Accounting policies, distribution rules, and the financial performance of central banks

Pizzo, Carmine and Goncharov, Igor and Novotny-Farkas, Zoltan (2024) Accounting policies, distribution rules, and the financial performance of central banks. In: Central Bank Capital in Turbulent Times : The Risk Management Dimension of Novel Monetary Policy Instruments. Contributions to Finance and Accounting Series . Springer, Cham. ISBN 9783031735486 (In Press)

Abstract

This paper provides comprehensive evidence on the financial performance of 148 central banks and its determinants over the period of 2010-2022. We observe a deterioration in central banks’ capital buffers (i.e., equity) and profitability over our sample period, with the year 2022 seeing the largest percentage of central banks reporting losses (40%). While this deterioration in financial performance reflects the outcome of economic factors such as inflation and increased balance sheet size, we show that central banks’ financial reporting choices and distribution rules also play a substantial role. Specifically, we find that financial reporting choices that aim to increase central bank transparency by allowing economic signals to be reflected in financial statements in an unbiased and timely manner (e.g., adoption of IFRS and fair value reporting) are associated with higher volatility of central bank profits and a higher likelihood of central bank losses and capital shortfalls. In turn, discretionary accounting policies, such as general risk provisions, can help central banks smooth their performance, but they have been less effective in reducing the likelihood of adverse performance in recent years. We further find that central banks build stronger capital buffers when distribution rules allow central banks to decide on the level of dividends or facilitate intertemporal dividend smoothing, but there is no evidence that equity targets reduce the likelihood of capital shortfalls. Because economic factors that increase the likelihood of losses and negative equity (e.g., inflation, bloated balance sheets) will likely persist in the coming years, our findings highlight potential issues with central bank (financial) independence. The paper ends by discussing reporting options central banks might take to mitigate these effects.