A European Central Bank Primer (V): What does the ECB’s balance sheet look like?

A European Central Bank Primer (V): What does the ECB’s balance sheet look like?

A European Central Bank Primer (V): What does the ECB’s balance sheet look like?

As the entity responsible for the conduct of monetary policy in the Eurozone, the ECB has a prerogative that no other financial institution possesses: it has an exclusive monopoly over the issuance of euros. As a result, the ECB’s financial position differs radically from that of any other bank in the Euro area. Today, we will take a closer look at the balance sheet of the Eurozone’s monetary authority.

But first, we need to define some basic concepts. A balance sheet is a financial statement that reflects the assets, owner’s equity and liabilities of a company. Assets are those resources that are used to generate revenue. For instance, for an automobile company, a factory used to produce cars is an asset. Similarly, loans are assets for commercial banks, although of intangible nature.

Liabilities are debts used to finance the purchase of new assets. The most common liabilities for non-financial companies are bonds and bank loans. Finally, the owner’s equity is the difference between the monetary value of assets and the monetary of value liabilities. By definition, the assets of a company must be equal to its liabilities plus the owner’s equity.

The balance sheet of a financial institution bears little resemblance to that of non-financial firms. As we mentioned before, the asset side of a commercial bank’s balance sheet contains mainly loans, securities (bonds and stocks) and other financial assets. The liability side is usually formed by deposits from customers and other debt instruments. Yet the ECB is a special kind of financial institution, so its balance sheet needs to be analyzed separately[1]. Which assets does the ECB hold?

The largest item on the asset side of the ECB’s balance sheet is securities held for monetary policy purposes, which accounts for 55 percent of all assets. It includes all securities purchased by the ECB in the conduct of monetary policy: sovereign bonds, corporate bonds and asset-backed securities. The weight of this item on the ECB’s balance sheet has increased dramatically since early 2015 when the ECB started its expanded asset purchase program (aka quantitative easing or QE).

The second item in importance is claims related to the allocation of euro banknotes within the Eurosystem. As we’ll see in a moment, euro notes are a liability of the European Central Bank[2]. This item is just the asset counterpart to this liability. The next item on the ECB’s balance sheet is claims on non-euro area residents denominated in foreign currency, which basically consists of bank balances and loans in dollars, yens and yuans.

Gold represents a significant fraction of the ECB’s assets, amounting to 4 percent. Why does the ECB hold gold? Even though central banks are peculiar financial institutions, financial principles apply to them as well. Central banks issue liabilities in the form of currency. As a result, the value of these liabilities (i.e., the value of the Euro) will depend on the quality of the assets backing them. Or put differently, if the ECB started to monetize all kind of junk assets, the euro would quickly depreciate. Since gold has historically been used as reserve currency, it is nowadays considered a high-quality, safe-haven asset; that’s why the ECB, like many other central banks, keeps gold in its vaults.

Other assets include current account balances with euro residents, fixed assets and other securities. Let’s now move on to the liability side. The largest liability is intra-Eurosystem liabilities, which reflects the balances of National Central Banks at the ECB. This item has grown considerably over the last years with the purchase of securities undertaken by the ECB under the umbrella of the asset purchase program.

Banknotes in circulation represents the second largest entry in the liability side. In the same way deposit accounts are liabilities for commercial banks, euro notes are liabilities for the ECB. The main difference is that deposits are redeemable in euros, whereas euros cannot be redeemed for any other asset.

Commercial banks’ reserves deposited at the ECB can be found under the entry other liabilities to euro are credit institutions denominated in euro, whereas liabilities to non-euro area residents denominated in euro consists of accounts belonging to other central banks, non-Eurozone commercial banks and supranational institutions. The right side of the ECB’s balance sheet includes other items such as provisions or revaluation accounts, which reflect the unrealized gains or losses on assets and liabilities.

To conclude, let’s take a look at the evolution of the ECB’s balance sheet over the last years. As shown in the graph below, the ECB’s balance sheet has gone through a significant expansion as a result of QE policies (brought to an end in December 2018) in an effort to get inflation back on track. At some point this or next year, the ECB is expected to start unwinding its balance sheet as the economy shows signs of recovery.

Source: Federal Reserve Bank of St. Louis


[1] All numbers come from the 2017 annual accounts of the ECB, which can be found at https://www.ecb.europa.eu/pub/pdf/annrep/ecb.annualaccounts2017.en.pdf?ac479d496da81da5c7e2b47d051001a7.

[2] To be more precise, banknotes are a liability of the Eurosystem, which comprises the ECB and the Eurozone’s National Central Banks.

Luis Pablo de la Horra

Luis Pablo de la Horra
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