Since the increases of policy interest rates in the years 2022-2023, a number of central banks are suffering significant losses from the materialisation of interest raterisk. These losses erode the capital buffers and raise questions about the cost-efficiency of monetary policy. This warrants a closer look at the topic of central bank capital and profitability. What is the role of central bank capital? What is the problem with central bank losses exactly? And what possibilities do central banks have to “manage” their capital and profitability? We revisit these questions for central banks in general, with a particular focus on the Eurosystem and De Nederlandsche Bank.

In contrast to commercial banks, there are no rules or clear guidelines for central banks’ capital adequacy. Although central banks cannot default as long as they have the right to issue legal tender, capital adequacy is important to be a credible, independent monetary authority over a medium-term horizon. Central banks face several challenges in determining their capital adequacy. First, the amount of capital only plays an auxiliary role in central banks’ effectiveness. Second, central banks face “latent risks” in addition to the regular calculable financial risks. These latent risks are difficult to quantify because they stem from contingent policy measures such as quantitative easing and lending of last resort. Latent risks are related to GDP and the size of the financial sector in the economy. We argue that a central bank’s target level of capital (1) can be calibrated with a confidence level that is lower than that used for commercial banks and (2) is proportional to GDP as a proxy for the latent risks. We propose a set of guidelines to arrive at such a central bank capital policy.

Central bank losses are regrettable and, to some extent, disruptive, as they constitute public money that could have been otherwise used for public purposes such as education and healthcare. But even low (positive) profits are undesirable. In general, central bank profits are important as they help to maintain a strong balance sheet and support financial independence from the government. A central bank should generate sufficient income over the medium term to grow its capital in line with GDP (Gross Domestic Product) which is roughly proportional to the underlying latent risks of the central bank from the economy and the banking sector.

Paul Wessels has worked in financial risk management since 2004 at ABN AMRO, KPMG and De Nederlandsche Bank (DNB). At DNB he was the head of the Risk Management department from 2015 to 2020 responsible for topics like capital management, ALM modelling, collateral management, interest rate risk management and overseeing the management of the central bank investments. Since 2021, Paul has moved to the payments and market infrastructures domain as the head of the DNB Payments and Collateral department. In 2024 he joined the European Central Bank as the controller of the Market Infrastructure Board, which is responsible for the various TARGET Services (T2, T2S, TIPS and ECMS). In recent years, Paul has authored several papers on central bank capital management and profitability.