Profit Distribution and Loss Coverage Rules for Central Banks

57 Pages Posted: 27 Apr 2016

See all articles by Daniela Bunea

Daniela Bunea

European Central Bank (ECB)

Polychronis Karakitsos

European Central Bank (ECB)

Niall Merriman

European Central Bank

Werner Studener

European Central Bank (ECB)

Date Written: April 26, 2016

Abstract

The issue of central bank profit distribution is both complex and often politically controversial. Based on the replies of 57 central banks worldwide to an ECB questionnaire, this paper analyses how profit distribution rules can affect the amounts distributed and the financial strength of central banks. The paper also investigates the link between profit distribution, accounting rules and financial strength. Research shows that central banks apply divergent rules as regards profit distribution and loss coverage. While they are not a measure of central bank performance, in the long run profits strengthen the credibility of central banks and contribute to their financial independence, whereas profit distribution rules that do not allow central banks to set up adequate reserves might have the opposite effect.

The interaction of profit distribution rules and accounting rules also plays an important role in central banks achieving financial strength. Accounting frameworks can materially influence central banks’ net results via their treatment of unrealised results and the creation of general risk provisions. Distribution policies can offset the volatility of distributed profits by recording changes in value in a separate account before calculating the amount of distributable profit. This paper also shows that central banks with less volatile distributable profits display higher ratios of equity to total assets over time.

Finally, the paper examines the role of stakeholders in influencing the profit distribution regimes of central banks, and develops a non-exhaustive set of general principles that could be considered in relation to profit distribution frameworks, with the aim of strengthening the financial, and therefore institutional, independence of central banks.

Keywords: profit distribution, loss coverage, accounting framework, financial strength, financial independence, stakeholders’ influence

JEL Classification: E37, E58, M48

Suggested Citation

Bunea, Daniela and Karakitsos, Polychronis and Merriman, Niall and Studener, Werner, Profit Distribution and Loss Coverage Rules for Central Banks (April 26, 2016). ECB Occasional Paper No. 169, Available at SSRN: https://ssrn.com/abstract=2770326 or http://dx.doi.org/10.2139/ssrn.2770326

Daniela Bunea (Contact Author)

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Polychronis Karakitsos

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Niall Merriman

European Central Bank ( email )

Kaiserstrasse 29
D-60311 Frankfurt am Main
Germany

Werner Studener

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

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