October 5, 2023 – The Bank of Canada needs bolstering for the losses and risks ahead, according to a new report from the C.D. Howe Institute. In “Losses, Risks and Reputation: Bolstering the Bank of Canada for the Road Ahead” author Janet Cosier, who served as the Bank’s Chief Risk Officer and Chief Financial Officer, provides solutions for the issues facing the Bank of Canada and advises how it can best prepare for emerging risks.
Central banks around the world, including the Bank of Canada, are dealing with a hangover from the quantitative easing (QE) policies undertaken during the pandemic, notes the author. Ensuing inflation and interest rate hikes have created balance sheet mismatches and net interest losses. As an example, the interest rate the Bank of Canada earns on its bond portfolio is lower than the interest rate it owes on settlement balances financial institutions hold at the Bank. The result has been a negative equity position on the Bank’s balance sheet.
“Given these circumstances, concerns have arisen about the ability of central banks to carry out their monetary policy mandates. Reputation and independence issues have come to the forefront. Questions have also emerged regarding the implications for public finances with the cessation of profit transfers to governments,” says Cosier.
One of the author’s main recommendations is that the federal government make an additional capital investment in the Bank of Canada so it can effectively manage its current losses and future financial challenges and risks.
“In 2023, the Government of Canada chose to allow the Bank to temporarily retain its net income in the future instead of remitting it to the government. However, I believe a more structured solution is for the government to undertake a capital investment,” she adds.
Among the reasons cited: the Bank’s cumulative financial losses are expected to continue in the short and medium term; it will take several years for the Bank to recoup its losses and start to restore its capital to the original level; and the Bank’s indemnity agreements with the government do not cover income losses.
“In a period of enhanced scrutiny on central banks, a long-lasting negative equity position could be interpreted as a sign of poor financial health,” Cosier concludes. “This approach may also lead to questions about the Bank’s financial strength, its policy credibility and reputation. A capital investment will enhance the Bank’s earning capacity to cover its operating costs and cumulative losses.”
The paper also provides guidance on enhancing the Bank of Canada’s financial risk management framework to make it more robust and transparent in a world of elevated balance-sheet risk. Among others, the recommendations include:
- Emerging financial risks – identify, monitor and take these risks into account for each of the Bank’s core functions in order to assess the total financial risk exposure of the Bank’s balance sheet and the adequacy of its capital reserves.
- Enterprise risk management reporting – enhance the focus on emerging risks for all of the Bank’s core functions and discuss these risks with the finance and audit committee and the board of directors, as the need arises. To enhance accountability and transparency, on an annual basis, disclose any significant emerging risks in the Bank’s audited financial statements, and discuss them in the annual report.
- Independent review of the Bank’s operations – undertake, in the short term, an independent review of the Bank’s monetary policy forecasting tools and decision-making processes related to the quantitative easing program by external monetary policy and public communications experts.
- Communications – enhance communications for the average reader with clear, simple, concise and consistent messages deploying different tools during these unprecedented times of high inflation and high interest rates to promote the transparency and accountability of the Bank.
- Review of quantitative easing program – provide estimates about the costs and benefits of the quantitative easing policy tool on the Canadian economy, given the large impact of this policy on government finances and other key stakeholders including the public.
For more information contact Janet Cosier, former Chief Risk Officer and Chief Financial Officer at the Bank of Canada; Jeremy Kronick, Associate Vice President and Director of the Centre on Financial and Monetary Policy at the C.D. Howe Institute; and Gillian Campbell, Communications Officer, C.D. Howe Institute at gcampbell@cdhowe.org.
The C.D. Howe Institute is an independent not-for-profit research institute whose mission is to raise living standards by fostering economically sound public policies. Widely considered to be Canada's most influential think tank, the Institute is a trusted source of essential policy intelligence, distinguished by research that is nonpartisan, evidence-based and subject to definitive expert review.