One of the hard economic puzzles: can central banks fail? It has always been written in all textbooks on economics that the Central Bank is the lender of last resort. It exists to save commercial banks that are close to bankruptcy. It was believed that the Central Bank is immortal and cannot go bankrupt. It is not ruled out, of course, that the Central Bank may have net losses following the results of a particular year. Few people know that there have already been cases of so-called technical defaults of central banks. Such a default was announced by the Central Bank of Tajikistan at the end of 2007. In early 2010, the same story happened to the Reserve Bank of Zimbabwe. However, these were only temporary stops. The Central Bank has something that commercial banks do not have – a printing press. With it, he can make any amount of additional money, use it to buy financial instruments with a good yield and plug the hole in his balance sheet resulting from losses.
In the article “Will Central Banks Survive?? (I will central banks survive?) Finnish economist Tuomas Malinen (Tuomas Malinen) argues: “Because the central bank controls the monetary base, it can create demand for its liabilities (currency) by buying government securities and gain seigniorage” (seigniorage – income received from the issue of money and appropriated by the issuer).
However, it is impossible to abuse the printing press. If you regularly cover losses through additional emission, the Central Bank can cut down the branch on which it sits, that is, destroy the monetary system by continuous emission. Actually, this began to happen after the crisis of 2008-2009, when the central banks began to engage in the so-called quantitative easing (a euphemism covering the growth of the money supply with the help of the Central Bank’s printing press). “Quantitative easing”, coupled with a reduction in the key rate of the Central Bank to zero or even negative values, began to accelerate inflation. “But the coverage of large losses due to seigniorage, – says the Finnish economist, – will lead to a large increase in the monetary base and, consequently, to very high inflation. So the central bank can technically cover any losses, but that can only be achieved through very high inflation and will eventually destroy the monetary system.”.
By and large, inflation can be defined as the depreciation of the obligations of the Central Bank. Inflation is a clear sign that the Central Bank is incurring losses, and losses are the result of improper placement of its assets. Tuomas Malinen predicts that the moment is not far off when all the products of the leading central banks pursuing a policy of “quantitative easing” – US dollars, euros, British pounds, Japanese yens and other currencies – will turn into dust. And it will be the death of the Federal Reserve, the European Central Bank, the Bank of England, the Bank of Japan and other central banks.
And what about the Central Bank of the Russian Federation? There was an unpleasant moment in the history of the Bank of Russia, when a loss of 27.8 billion rubles was recorded in 1998. But the next year, this loss was covered by profit. And then until 2017, the Bank of Russia had a positive financial result every year.
The euphoria ended in 2017, when a loss of 435.3 billion rubles was recorded. In 2018, a new loss in the amount of 434.7 billion rubles, in 2019 – a loss of 182.7 billion rubles, in 2020 – another loss of 61.5 billion rubles. The annual report of the Bank of Russia for 2021 has recently been published. And again, a loss of 26.3 billion rubles. Total five consecutive years of losses. I don’t know if there are precedents in the world for the Central Bank to have negative financial results for such a long time. The total losses amounted to 1.14 trillion. rub. No technical defaults were announced in the work of the Central Bank. There were no serious investigations into the causes and consequences of such a chronic unprofitability of the Bank of Russia.
In late February – early March of this year, an unprecedented event took place in the world of finance: the foreign exchange reserves of the Russian Federation were frozen for an amount, as reported by the media, in excess of $ 300 billion. Judging by the data presented in the latest annual report of the Central Bank (as of as of January 1, 2022), foreign exchange reserves in the amount of at least $350 billion were frozen. Much has been said and written about this freeze, but for some reason it is very rarely remembered that these reserves are part of the assets of the Bank of Russia.
The freeze created a hole in the balance sheet of the Central Bank. What are its dimensions? According to my calculations, a part equal to 25.42 trillion was torn out of the assets of the Bank of Russia. rub. This is almost half of all assets of the Bank of Russia (as of January 1, 2022). In the assets of the Bank of Russia there is also a position of “claims on the IMF”, this is a part of international reserves that has not yet been frozen, but Washington is trying to freeze it too. If it is possible to block even the “requirements for the IMF”, then the size of the hole will grow to 28.57 trillion. rub. This is significantly more than half of all assets of the Bank of Russia. And the frozen assets are nothing but the losses of the Bank of Russia. Within a few days (at the turn of February – March 2022), the Central Bank had losses, the magnitude of which was approximately 25 times higher than its cumulative losses over the five-year period 2017-2021. The emergence of such a giant hole in the balance sheet of the Bank of Russia means no longer some kind of “technical default”, but the real bankruptcy of the Bank of Russia.
However, not everything is clear here. With the reduction of the assets of the Bank of Russia by half, one could assume that the ruble, backed by foreign exchange reserves, would have to fall by about half against the US dollar, euro and other reserve currencies. Indeed, in March there was a rapid fall of the ruble to about 130 rubles per 1 US dollar. However, then the ruble exchange rate began to recover to the level that it was before the start of the sanctions war. Experts do not rule out that the Russian ruble may continue to strengthen and its rate may reach 50 rubles per dollar. Then the following question arises: were the foreign exchange reserves really a collateral for the ruble, as we were constantly told? Foreign exchange reserves have disappeared, and the ruble remains at about the same level.
The next question is: can the Central Bank live with a giant hole in its balance sheet? Based on the rules that apply to commercial banks, it should be recognized that the Bank of Russia – bankrupt. Such a hole is incompatible with life. Even with the loss of 10% of assets, it is believed that the commercial bank “dead dead”. And in the case of the Bank of Russia, we are talking about a loss of at least 50%. Of course, Russia cannot live without the Central Bank, but even with such a “hole” the Bank of Russia cannot live.
Maybe try to bring the liabilities of the Bank of Russia (rubles put into circulation) in some way in line with the halved assets? For example, by some means devaluing the Russian ruble by half. Some experts suggest that after the strengthening of the ruble, its natural weakening will occur (most likely as early as next year) and a new equilibrium will arise with an exchange rate of about 150 rubles per US dollar.
Or maybe try to close up the hole that has formed? For example, Elvira Nabiullina stated that she was preparing statements of claim for the illegality of freezing to international courts. And in the United States, by the way, at the same time they are preparing laws according to which Russia’s foreign exchange reserves should not just be frozen, but confiscated. I think that the Bank of Russia will not return a single dollar to its assets.
Or maybe remember what the Chinese would do in this situation? Their Central Bank is called the People’s Bank of China (PBOC), is part of the executive branch of government, its activities are regulated by a special law. This law contains an article regulating the actions of the government in the event of NBK losses. It provides that these losses should be covered by the state budget. Let’s estimate how this method would look in relation to Russia. The federal budget revenues planned for 2022 for 2022 amount to 25.0 trillion rubles. rub.; expenses – 23.7 trillion. rub. Well, with difficulty, but the entire annual budget of the Russian Federation would probably be enough to close the “hole” in the balance sheet of the Bank of Russia. However, this option can be classified as fantasy.
Or maybe Russia should start life from scratch? Abolish the current Bank of Russia (to carry out the bankruptcy procedure), and create a new Central Bank in its place, transferring all the “live” assets and liabilities of the old one to its balance sheet. There are precedents in the history of our country. So, in 1920, the People’s Bank of the RSFSR was abolished in Russia, and a year later the State Bank of the RSFSR was created (as part of the People’s Commissariat of Finance).
There are other options that I won’t talk about. But you can’t pretend like nothing happened. The Central Bank itself reports that “the situation is under control” and it, they say, continues to fulfill the tasks assigned to it. In April, the State Duma heard the Annual Report of the Bank of Russia and voted for the appointment of E. Nabiullina to the post of Chairman of the Bank of Russia for the next five years. But for some reason, none of the deputies raised the question of how the Bank of Russia would get out of its current state, which has all the signs of bankruptcy. The Accounts Chamber, which, it would seem, should have commented on the state of the Bank of Russia, also remains silent.
From my point of view, the best option would be to carry out a radical monetary reform, as I have already written about. In the new monetary system, the Central Bank should, firstly, become a full-fledged state institution, which is part of the executive branch of government (in this case, it is desirable to return the name “State Bank” to it). Secondly, its main goal should be to ensure the economic development of the country (rather than “targeting inflation”).
This goal should completely change the structure of the assets of the Central Bank. In the balance sheet of the Bank of Russia at the beginning of this year, foreign exchange reserves accounted for approximately 2/3 of the assets of the Central Bank. Another 20% of assets are gold reserves. For loans to Russian banks and investments in securities of Russian issuers – no more than 10%. In order to survive in the sanctions war, we need the Central Bank, in which at least 2/3 of the assets are loans to the Russian economy and investments in Russian securities. Then there will be economic development in Russia, there will be no inflation, and the risk of freezing the assets of the Central Bank by the collective West will disappear. And the risk of bankruptcy of the Central Bank will become purely hypothetical.
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