How ECB has turned the central bank seignorage model upside down?

Of all the noise around central banks. this blog just likes the discussions around central bank balance sheets. Learning about central bank balance sheets is perhaps all there is to monetary policy. But again it is hardly emphasised enough.

Daniel Gros has a superb piece on how  negative rates have impacted ECB balance sheet. Things have turned upside down actually. Traditionally central banks issue liabilities at near zerocost and earn on its assets which is usually investment in government bonds. With negative rates, ECB earns on its liabilities and distributes its earnings across the Eurozone via the national central banks. ECB has become more like an investment bank which uses leverage to earn interest on its assets.

The theoretical seigniorage revenues should thus disappear, and even become ever more negative with negative rates.  But in reality central bank profits are holding up rather well.  The reason is that as their traditional business model is destroyed by negative rates, central banks have gone in another business, namely maturity transformation of the kind usually done by investment banks.  Central banks have started to leverage up their balance sheet, buying large amounts of long-term government bonds (financed by short-term deposits).  This is called ‘quantitative easing’. The purpose is to force long-term interest rates down.

QE in general increases the income of a central bank, especially if earns on both sides; on its liabilities it charges a fee on the deposits of commercial banks and on its asset side it earns, or rather used to earn, a return on long-term government bonds.  With German long-term rates negative, the Bundesbank loses on its investments, but the ten-year rate is still higher than the deposit rate.

One should thus split the balance sheet of a central bank in two conceptually very different parts:

  1. The issuing department (which issues legal tender); and
  2. The investment banking department, which issues short-term deposits to buy longer-term and/or more risky assets, which usually yield much more than a central bank has to pay on its short-term debt.

The revenues (= profits since there are no costs, except the printing of bank notes) of the issuing department correspond to theoretical seigniorage: ‘the’ interest rates times cash in circulation. (Required reserves on which interest is paid net out of the calculation.) 

The profits of the investment banking department are equal to the difference between what the central bank pays in its liabilities (short-term deposits of commercial banks) and what it earns on the securities it has invested in. The profits of the investment banking department are not certain. If the short-term refinancing costs increase losses can arise quickly.


The ECB has thus effectively turned the old business model of central banks around – today it earns a stream of income on its liabilities, while the returns of an increasing part of its assets go to the NCBs. This cannot be a stable arrangement.

Great reading. Will take time though to figure things. ECB operations are far more complicated given there are so many entities involved..


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