BANK NEGARA SHOULD HAVE GONE BANKRUPT AFTER NOR MOHMAMED’S FOREX ‘DEATH BLOW’ – DID IT PRINT MONEY TO STAY AFLOAT?

Continuing on the FX theme and the recent RCI, something’s puzzled me for quite a few years. Why did BNM and/or the government decide to “amortise” the FX losses, rather than take them on BNM’s balance sheet at once?

For the uninitiated, BNM’s losses of approximately RM31.4b in the early 1990s were progressively “written-off” on a gradual basis over a period of 10 years beginning in 1993. My memory on this is a bit hazy, but my understanding was that the losses were carried as memo items, and periodically written off against the Bank’s annual profits (and euphemistically carried as “deferred expenditure” on the asset side of the Bank’s balance sheet).

The main effect of this clever piece of accounting, or boondoggle depending on your perspective, is that it preserved the illusion that BNM’s equity base remained in the black. Writing off the lossses at one go would have wiped out BNM’s equity and accumulated reserves (not to be confused with FX reserves) of about RM13.6b (at the end of 1991), resulting in the central bank being technically insolvent, or more vulgarly, bankrupt.

For most any company this would be a death blow, as with liabilities exceeding assets, there would be justifiable reason to believe that creditors would not receive the full value of what’s owed to them. For banks especially, such a situation is unbelievably dangerous, as even a hint of it would cause a bank run which would make insolvency not just possible but probable.

But central banks are very different animals. Some parts of central bank “liabilities” are not liabilities in the common sense of the word. Each and every one of us carries some of those liabilities in our pockets and wallets – specifically notes and coins. These are carried on a central bank’s balance sheet as liabilities, but they’re not “redeemable” except in other forms of money/currency.

Second, because a central bank can “print money” on demand, there’s no question of it ever defaulting on the other liabilities it has, specifically deposits of the banking system at the central bank. A call on such deposits can simply be met by the central bank crediting the relevant accounts ex nihilo. An independent, sovereign central bank can never be illiquid (Eurozone institutions excepted).

So from an operational perspective, whether a central bank has a positive or negative balance in its capital account is hardly relevant, as it can perform its functions regardless. This isn’t even just an academic, theoretical viewpoint – central banks have operated, quite sucessfully, with negative equity in the past. For an example of a currrent one (click here for the full document):

01_BCCh_2016

So negative capital (i.e. being bankrupt) isn’t really an issue for central banks. If there is a problem, the academic literature points to the potential for a conflict of policy objectives (a run on central bank deposits might lead to higher inflation from excessive money creation), or political (loss of independence, due to “needing” a government guarantee).

But this leads me back to my original question. Why weren’t the losses taken on in full and immediately? I still can’t figure it out.

– http://econsmalaysia.blogspot.sg

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