If we look at the balance sheets of the major central banks (Fed, ECB, BoJ, BoE, PBOC, SNB), we will see assets of around USD 30 trillion.

When inflation was low, bond yields were falling, and policy rates were stuck around zero, the situation was not just manageable for central banks; it was very profitable. But now we are seeing the payback as inflation soars, policy rates rise, and bond prices sink. Talk of central banks going bust is swirling, but, from what we can tell, nobody cares.

If we look at the balance sheets of the major central banks (Fed, ECB, BoJ, BoE, PBOC, SNB), we will see assets of around USD 30 trillion. That’s about a four-fold increase on the pre-GFC level. The Fed’s holdings amount to around a third of US GDP; for the euro zone, it’s about two-thirds; and, in Japan, it is over one-and-a-quarter times the level of GDP. These are huge numbers. But as well as having very significant monetary consequences, these asset holdings have a bearing on countries' fiscal positions as well. This is because the profits on these holdings are transferred to the government.

In some cases, these transfers can be quite substantial. The SNB, for instance, which has conducted the equivalent of QE via the FX market rather than the bond market, transferred some CHF6bn to the government last year. Other central banks have been making large transfers as the returns they were making on their assets exceeded the amounts they had to pay banks on their deposits at the central bank. But now this has all gone into reverse; the amount the central banks have to pay out on deposits has risen in line with the increase in policy rates, while the earnings on their assets (bonds in most cases) have gone down. The SNB has announced losses of CHF142bn in the first 9 months of 2022.

The Reserve Bank of Australia is in an even worse position, as its losses have been so heavy that it is now in a negative equity position of AUD12.4bn. But while it might seem technically bankrupt, central banks can always bail themselves out in the extreme as long as their liabilities are not inflation-linked and not denominated in foreign currency.

But even before any monetary printing presses are turned on, banks can use accumulated reserves built up during the good times to cover any deficits and governments can always recapitalize the banks. In fact, they need not do anything. In the case of the RBA, the government’s position is that no "bailout" is needed; it can just wait until the RBA’s investments come good again, which, in the RBA’s view, may mean that positive equity does not return until 2029 at the earliest.

Mr. Steve Barrow, Head of Standard Bank G10 Strategy, said as long as central banks can carry on with negative equity and can perform their monetary policy operations without any hindrance, the "cost" of these potentially huge losses may seem trivial for financial markets. But that’s not necessarily the case.

As we’ve said, for some government’s these costs could become quite large, like in the UK, where the BoE has an indemnity from the government against losses. And then, if governments do recapitalize central banks, there is always going to be a question mark over whether this undermines their independence, as the central banks are left somewhat beholden to the government and might be perceived to follow policies that work to the benefit of this relationship and perhaps against the interests of the wider economy.

Of course, few would argue that this is a real risk amongst major developed nations, but it may be a different story in some emerging nations that have undertaken similar operations. Another point is that, at this stage, the scale of the accumulated losses might not be fully appreciated by the market. As losses increase, so could pressure for central banks to stop paying interest on bank deposits, potentially at a cost to bank earnings and their share price. "We’d argue that this issue should not be ignored. It will not mean some sort of financial calamity down the road, but it will have some consequences that astute investors might be factoring in already", said Mr. Steve Barrow.