Governments are, in most cases, the sole shareholders to whom central banks distribute their profits, although for historical reasons some central banks have private shareholders that usually receive predefined dividends....Publication ECB

05/04/2016                                       Publication

Occasional paper no. 169: Profit distribution and loss coverage rules for central banks, by Daniela Bunea, Polychronis Karakitsos, et al.

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Summary

The profit made by central banks, unlike that of private companies and commercial banks, is not an indicator of policy performance or operational efficiency. 

Moreover, unlike those entities, central banks are generally constrained by national law in the degree of freedom they have to determine their annual profit distribution (dividend to shareholders). 

However, in the long run positive financial results strengthen the credibility of central banks and they contribute to their financial independence to the extent that they allow central banks to construct appropriate reserves to protect themselves against the materialisation of the risk exposures contained in their balance sheets. Governments are, in most cases, the sole shareholders to whom central banks distribute their profits, although for historical reasons some central banks have private shareholders that usually receive predefined dividends. 

The extent to which current net income is used to build reserves against future losses is, in principle, only a matter of timing of distribution, given that such reserves are also used to smooth the future impact of potential losses and so reduce the need for the government to recapitalise the central bank when losses are incurred. On the other hand, any distribution of profit increases the spending power of the government and also reduces its borrowing costs. Therefore, any loss suffered by the central bank or any retention of profit in reserves or other buffers implies reductions in public revenue or even additional expenses. 

This situation has occasionally caused the issue of profit distribution to be highly controversial. The purpose of this paper is to investigate the policies and practices applied by a significant number of central banks worldwide in relation to profit distribution and coverage of losses. The analysis also covers the related accounting frameworks, which can affect the extent and the volatility of reported, and therefore distributable, profits and which consequently interact with the profit distribution rules as concerns central banks achieving and maintaining financial strength.

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