The Bank of Canada’s balance sheet reflects the unique role it plays as Canada’s central bank. It is different from the balance sheets of other financial institutions—the assets and liabilities on the Bank’s balance sheet are intended to support its core functions rather than to generate profit.
Currently, the Bank is facing a temporary net loss for the first time in history. Canada’s experience is not unique—most central banks in advanced countries are also facing losses as they raise interest rates. The losses have no impact on the Bank’s ability to conduct monetary policy.
Interest earnings in normal times
In normal times, the Bank’s main liabilities are bank notes, and its main assets are Government of Canada bonds. Since it pays no interest on bank notes, the Bank generally has positive net interest earnings.
The interest earned, minus the cost of producing, distributing and replacing bank notes, is called seigniorage. A portion of these earnings pays for the Bank’s operating costs. The remainder goes to the government and becomes part of its revenue. In a typical year, the Bank transfers approximately $1 billion in net interest earnings to the government.
Interest earnings grew considerably during the pandemic
The Bank’s primary monetary policy tool is its policy interest rate. The Bank adjusts the policy rate down to stimulate the economy and up to cool the economy off. In extraordinary situations, when the economy experiences a large shock that causes financial markets to freeze or pushes the economy into a deep recession, the Bank can support its primary policy tool by also expanding its balance sheet.
This extraordinary policy tool is known as quantitative easing and it involves the Bank purchasing additional assets, primarily government bonds, in the open market. By purchasing government bonds in the market, the Bank adds to the demand for these assets which pushes their price up and their yield down. Lowering the yield on government bonds lowers the interest rates on mortgages, and consumer and business loans. In doing so, it adds stimulus to the economy, helping it to recover from a shock. The COVID‑19 pandemic was the first time the Bank used quantitative easing.
As a result of deploying quantitative easing to support the recovery from the economic shock of the pandemic, the Bank’s assets grew significantly in 2020 and 2021, increasing the total interest earned by the Bank. To fund the bond purchases, the Bank used a liability unique to central banks called settlement balances. Settlement balances pay interest equal to the Bank’s policy interest rate. Since interest the Bank paid on settlement balances was close to zero for most of 2020 and 2021, approximately $2.6 billion in extra income from its assets was remitted to the government.
Net interest rate margin
The difference between interest earned on the bonds the Bank purchased (assets) and the interest paid on the Bank’s settlement balances (liabilities) is the net interest rate margin. The interest on the Bank’s assets is fixed and depends on the maturity structure of the Government of Canada bonds it holds. The interest it pays on settlement balances varies as the policy rate changes.
When the policy interest rate was very low, the Bank’s assets earned more interest than the Bank was paying on settlement balances. The Bank’s net interest rate margin was positive and larger than normal.
As the policy interest rate increased, interest payments on settlement balances rose as well, but the interest rate the Bank earned on the bonds it purchased remined fixed. As a result, the Bank’s net interest rate margin declined. In the third quarter of 2022, the difference between the interest the Bank pays on settlement balances and what it receives on its bonds turned negative. As a result, the Bank is facing a temporary net loss for the first time in history.
What this means for the Bank’s financial results
Following a period of losses, the Bank will return to a positive net income position, likely around 2025 or 2026. The size and duration of the losses will depend on several factors, including the path of interest rates and the evolution of both the economy and the balance sheet.
The losses have no impact on the Bank’s ability to conduct monetary policy or on the Bank’s operations. The Bank’s policy actions are guided by its price stability and financial stability mandates.
Most major central banks are also facing losses as interest rates have risen. Central banks around the world have different frameworks for managing their earnings, reserves and equity.
In Canada, the Bank of Canada Act currently states that the Bank cannot accumulate earnings to offset losses.
To provide the Bank the capacity to manage its losses, the government has indicated that it will introduce legislative amendments that would allow the Bank to temporarily retain net income in the future, rather than remitting them to the Government of Canada. This would allow the Bank to use its future income to offset its accumulated losses. Once sufficient equity has been restored, the Bank would resume remitting to the government.