Why the Bank of Canada could lose billions of dollars in next few years – National

The Bank of Canada may lose up to $8.8 billion over the next few years, according to a new report warning the central bank may run into a communications challenge as a result of the losses.

The report from the C.D. Howe Institute estimates the total losses over the next two to three years will add up to between $3.6 and $8.8 billion.

“A lot of what determines the size of the losses really comes down to what interest rates are going to be over the next two to three years,” said Trevor Tombe, an economics professor at the University of Calgary and co-author of the report.

In the fall, the Bank of Canada posted its first loss in its 87-year history, losing $522 million in its third quarter.

The central bank said in its financial report that revenue from interest on its assets did not keep pace with interest charges on deposits at the bank, that have grown amid rising interest rates.

That problem is expected to persist as interest rates remain elevated.

The other factor influencing the size of the losses is how large financial institutions’ deposits at the central bank are, Tombe said.

While the losses don’t affect the Bank of Canada’s ability to conduct monetary policy, Tombe said they pose a communications challenge for the central bank.

“Many will look at that and say, ‘Well, doesn’t that mean, the bank is insolvent?”’ he said.

Historically, the Bank of Canada has always turned a profit, which it remits to the federal government. According to the report, those profits over the bank’s entire history total to about $160 billion in 2021 dollars.

However, the central bank’s policy decisions during the pandemic have led to the current predicament.

In response to the economic crisis brought on by COVID-19, the Bank of Canada dramatically expanded its assets as part of a government bond purchasing program. Also known as quantitative easing, the policy was part of the central bank’s efforts to stimulate the economy.

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That expansion in assets is now costing the central bank, as it paid for the government bonds with the creation of settlement balances.

With interest rates now elevated, the interest charges the central bank pays on these settlement balances has exceeded the interest it earns on the government bonds.

While the losses are a first for the Bank of Canada, other central banks who also engaged in quantitative easing during the pandemic, are also posting losses.

The Bank of Canada is now looking to the federal government for a solution to balance its books. However, economists note the solutions are about accounting and the losses will inevitably be covered by the federal government.

Tombe said finding a solution an appropriate accounting solution still matters because of the recent political attention on the central bank.

“Any other potential reputational hits that it takes might further erode public confidence in the institution,” he said.

Tombe and his co-author recommend the Bank of Canada run a deferred asset, which would allow the central bank to record the losses currently being incurred against future expected profits.

As the Bank of Canada goes back to making money, it would hold on to the profits instead of remitting it to government coffers.

However, this solution would require an amendment to the Bank of Canada Act, which currently doesn’t allow the central bank to hold on to profits.

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Tombe said if the act is to be amended, it would be a good opportunity to prepare the Bank of Canada for the next time it may incur losses.

“We should anticipate that we might find ourselves in a situation like this, again,” said Tombe. “And so this is an opportunity to potentially think about larger reforms to the Bank of Canada Act to ensure that we are ready for the next time.”

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