The Supervisory Board of Eesti Pank decided on Tuesday, May 5 2015 to transfer one quarter, or 4.3 million, of the 17 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 the policy of the Supervisory Board that the central bank should have sufficient reserves so that if there is any problem Eesti Pank can cope without any help from the state. Central banks normally face losses when economies in general are in difficulties. Increasing the reserves reduces the chances of an additional burden needing to be placed on the state budget in an economic crisis”, he explained.
The ratio of Eesti Pank’s increased capital to the assets used for monetary policy is one of the lowest of any of the central banks of the euro area. The comparison with the other central banks of the euro area is important, as the balance of risks to capital of the central banks of the euro area and the European Central Bank all taken together is considered when joint monetary policy decisions are made.
For this reason the Supervisory Board set a long-term goal in 2012 of increasing Eesti Pank’s capital ratio to 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.
Last year, Eesti Pank received 16.7 million euros in income from the joint monetary policy and currency issuance activities of the Eurosystem, which contains the national central banks of the euro area and the European Central Bank. In 2013 income from this source was 42.2 million euros. Earnings from investment activities were 12 million euros last year, and 3.7 million in the previous year. Eesti Pank’s operating expenses fell last year to 17 million euros from the 17.4 million of a year before.
The net income for 2014 was reduced by general risk provisions of 7.7 million euros to cover risks. In the past three years Eesti Pank has built up risk provisions of 26 million euros in total. 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 133 million euros to the state budget.
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 2014 was 0.28 percent, which is the basis for the distribution of the previous year’s income and expenses. From 2015, Eesti Pank’s participation is 0.27 percent.
The Eurosystem held 513 billion euros in monetary policy loans to commercial banks and 339 billion euros of securities held for monetary policy purposes as at 24 April.
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 Securities Market Programme (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 is meant in 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: Eesti Pank
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