Future Proofing Central Banks’ Financial Strength

Stijn Claessens, Thomas Glaessner and Daniela Klingebiel

No 20049, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: Central banks have successfully used their policy tools in recent decades to meet key mandates in monetary policy, financial stability and payments. They have largely succeeded in controlling inflation and stabilizing economies and financial systems. This paper argues, however, that diminishing central bank financial strength increasingly threatens their operational capacity, credibility, and independence. Past policy responses to shocks have bloated many central banks’ balance sheets and have already resulted in large losses. Key trends—notably high public debt levels, large fiscal deficits, rising populism, technological advances and growing geostrategic fragmentation—further strain central bank financial strength. To safeguard independence and avoid political interference, central banks must proactively strengthen their financial position. Recommended measures include improving financial reporting, building larger capital buffers, implementing automatic fiscal recapitalization mechanisms with clearly defined triggers, and conducting stress tests. For many central banks, declining seigniorage income—due to the rising use of innovative payment technologies—necessitates developing new revenue sources to cover operational costs. Potential sources include new or increased fees for key financial oversight functions and liquidity facilities, which can also improve private sector risk management incentives. Somewhat reducing the remuneration on commercial bank reserves and introducing additional fees can also raise revenues. Central banks should maintain a long-term perspective on their core mandates and, where changes are justified on their own merits, adjust policies and tools to uphold their financial strength. Possible adjustments include reducing reliance on unconventional monetary policies, transitioning to a scarce central bank reserves regime, and increasing risk- and cost-sharing with the private sector to limit excessive central banks’ balance sheet exposures and fiscal costs resulting from financial instability.

Keywords: Seigniorage; Monetary policy; Financial stability; Central bank independence; Fiscal dominance (search for similar items in EconPapers)
JEL-codes: E02 E42 E58 E62 F36 F42 F53 F65 G18 G28 N20 (search for similar items in EconPapers)
Date: 2025-03
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