By Johanna Treeck
FRANKFURT — The eurozone’s sovereign debt crisis was driven by the fiscal largesse of the bloc’s most profligate nations.
A decade on, it is the central banks of the Eurozone’s strongest economies, such as the German Bundesbank, that are expected to slide into the red even as the weaker members‘ central banks stay in profit.
The scope of the losses will be revealed over the next few weeks as the eurozone’s respective national central banks (NCBs) present their annual reports. On Thursday, the European Central Bank (ECB) kicked off the earnings parade with a €1.6 billion loss — its first in almost two decades.
Even so, the ECB balance sheet only reflects a fraction of the Eurosystem’s monetary policy operations, most of which are conducted by the region’s NCBs. Many of these, including the Bundesbank — which will report on March 1 — are expected to reveal even larger losses.
The trend is expected to see the NCBs of other fiscally prudent countries, among them the Netherlands, Austria and Finland — which were most skeptical of the measures now leading to losses — eventually generate a mirror image of the north-south rupture seen during the original eurozone sovereign debt crisis.
Some fear the role reversal could reopen the old wounds of the debt crisis that once pitched eurozone government against government, while inflaming public sentiment and casting serious questions about the viability of the euro currency.
“The hit on southern central banks is much smaller and you can bet on it that this will raise tensions,” said Johan Van Overtveldt, the Belgian chair of the EU Parliament’s budget committee. The impending losses of the region’s central banks “will surface in practically every discussion, directly or indirectly.”
During the sovereign debt crisis, the taxpayers from northern Europe often felt they had to pay for the fiscal recklessness of their southern neighbors.
No risk-sharing means no loss-sharing
In normal profitable times, the ECB usually passes its gains to NCBs, which in turn hand their overall profit-takes to their respective governments. In the past, the ECB has generated as much as €2.4 billion to share with NCBs, while NCBs have been known to rake in as much as €6.3 billion on an individual basis.
To guard against a threat to public balance sheets, most central banks — including the ECB — maintain large provision funds for the purpose of absorbing unexpected shortfalls.
These are rarely tapped. This year, however, the ECB’s Governing Council was forced to dip into the last-resort measure to keep its accounts tidy and in balance.
“There will be no profit distribution to the euro area national central banks,” the ECB noted.
Other loss-generating NCBs are expected to follow suit, either by tapping their provision funds or in some cases wiping them out entirely. The size of the draw downs plus their unequal distribution now risks upsetting eurozone cohesion.
Analysts suggest northern eurozone members only have themselves to blame for any fiscal exposures pertaining to bond purchases, particularly because they made a point of shielding themselves from the risk of southern member state defaults.
“The northerners insisted on no risk-sharing when the PSPP [the public sector purchase program] started,” said Daniel Gros, an economist and board member of the Centre for European Policy Studies, referring to the trillions of euros the ECB spent on government bonds. “This means now also no loss-sharing.”
The potential political explosiveness of losses was highlighted last week when the Financial Times published an op-ed by Professor Markus Kerber, an influential Euroskeptic, who warned they could “undermine public confidence in the euro, especially in Germany,” and that “we may now be approaching a necessary moment of truth for the central bank.”
What’s driving the losses?
The ECB and the wider Eurosystem are not alone among major international counterparts in recording hits to their balance sheets. The combined forces of inflation and higher interest rates have been a drag on many Western central banks. In the eurozone, however, the added pressure of managing losses within the framework of a single monetary system and no fiscal union means the costs will not be spread equally among member states.
Much of the stress — as well as the divergence — is related to the massive support measures central banks took to prevent the eurozone from falling apart during the sovereign debt crisis, as well as to thwart an economic crisis during the global pandemic.
For the Bundesbank, what was once a German strength — the capacity of its government to borrow at negative interest rates due to the relative health of its economy — has become a burden. The Bundesbank is now having to bear the cost of a mountain of negative-yielding assets acquired as a result of its asset purchases, meaning it has to pay the German Treasury for the privilege of holding its bonds.
The NCBs of weaker countries, on the other hand, stand to benefit from the generous positive yields they picked up when the debt of their respective governments was highly distressed.
The ECB’s own performance has been hit by foreign exchange effects on its dollar holdings and payments linked to the management of the Target2 settlement system.
One other loss-generating factor stems from the effect that rising interest rates have on the sums central banks must pay to commercial banks holding excess liquidity in their deposit facilities. As interest rates go up, these sums grow ever larger.
Since excess liquidity tends to flow to economically stronger member states, this compounds the problem by causing the NCBs of stronger states to warehouse a larger share of increasingly heavily remunerated deposits.
