 It's not uncommon to see headlines like company X makes bumper profits or bank Y suffers record loss. Earning season is a busy time for businesses, usually every quarter in fact, and once a year the same applies to central banks. We've just published our annual accounts. They're basically an overview of our financial position at the end of 2022, and they showed zero profit for the year. In fact, we drew on provisions that we'd set aside in previous years to avoid making a loss. That's the topic we'll be discussing today. We want to explain how central bank losses and profits come about and what they really mean for people. We'll also ask if it even matters whether a central bank makes a profit or a loss. You're listening to the ECB podcast, bringing you insights into the world of economics and central banking. My name is Katie Ranger. I'm joined in the studio by one of our press officers here at the ECB, William Lelyfield, who's going to break all this down for us. William, great to have you here on the podcast. Yes, thank you, Katie. I'm very excited to be here. Now, before we start, I just want to give a bit of info as to why this topic is relevant at the moment. In today's difficult economic environment, central banks across the world are either making or warning of losses. It's important to remember, though, that central banks are not like ordinary companies. They can lose money and still operate effectively. A small disclaimer before we start. In our conversation today, we will be talking about where profits and losses can come from in the euro system. So that's the ECB and the central banks in the 20 countries using the euro. Now, William, we've got all that out the way. Let's start with the basics. A central bank doesn't work towards making a profit. Its aim or its mandate is actually to keep prices stable. So tell me, where do profits come in all of this? Yes, as you say, we are a public institution, but like any like an ordinary company, we can make profits and losses. But making profits or avoiding losses at all costs is not our aim. Our aim is to keep prices stable. So they're basically a byproduct of what we do of our mandate. So if we do generate profits, where does that income come from? So for a central bank like the ECB and national central banks of the euro system, our profits typically come from the assets that we hold. So these can be bonds that we hold. It can be interest rates that bank pay us when they borrow money from us. And we also have foreign reserves, which also pays us an interest. So these interest rates basically are our main source of income. So for example, you said loans, the banks take from us. So just like I have a loan from the bank, I pay the bank interest and the bank pays the ECB interest. All right. So if this income is bigger than our costs, then we make a profit, obviously, just like any other normal company. What do we do with that profit? So what we do is we first set aside some of it, because we want to be prepared for times when maybe profits are not so big. Whatever is left, then we distribute among our shareholders. And our shareholders are the national central banks, and they usually distribute it to their shareholder, which is nine out of 10 times the national finance ministry. Okay. So that's the profits. Let's look at the other side of things. What things can be a cost for us? So when banks deposit money with us and banks do deposit money with us, because they have accounts with us, just like citizens have accounts with commercial banks. Commercial banks have accounts with the Euro system, and we pay interest rate on these deposits. And that's, I would say, the biggest source of costs. And that's linked, for example, to one of the key interest rates that we set every six weeks, right? Exactly. When we set interest rate, we set three interest rates, and one of them is the deposit facility rate. And this is what we pay the banks. And currently, this percentage is two and a half percent. All right. So these losses that we've seen this year have been down to different things, some of them a little bit more tricky to explain than others. But this last point that we talked about, the interest rates, this is key here because they're closely linked to some of those losses. I just want to zoom out a second to look at the economic environment that we're in right now, because it's also important. Inflation is high, and we are raising our key interest rates to tackle that, including the deposit facility rate that we just talked about. William, what does all of this mean for our profits and losses? Can you really take us through what's going on step by step? Yes. So what happened? We recently increased our interest rate again with half a percentage point. And this has been going on since July 2020? Yeah, exactly. So the amount that we pay on this deposit facility, on the money that banks pay with us, is increasing quite rapidly because we are currently already at two and a half percent, and it doesn't look like we're done yet. So we are faced with increasing costs in this deposit facility. And on the other side of this, our income on the bonds that we hold, the interest rate on bonds that we hold is quite low because many of the bonds that we bought had long maturities, so we're stuck with them for a very long time. And maturity means it's the promise that you get repaid. So if you buy a bond with a maturity of 20 years, that means that in 20 years you get your money back in these 20 years towards the date of maturity, you will get an interest rate every year, but you will get your money back only in 20 years. For a five-year bond, you will get your money back in five years, for a one-year bond and one year. Okay, so let me recap quickly. We have been raising interest rates. This cost that we have linked to the increase in interest rates that we pay on bank's deposits is going up, but the income that we're getting is not going up at the same rate. So there's a mismatch in our income and our costs. And part of this is linked to the fact that in recent years we bought all of these bonds with very long maturities and very low interest rates, which means that the income we get will not change for quite a while, at least not in time for it to be matched up with the costs. Exactly. All right, so we've got it clear where the losses have come from. But the whole thing about the bonds, it makes me wonder why didn't we buy bonds with higher interest rates? And here I come back to what I've said before. So everything we do has a monetary policy reason. And back then we were in a period of too low inflation, which is maybe a bit difficult to imagine at the moment. But it's not that long ago. And to tackle too low inflation, we bought a lot of bonds with long maturities and low interest rates to help us reach our price stability objective. William, could we have done anything to avoid these losses? Only theoretically. Theoretically, we could have sold the bonds when they were still worth more than they are at the moment. But we are not in the business of, let's say, buying and selling bonds just to make profits or avoid losses. We are in the business of doing monetary policy. And back then we had a good monetary policy reason to buy these bonds. And now we have a good monetary policy reason to keep these bonds until, as we said, maturity. And it's also perfectly normal that in good times we make profits. And then we set some of these profits aside so that in less good times we have a buffer to cover these losses. Like we've seen this year. Like we've seen this year. That we ended up at zero, despite having losses. Now, what do the losses actually mean? I mean, what do they mean for people? Do they hurt anyone? Well, the benefit that that that national central banks and via the national central banks, the finance ministries and via the finance ministries, the taxpayers would get if we have profits, of course, is not coming. So in that sense, we distribute less profits. And that that is, of course, not something that finance ministries like like to hear and probably taxpayers also know. But we have made profits in the past. So in the past, we have been making transfers to the finance. Yeah, we have made huge transfers actually. So the euro system as a whole has made three around 300 billion in profits since 2012. The ECB alone around 13 billion. So we have transferred a lot of these profit to taxpayers. Yeah. And now this time, we can't. And if we hadn't had enough provisions, what would have happened there? Then we would have made losses. So outright losses. So even below the line, there would have not been a zero as we have now, but there would be a negative number. And this could potentially be covered by income that the national central banks, our shareholders make. And if that would not be enough, we could theoretically also function with, with, let's say, negative capital. And that's what I said at the beginning, right, that central bank can make a loss and still operate effectively, not like a normal company, which would go bankrupt. Exactly. Okay. So overall, all fine for this year. What's ahead of us though? Do we expect to make more losses in the near future? Yes. Unfortunately, it looks like there will be a few more years where we will experience losses. But gradually, the situation should improve. Because on the one hand, the interest rates on our assets, on our, for example, the bonds that we hold, but also the interest rates on loans that we will be providing to banks again, is much higher than the interest rate that we are getting now. And that should then match, and more than match ideally, the costs that we make on this, on this deposit facility that I mentioned before. So then the mismatch between income and costs will start to balance out. Exactly. Okay. Thank you so much, William, for breaking all that down. Now, before we wrap up, we always have a question that we ask all our guests on the podcast. And that's for a hot tip linked to the topic we're discussing today, very broadly linked, shall we say? Have you thought of something to inspire our listeners? So, Katie, you already warned me that this question would come, and I was a bit struggling to find something nice. And to avoid the obvious money by Pink Floyd, I thought it was nice to go with a song called Money Talks by ACDC, which is one of, I would say, my favorite. There are actually three songs that I'm aware of that have Money Talks in their title. And so there's something for everyone. There's a sort of a house type of song from, I think, the 90s by a band called The Adventures of Stevie V, which is called Money Talks. And for their very old listeners, there's also a version by the Kings. Okay, we should have said at the beginning that William is a big music fan. So I'm not surprised that your hot tip is song or songs here. But that's great. Thank you so much, William. It was a pleasure. Well, that brings us to the end of this episode. I want to thank William Lelefeld, press officer here at the ECB for explaining everything about central bank profits and losses. As usual, you can check out the show notes for additional material on this topic. You've been listening to the ECB podcast with Katie Ranger. If you like what you've heard, please subscribe and leave us a review. Until next time, thanks for listening.