is a pioneer of central banking. Not only is it the oldest, it was the first to implement negative interest rates. Now it might lead the charge when it comes to bailing out central banks themselves.
From a speech/release by Erik Thedéen, Riksbank governor, to the Swedish parliament’s finance committee yesterday (our emphasis):
In the annual accounts for the financial year 2022, the Riksbank reported a loss of just over SEK 80 billion. As a result of the loss, the Riksbank’s equity was negative, SEK -18 billion.
“The loss and negative equity are due to the sharp rise in interest rates in 2022. This has led to a fall in the value of the bonds purchased by the Riksbank during the period 2015-2021 to maintain confidence in the inflation target, secure the credit supply during the coronavirus pandemic and contribute to good economic development,” said Mr Thedéen.
When the value of the Riksbank’s holdings of bonds decreases, it leads to unrealised losses that burden the Riksbank’s result and equity. “A negative equity does not affect the Riksbank’s ability to conduct monetary policy in the short term. But to maintain confidence in an independent monetary policy in the long term, it is necessary that the Riksbank is financially independent, that is, has sufficient equity and earnings to cover its costs,” continued Mr Thedéen.
It’s well-known that the Riksbank — like every other central bank that dabbled with QE over the past decade-plus — is nursing some hefty losses on its bond portfolio. The Fed, for example, is sitting on a cumulative loss of over $1tn. In the Riksbank’s case, it’s about SKr80bn; or about 1.3 per cent of GDP.
That means the Swedish central bank is currently operating with negative equity. But as Alphaville has discussed before, this is not actually as big a deal as you might think.
For one thing, central banks are not normal companies subject to normal accounting rules. They are state constructs that can literally create money. And as Thedéen noted, negative equity doesn’t actually affect a central bank’s ability to do its job.
The Czech National Bank has had negative equity for most of the past two decades, for example, mostly because it is successful: most of its assets are in foreign currencies, the CNB’s credibility has helped the koruna rise against most of them, causing a loss. As the CNB said back in 2010 when the European Central Bank raised the issue:
The CNB has a good reputation at home and abroad as a credible and fully independent central bank. Throughout its existence, its capital position has never undermined its independence or limited its decision-making and operational capacity in any way. The CNB is therefore convinced that there can be no doubt about its legal and factual independence. Negative capital presents no problem for the CNB, and the central bank is able to meet its obligations.
However, negative equity is obviously not a great look, even if the theoretical and practical implications are de minimis — and in the Riksbank’s case, legally impossible.
Last year Sweden passed a new Riksbank Act that stipulates that it should target capital of SKr60bn, or at least SKr40bn. And if it falls below SKr20bn the Riksbank has to go to the Swedish parliament to ask for more money.
Thedéen’s speech yesterday is therefore the first step in the process The Riksbank governor said that it planned to ask for the money once its 2023 annual report is finished and it has a better idea of how much it needs — so roughly by March 2024.
SEB’s Amanda Sundström and Olle Holmgren reckon that Thedéen’s speech implies a SKr80bn capital injection will be sought:
The size of the capital injection is uncertain and there are risks both to the downside and upside. To reduce the risks in the balance sheet, the Riksbank has started hedging a quarter of the foreign exchange reserves. Realized profits made on FX hedging could potentially act to offset some of the need for capital injections. There are also potentially profits from other Riksbank holdings, e.g. gold and the FX reserve in general which could limit the size of the capital injection, although this is uncertain given discrepancies between the Riksbank’s accounting principles and the Riksbank Act. Profits from the currency hedging is a downside risk for the capital injection but Mr Thedéen also indicates that equity needs to be restored to above the base level to in order to generate sufficient earnings to guarantee the Riksbank’s independence. The Riksbank states that it is also investigating the prospects for additional earnings. The low amounts of currency in circulation in Sweden means that the Riksbank could struggle to generate sufficient earnings also with capital at the target level (SEK 60bn) and Mr Thedéen indicated that the Riksbank could petition that the bank should have the possibility for additional earnings which in comments to the press was specified as fees from the financial sector.
Obviously, calling this a central bank bailout — as we did in the headline — is pretty clickbaity facetious. In theory, this Riksbank capital injection is a bit redundant. It’s just a political economy thing, forced by the new Riksbank Act, and different countries solve this issue differently.
The Federal Reserve, for example, simply creates a “deferred asset” from the losses rather than reducing its capital — almost like an assumed promise from the US government to make it up at some point. But when it starts making money again it will just gradually whittle down this deferred asset, and not repatriate any profits to Treasury until it the losses have been all recouped.
The Bank of England has taken a different tack. Back in 2009 it extracted a promise from the UK government that it would continuously be made whole on any losses the central bank might suffer from its QE programme.
For a long time, this seemed a distant prospect. In the first decade of QE the BoE made £124bn that it remitted to the UK Treasury. But rate increases, tumbling bonds and outright sales that crystallise losses have thrown that into reverse. Over the past year the UK government has had to send over £29bn back to the BoE, and Deutsche Bank forecasts this could go to almost £90bn over the next two years.
On the whole the CNB approach seems a bit smarter.
Further reading:
— How quantitative tightening *really* works
