Aggressive rate hikes over the last few years aimed at containing inflation have led to significant valuation losses across many of the largest central banks. High public debt and political polarisation, technological disruption, and geopolitical fragmentation are further adding pressure on central banks. This column proposes three sets of measures to enhance central bank financial strength. These include strengthening accounting and capital frameworks, identifying new revenue sources, and recalibrating monetary policy tools and financial stability policies. These reforms will enable central banks to manage shocks more effectively without relying on fiscal authorities for support.
As major central banks, including the US Federal Reserve, the Bank of England, the Deutsche Bundesbank, and the ECB, record substantial operating losses and suspend remittances to respective ministries of finance and treasuries, the debate over central bank financial resilience is shifting from academic circles to mainstream policy discussions. Central bank financial strength is not merely a technical concern – it is fundamental to their independence and functional autonomy, as noted earlier by Bindseil et al. (2004), Stella (2005), and Goodhart (2010). The recent literature (e.g. Cecchetti and Hilscher 2024 and Buiter 2024) underscores these lessons.
While weak financial strength may not immediately impair policy, it can do so over time. Gebauer et al. (2024) conclude that “if the ECB adopted a ‘zero-loss’ strategy to mitigate accruing losses ex-post, it would need to implement a significantly lower interest rate path compared to the assumptions underlying the ECB’s own projections”. Weak financial strength also makes central banks more vulnerable to political interference, particularly when fiscal support is uncertain. As Buiter (2024) highlights, central bank financing is an integral part of public financing, and its losses are ultimately fiscal losses.
The record recent losses coincide with a fraught macroeconomic and (geo)-political landscape that further complicates maintaining central bank financial strength. Three developments in particular put central banks’ financial strength further at risk: (1) high public debt accompanied by large fiscal deficits, (2) declining seigniorage as digitalisation accelerates, and (3) rising geo-strategic and political fragmentation coupled with populism. Building on the existing literature, we argue that in light of these trends, central banks must be proactive to maintain and enhance their financial resilience. Necessary steps include revising accounting, reserving and income distribution frameworks, identifying alternative revenue streams, and adjusting monetary, financial stability, and payment policies. These steps are not merely defensive in an increasingly complex world: when carefully designed, they can simultaneously strengthen central banks’ effectiveness and preserve, and even enhance, their financial strength.
The problem: Large central bank balance sheets and adverse trends combine
Over the past two decades, many of the world’s largest central banks have dramatically expanded their roles and balance sheets (Figure 1). The global crisis and the COVID-19 pandemic necessitated massive asset purchase programmes and long-term liquidity operations, increasing exposure to interest rate and credit risks. More recently, aggressive rate hikes aimed at containing inflation have led to significant valuation losses.
Not all central banks have experienced losses to the same extent or for the same reasons. Advanced economy central banks with large domestic securities portfolios have borne the brunt. The Federal Reserve reported $114.3 billion in net losses in 2023 and $77.6 billion in 2024, primarily due to valuation losses. Emerging market and small open economy central banks, which hold a higher share of foreign exchange reserves, have been more vulnerable to exchange rate volatility. The Swiss National Bank, for example, reported a record loss of $143 billion in 2022, the largest in its 115-year history, mainly due to exchange rate-related losses. A few emerging market central banks have incurred losses from their quasi-fiscal activities.
Figure 1 Selected advanced economy central bank balance sheets (percent of GDP)
Source: BIS (//data.bis.org/topics/CBTA/tables-and-dashboards)
Three trends are compounding pressures on central bank income and increasing risks to capital positions:
- High public debt and populism. While views differ as to the degree (e.g. Cecchetti and Hilscher 2024 are more optimistic), fiscal constraints and political polarisation reduce the likelihood of timely fiscal support to recapitalise the central bank if needed. Many central banks remit profits to their Ministry of Finance or Treasury but lack statutory mechanisms for receiving support when losses accumulate. Populism also increases the risk of political interference with central banks, from critiques of policies to requests to support non-core goals, as observed in both advanced and emerging market economies.
- Technological disruption. Digital payment systems are reducing the demand for physical currency, eroding seigniorage — a historically stable income stream. For some central banks, like the Riksbank in Sweden, this decline means that revenues may no longer cover the cost of core operations. In wholesale markets, technologies like distributed ledger technology can also bypass traditional payments and settlement mechanisms, further diminishing central bank income.
- Geopolitical fragmentation. Global economic and political conflicts, and national security concerns are leading to increased trade and investment barriers which are disrupting supply chains and capital flows and increasing economic and financial volatility. This is complicating the execution of central banks’ core tasks and increasing risks to their financial strength. Restrictions on asset choices have led some central banks to invest more heavily in gold, worsening the risk-return profile of foreign exchange reserves. Fragmentation also undermines policy coordination, notably when stress arises.
Each of these trends threatens the financial strength of central banks and complicates executing their tasks, as further illustrated in Table 1.
Table 1 Trends and their adverse impacts on central banks’ financial strength
Notes: XXX indicates more important, XX moderately important, X less important, . largely absent. *By challenging tasks, the trends increase risks and can reduce financial strength.
Three sets of recommendations
To safeguard their independence and avoid political interference, central banks must proactively enhance their financial strength. We propose three sets of key measures:
1. Strengthen accounting and capital frameworks
Central banks should adopt mark-to-market accounting consistent with International Financial Reporting Standards (IFRS) to better reflect their true financial conditions. Even more importantly, they should differentiate income recognition from income distribution. Unrealised gains should not automatically be remitted to fiscal authorities. Rather they should first be used to build capital buffers during good times, enhancing resilience during stress times. Several jurisdictions, including Australia and the UK, already implement such asymmetric rules. Furthermore, before remitting profits, central banks should use stress tests to assess whether projected income and capital buffers are sufficient under adverse scenarios (IMF 2024). As Adrian et al. (2024) also emphasise, income distribution rules should be both forward-looking and risk-based to account for the potential losses from unconventional monetary policies and to safeguard central bank financial autonomy and, ultimately, their independence.
Where possible, automatic recapitalisation mechanisms should be embedded in law, triggered by clearly defined thresholds, and complemented by discretionary mechanisms when extreme shocks exceed expected losses.
Indemnification arrangements can be appropriate for non-core fiscal tasks conducted, such as crisis lending to specific sectors. Notwithstanding, for core monetary and financial stability operations, such as asset purchases, indemnities should be used with great caution. Poorly designed schemes risk distorting incentives and weakening central bank independence.
2. Identify new revenue sources
As seigniorage declines, central banks must diversify their income sources to avoid pressures on executing their core tasks. Options include:
- Adopt tiered remuneration on commercial bank reserves, as the Swiss National Bank does, to reduce costs without impairing monetary control. Offer facilities, such as Australia’s Committed Liquidity Facility, at a fee, also to support systemic liquidity.
- Ensure adequate compensation for functions performed at the request of finance ministries to cover operational and reputational costs and risks.
- Increase existing or introduce new regulatory fees for supervisory, settlement, and liquidity services. If necessary, implement a general fee on institutions to cover core operations costs (e.g. the Bank of England levies a modest charge to fund itself).
- Broaden investment mandates for foreign reserve management within conservative parameters to raise returns without excessive risks.
3. Recalibrate monetary policy tools and adjust financial stability policies
As central banks maintain a long-term perspective on core mandates, where changes are justified at their own merits, they can adjust policies and tools to help maintain their financial strength.
The recent experiences show that some unconventional monetary policy tools, particularly large-scale asset purchases, impose significant financial risks for central banks while distorting private sector risk-taking. Central banks should therefore aim to limit the use of asset purchases to crisis scenarios and to give preference to short-term lending operations with clear exit strategies.
In operations, central banks should reevaluate their floor systems with ample reserves and where it is feasible move to scarce reserve frameworks to help shrink their balance sheets and restore market discipline. Forward guidance should be used sparingly as unconditional commitments expose central banks to credibility and financial risks when forecasts prove incorrect. Instead, communication should focus on the policy reaction function and reinforce flexibility.
To protect financial strength and avoid moral hazard, financial stability interventions should be (1) targeted, to avoid blanket guarantees that benefit institutions not in distress; (2) temporary, by including sunset clauses to ensure withdrawal once conditions normalise; and (3) transparent, by disclosing objectives, eligibility criteria, and costs. Clear collateral policies, proper pricing of facilities, and robust central counterparty arrangements can also reduce financial stability risks.
Central banks should also invest in data infrastructure, not just to improve surveillance of vulnerabilities, but to enhance risk-sharing with the private sector in times of stress and reduce the burden on public balance sheets of interventions.
Conclusion: Many central banks need to accelerate reforms
Many of the recommendations outlined are already being considered by policymakers, central bankers, and researchers (e.g. G30 2023, Borio 2023, 2024, Schnabel 2024, Carstens 2025), but they must be accelerated to support central banks’ balance sheet integrity and income stability, essential for their independence and credible policy operations. Strengthening capital frameworks, diversifying income sources, and better intervention strategies will enable central banks to manage shocks more effectively without relying on fiscal authorities for support. Reforms should be tailored to specific economic contexts. Emerging markets with pegged exchange rates, for example, face different constraints than advanced economies with floating regimes. But the principle remains: without financial strength, there is no independence; without independence, there is no credible policy.
Source : VOXeu
