Central bank allocated 25 pct of its profit to the state budget

The Supervisory Board of Eesti Pank decided on Tuesday to transfer one quarter, or 5.9 million, of the 23.5 million euros it made in profit last year to the state budget. The remaining three quarters of last year’s profit will go to strengthen the capital of the bank.

Chairman of the Supervisory Board Mart Laar said that the amount of capital that can be transferred is limited because Eesti Pank has relatively little capital compared to that held by the other central banks of the euro area.

“It is important for the central bank to have sufficient reserves so that if there is any problem we can cope without any help from the state. Central banks normally have problems when economies in general are in difficulties. Building up reserves reduces the risk of us needing to place any additional burden on taxpayers in time of difficulties. It is especially necessary to build up reserves at the moment, as risk factors around Estonia have increased”, said Mr Laar.

The ratio of Eesti Pank’s capital to the risk assets used for monetary policy was one of the three lowest of any of the central banks of the euro area at the end of last year. In 2012 the Supervisory Board set a long-term goal of increasing Eesti Pank’s capital ratio the average level of the central banks of the euro area. This means it is necessary to raise the level of capital by about a billion euros to 1.3 billion.

The Supervisory Board decided that the relative level of the Eesti Pank capital should increase to the average level of the central banks of the euro area, as the balance of risks to the capital of the Eurosystem as a whole is considered when joint monetary policy decisions are made.

Last year, Eesti Pank received 42.2 million euros in income from the joint monetary policy and currency issuance activities of the Eurosystem, the national central banks of the euro area and the European Central Bank. In 2012 income from this source was 51.6 million euros. Earnings from investment activities were 3.7 million euros last year, and 8.1 million in the previous year. Eesti Pank’s operating expenses increased last year to 17.4 million euros from the 16.2 million of the previous year because of the costs of issuing cash.

The net income for 2013 was reduced by general risk provisions of 6.8 million euros to cover risks, following the first such provisions last year of 11.5 million euros. Risk provisions are the first line of defence against losses on top of the reserves already held at the central bank.

Since 1992 Eesti Pank has allocated a total of 129 million euros to the state budget.

Background

Risks to Eesti Pank in monetary policy
The risks to Eesti Pank under the currency board came from the investments of the central bank and from the banking system. When Eesti Pank became a euro area central bank, it also took on the risks of the euro area as a whole, which are mainly related to monetary policy operations.

The Eurosystem is made up of the central banks of the euro area countries and the European Central Bank. The Eurosystem divides the income and costs of the single monetary policy, so that the income earned from monetary policy loans to euro area banks is divided among the central banks to match their participation in the Eurosystem, and the same is done with risks. Eesti Pank’s participation in the Eurosystem at the end of 2013 was 0.26 percent, which is the basis for the distribution of the previous year’s income and expenses. From 2014, Eesti Pank’s participation is 0.28 percent.

The Eurosystem’s monetary policy operations currently fall into two groups, monetary policy loans to commercial banks, which stood at 680 billion euros at the end of April, and the Securities Markets Programme, SMP, which stood at 220 billion euros.

Hedging of monetary policy risks
To hedge against the risks of the monetary policy loans, the central banks of the Eurosystem have the right of claim against banks that have taken loans. The content of the collateral is the equity of the bank that has taken the loan. The euro area central banks only give out loans if collateral is provided, meaning that if the bank cannot pay back its loan to the central banks, then the central banks can instead take the collateral. If even this is not enough, the credit risks for the central banks are reduced by the national authorities and their desire to recapitalise their insolvent banks.

The SMP is backed by the promises of governments to meet all their obligations in full, meaning that if governments fail to meet their obligations fully or partially, including their obligations to the central banks of the euro area, then the euro area central banks suffer the loss.

The capital of central banks and its importance
In this case, the capital of Eesti Pank and the other central banks that is meant is the wider sense of the part of the reserves and capital that the bank can use to cover losses.

The level of capital of the central bank is important because a central bank that has little or negative capital can cause two sorts of public concern. The first is the question of the central bank’s independence, if the bank needs to ask the government for additional capital. The second is the question of how much the central bank really wants to meet its inflation targets, which will then cause increased public expectations of inflation. The result of both these concerns is a loss of trust and of public faith that the central bank will be able to keep inflation under control successfully.

 

Source: Bank of Estonia

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