The Supervisory Board of Eesti Pank decided on Tuesday to transfer one quarter, or 7.5 million, of the 30.1 million euros it made in profit last year to the state budget. The remaining three quarters of last year’s profit will go to strengthening the capital of the bank.

Chairman of the Supervisory Board Mart Laar said that the amount the central bank can contribute to the state budget is limited because Eesti Pank has relatively little capital compared to that held by the other central banks of the euro area. The Supervisory Board has decided to create sufficient reserves so that the central bank can cope without any help from the state should problems arise, he explained.

He further added that: “Central banks face multiple financial risks relating to possible economic crises and the monetary policy measures of the central banks of the euro area in recent years have increased those risks significantly”.

The ratio of Eesti Pank’s increased capital to the assets used for monetary policy is one of the lowest of any of the central banks of the euro area. The comparison with the other central banks of the euro area is important, as the balance of risks to capital of the central banks of the euro area and the European Central Bank as a whole is considered when joint monetary policy decisions are made.

For this reason the Supervisory Board set a long-term goal in 2012 of increasing Eesti Pank’s capital ratio to the average level of the central banks of the euro area. This means it is necessary to raise the level of capital by about a billion euros to 1.3 billion.

Eesti Pank earned 26.9 million euros last year in income from the joint monetary policy and currency issuing of the Eurosystem, down from 28.6 million euros the year before. Earnings from investment activities were 23 million euros last year, and 12 million in the previous year. Eesti Pank’s operating expenses were 17 million euros last year, which was the same as a year before.

The net income was reduced by general risk provisions of 4 million euros to cover risks, which was less than the 7.7 million euros of risk provisions in the previous year. In the past four years Eesti Pank has built up risk provisions of 30 million euros in total. Risk provisions are the first line of defence against losses on top of the reserves already held at the central bank.

Since 1992 Eesti Pank has allocated a total of 141 million euros to the state budget.

Background

Risks to Eesti Pank in monetary policy
The risks to Eesti Pank under the currency board came from the investments of the central bank and from the banking system. When Eesti Pank became a euro area central bank, it also took on the risks of the joint activities of the euro area central banks, which mainly stem from monetary policy loans and asset purchases.

The euro area central banks divide the income and costs of the single monetary policy, so that the income earned from monetary policy loans to commercial banks, or the costs from them, is divided among the national central banks to match their participation in the European Central Bank. This participation is called the capital key of the European Central Bank, and since the start of 2015 Eesti Pank’s capital key has been 0.274%.

The total volume of assets bought by the central banks of the euro area in their monetary policy transactions stood at 1.5 trillion euros on 15 April this year. Of this, 907 billion euros is in assets where the risks and income are shared among the euro area central banks using the capital key. This means that Eesti Pank’s share of the pooled risks is 2.5 billion euros.

Hedging of monetary policy risks
To hedge against the risks of the monetary policy loans, the central banks of the Eurosystem have the right of claim against banks that have taken loans. The content of the collateral is the equity of the bank that has taken the loan. The euro area central banks only give out loans if collateral is provided, meaning that if the bank cannot pay back its loan to the central banks, then the central banks can instead take the collateral. If even this is not enough, the credit risks for the central banks are reduced by the national authorities and their desire to recapitalise their insolvent banks.

The SMP is backed by the promises of governments to meet all their obligations in full, meaning that if governments fail to meet their obligations fully or partially, including their obligations to the central banks of the euro area, then the euro area central banks suffer the loss.

The capital of central banks and its importance
In this case, the capital of Eesti Pank and the other central banks that is meant is the wider sense of the part of the reserves and capital that the bank can use to cover losses.

The level of capital of the central bank is important because a central bank that has little or negative capital can cause two sorts of public concern. The first is the question of the central bank’s independence, if the bank needs to ask the government for additional capital. The second is the question of how much the central bank really wants to meet its inflation targets, which will then cause increased public expectations of inflation. The result of both these concerns is a loss of trust and of public faith that the central bank will be able to keep inflation under control successfully.

For further information:
Viljar Rääsk
Public Relations Office
Ph: +372 668 0745, +372 527 5055
Email: viljar.raask@eestipank.ee
Press enquiries: press@eestipank.ee