Rapid Rate Hikes Leave ECB Facing Losses as Interest Costs Rose and Asset Values Fell in 2022

23 February 2023

By Xavier D’Arcy – FRANKFURT (Econostream) – The European Central Bank announced on Thursday that it incurred losses of over €1.6 billion in 2022, a deficit it had to compensate for using funds from its provision for financial risks.

‘These losses mainly arose from the interest expense resulting from the ECB’s net TARGET2 liability and security write-downs in the own funds and US dollar portfolios’, the ECB said in a statement accompanying the release of its annual accounts.

According to the ECB, the liabilities to Eurosystem central banks via the TARGET2 payments system - on which interest costs have now soared - evolved ‘as a result of the ECB’s net purchases of securities held for monetary policy purposes’ in recent years.

These balances are remunerated at the ECB’s main refinancing operations (MRO) rate. Interest expenses on these liabilities stood at over €2 billion in 2022, compared to a net interest income of €22 million in 2021, the ECB said. Policy rates rose at an unprecedented pace last year, having previously been in negative territory, and the MRO rate now stands at 3%.

A revaluation of the ECB’s dollar-denominated assets also contributed significantly to the central bank’s losses in 2022, the ECB said. Write-downs amounted to €1.8 billion, according to the annual accounts, due to a ‘decline in the market value of securities held in the own funds and US dollar portfolios as a result of the significant increase in the corresponding yields.’

The ECB said that it was ‘subject to interest rate risk arising from mismatches between the interest rate earned on its assets and the interest rate paid on its liabilities’. This was particularly due, it explained, to the ‘existence of maturity and yield mismatches between assets and liabilities.’

These mismatches were key in making the ECB incur losses last year, with yields on its liabilities, particularly TARGET2 balances, adjusting much faster than yields on the assets the ECB holds, such as government bonds.

Internal ECB projections indicate that ‘the ECB, before any releases from or transfers to the provision for financial risks, may experience losses in the short to medium term, while expecting a return to profits in the long run’.

Following the review of the ECB’s accounts, the ECB announced that ‘the Governing Council decided to release €1.6 billion from the provision for financial risks to offset losses incurred in 2022, after which the ECB’s financial result was zero.’ After having to draw on this provision, the ECB’s buffer for financial risks now stands at €6.6 billion.