The German government might be swimming in surplus cash at the moment – much to the consternation of its indebted European neighbors – but it may have just lost one of its biggest cash cows for the coming years.
That would be the German central bank, the Bundesbank, a non-profit institution that passes on whatever it earns from its own balance sheet to the federal government in Berlin every year.
Those earnings collapsed last year. In 2016, the central bank earned just €1 billion, down sharply from €3.2 billion in 2015. The spoils being handed to Berlin amounted to just €400 million, the central bank announced Thursday, as it also needs to set aside extra cash for a pension fund.
That may be just the beginning. The central bank of Europe’s largest economy warned it could actually start losing money in the next decade – a dramatic turn that it blames partly on the European Central Bank and its president, Mario Draghi.
The news of the plunging profits for 2016 caught Berlin by surprise. The finance ministry had hoped to get €2.5 billion out of its central bank – money the ministry had already calculated into its 2017 budget.
Despite the hit, Germany’s finance ministry insisted in a statement that the plunge will not push the country into running a budget deficit for this year. But the math for Finance Minister Wolfgang Schäuble, who has managed to balance Germany’s books since 2014, has no doubt gotten a lot tougher.
Other politicians also withheld their criticism Thursday, citing the Bundesbank's independence, though no doubt there are many that wish the central bank would have sent more funds over their way.
Why the sharp drop? Essentially, the Bundesbank is preparing for rainy days in the future. It has created a reserve fund that now has more than €15 billion in its coffers – money it expects it will have to pay out when the time comes for interest rates to start rising again in the 19-nation euro zone.
This is a new situation for us. Jens Weidmann, Bundesbank President
And it's not just the central bank that could have to pay up. Andreas Dombret, a Bundesbank board member in charge of financial regulation, warned that private banks, too, need to start setting money aside.
“The longer the low interest rate phase goes on, the greater the risks in the event that interest rates increase,” Mr. Dombret wrote in an editorial for Handelsblatt to be publisehd Friday. An increase in rates would help the banking sector stabilize and recover over the long term, but in the short to medium term banks have to make sure that their capital buffers are sufficient to deal with a rate hike.
“For the affected institutions, it is more than time for them to further strengthen their capital base,” Mr. Dombret added.
From the Bundesbank's perspective, Mario Draghi is the culprit. The Frankfurt-based ECB, which steers monetary policy for the entire 19-nation euro zone, has directed national central banks like the Bundesbank to buy hundreds of billions in government and corporate bonds over the past few years – a program known as quantitative easing that is designed to kick-start lending and revive the euro zone’s economy.
The German central bank, which has seen its balance sheet triple to €1.4 trillion in the past 10 years as a result, now fears that it will soon start making a loss on those massive holdings as interest rates in the 19-nation euro zone begin to rise again from their current record lows.
That’s because the bank not only holds assets but allows financial firms to park their excess reserves with the central bank. In normal times, the bank earns more money on the assets it owns than it has to pay out to banks depositing cash with them. But these aren’t normal times and the Bundesbank fears the situation will reverse in the coming years.
“This is a new situation for us. Back when monetary policy only steered short-term interest rates on the money market, the Bundesbank’s balance sheet was, de facto, free from interest rate risk,” Jens Weidmann, president of the Bundesbank, said Thursday. “Our monetary policy operations were therefore sure to contribute to our profits.”
Germany’s central bank actually earned €3.3 billion in net income. That’s €400 million more than it earned in 2015. But it set about €1.8 billion of that aside for a special fund to guard against future risks – that fund now has €15.4 billion in its coffers. Another €600 million was held back due to accounting changes for its own pension fund.
These interest earnings are not sustainable, at least not if interest rates start to rise again. Quite the opposite, in fact. Jens Weidmann, Bundesbank President
Ironically, much of the money the Bundesbank did earn last year came from the banks themselves, rather than the assets it owns. That’s because the ECB for the past few years has pushed the interest rate on bank deposits into negative territory – a policy it hoped would force the banks to lend their cash out to consumers and businesses – meaning banks actually have to pay the central bank a fee to park their excess cash with the institution.
But the good times can’t last: “These interest earnings are not sustainable, at least not if interest rates start to rise again. Quite the opposite, in fact,” Mr. Weidmann said.
Mr. Weidmann, a frequent critic of the ECB who opposed the bond-buying program, says he’s been backed into a corner. As interest rates rise, the Bundesbank will have to start paying interest again to banks – without earning any more money on the assets on its balance sheet. The hundreds of billions of bonds the Bundesbank has been buying over the last few years are at record low interest rates – and have to be held for a period of as long as 10 years.
“All in all, this maturity mismatch could then lead to losses,” Mr. Weidmann explained.
The Bundesbank calculated that a rise in interest rates of just 1 percentage point will cost the central bank €3 billion – virtually all of the income it earned in 2016.
Still, the fact that the Bundesbank is set to lose money as rates rise won’t stop Mr. Weidmann from pushing for an end to the ECB’s easy money policies – partly because the central bank believes Mr. Draghi’s actions are creating the same kinds of risks in the balance sheets of private banks as the Bundesbank itself is facing.
After all, the central bank has prepared for the rainy day by setting aside cash now. It’s the German government that has to worry that its cash cow might soon run out of milk.
Christopher Cermak is an editor with Handelsblatt Global. To contact the author: [email protected]