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The Bank of Canada could lose $3.6 billion to $8.8 billion over the next two to three years, a new report from the C.D. Howe Institute said.
Trevor Tombe and Sonja Chen, authors of the think-tank’s report released on Jan. 12, said their “preferred estimate” is for cumulative losses of $5.7 billion ending in late 2024 or early 2025 with the central bank recording “peak losses” in the first quarter of 2023. The pair’s estimates are based on a series of scenario assumptions they pulled together.
The Bank of Canada isn’t in the business of making profits the way traditional financial institutions are. “Despite these short-term losses, the long-run financial position of the bank remains sound,” Tombe and Chen wrote. But, they also noted in the report, Reversal of Fortunes: Rising Interest Rates and Losses at the Bank of Canada, that the loss will cost the government.
They estimated the central bank’s payments to Ottawa have totalled nearly $160 billion during its 88-year history. For the fiscal year that ended March 31, 2022, they said the profits transferred to Ottawa plus the interest on Government of Canada deposits totalled $2.7 billion.
The loss of revenue means the federal deficit — estimated at $36.4 billion for 2022-23 in the October fiscal update — will rise. Covering the Bank of Canada’s losses will also increase debt payments by $90 million based on a 3.5 per cent borrowing rate. Still, Tombe and Chen described the losses as “modest” relative to gross domestic product.
Tiff Macklem, the central bank governor, surprised the country’s financial and political communities when he told the House finance committee in November that the bank would lose money for the first time since its founding in 1935.
“After a period of above-average income, our net interest income is now turning negative,” he said on Nov. 23. “The size and duration of the losses will ultimately depend on a number of factors, including the path of interest rates and the evolution of both the economy and the balance sheet.”
Not long after the committee appearance, the Bank of Canada reported a loss of $522 million in its third quarter ending Sept. 30, with “net interest revenue” coming in at a loss of $350 million, compared with a gain of $814 million in the year-earlier period.
Tombe and Chen aren’t necessarily bothered by the loss as it relates to the central bank’s ability to function, but said it is clouding the public’s perception.
“While this does not undermine the bank’s ability to conduct monetary policy, it does create novel reputational and communications challenges for the bank at a time of elevated public attention on its activities,” they said.
The Bank of Canada has come under scrutiny amid an extraordinary cycle of interest rate hikes, raising its benchmark lending rate to 4.25 per cent in December 2022 from 0.25 per cent in March in an effort to reduce inflation, which peaked at 8.1 per cent in June 2022, but now sits at 6.8 per cent.
Consumers have suffered from the rate increases, but the central bank isn’t immune to them, either.
The Bank of Canada embarked on a round of quantitative easing by purchasing federal government bonds and other assets, mostly from financial institutions, when the pandemic threatened to derail the economy. Those bonds were then added to the balances institutions are required to keep with the central bank. The deposits earn interest, so as the bank increased the cost of borrowing the amount of interest it paid to the institutions rose, resulting in expenses outpacing revenues.
But to those who would take issue with the red ink, Tombe and Chen said their loss projections are smaller than the profit the Bank of Canada booked in 2019 and 2020.
In the report’s closing comments, the authors proposed the central bank deal with future losses by possibly following the United States Federal Reserve’s lead to create a deferred account where losses can be sequestered and then paid off as revenue rebounds.
“Whichever course is chosen, future amendments to the Bank of Canada Act are almost surely in store,” they said.
