Central Bank Profits Characterized by a High Degree of Uncertainty
Central Bank of China
Release date: December 25, 2006
Central Bank Profits Characterized by a High Degree of Uncertainty
Looking at the balance sheet of Taiwan’s central bank as of the end of November 2006, foreign currency denominated assets account for 96.49% of total assets. Revenue of the CBC is, therefore, heavily influenced by returns on foreign assets.
Returns on foreign assets in turn are affected by the following factors:
1. Level of foreign exchange reserves
Balance of payments has a big impact on the changes in the level of foreign exchange reserves. In recent years, the most important factor has been capital flows associated with foreign portfolio investment.
2. Interest rates
Interest rates of all the major reserve currencies, the US dollar, the Euro, and the Japanese yen, are determined by foreign central banks.
3. NT dollar exchange rate
Returns on foreign assets must be converted back to the domestic currency, the NT dollar. The NT dollar exchange rate is determined by market forces.
It’s obvious from the above analysis that revenue of Taiwan’s central banks is determined mainly by external factors.
Looking at the other side, Certificate of Deposit Issued and Redeposit of Financial Institutions are the two major liabilities on the balance sheet. Interest expenses created by these two items are influenced by domestic interest rates. For example, if the central bank adjusts the interest rate upwards by 25 basis points to fight inflation, interest expense will increase by NT 18.2 billion.
Since the size of revenue and the amount of interest expense are both highly uncertain, profits are hard to predict. Between 1987 and 1990, profits of Taiwan’s central bank were NT41.8 billion, NT22.8 billion, NT 22 billion, and NT 30.2 billion, respectively. The combined total for the four years was NT116.8 billion. During this period, however, the NT dollar appreciated sharply against the US dollar. Assets denominated in foreign currencies suffered unrealized revaluation losses. This figure was as high as NT634.9 billion at the end of April 1989. In order to make up for the unrealized revaluation losses, Taiwan’s central bank did not transfer any profits to the Ministry of Finance between 1987 and 1990. At the time, the Treasury Department of the Taiwan’s Ministry of Finance asked the Accounting Department of this bank to study the impact of exchange rate movements on central bank profitability. The Ministry of Finance also reduced the central bank’s budget allotment to ease the task of balancing the government’s budget.