Central banks have increasingly become a country’s national identity. Their roles are uniquely defined in their charters and have become important pillars supporting and managing economies around the world. Thus, understanding the roles of central banks is crucial to understanding central bank finances and their financial strength—issues of great public concern and debate especially during the current economic crisis

The roles of central banks have evolved over time; from issuance of currency and being the government’s bank to more complex roles such as managing monetary and exchange rate policies, providing banking services to the banking sector, lender of last resort, overall macroeconomic management, and more recently financial inclusion and climate change. Essentially, the roles of central banks have expanded to areas that were once not traditionally considered within the purview of a central bank. By their nature central bank roles are more socially manifested than commercial.

Given such roles, central banks are expected to ensure that a “socially” optimal outcome is achieved to provide an impetus for economic growth and/or price stability, as well as financial stability. As such, some may argue that the financial position of central banks is irrelevant to accomplish such roles or mandates, let alone the importance of the central bank balance sheet. This assertion seems to be anchored on two key views. First, as already mentioned, the mandates of the central banks are expected to be “socially” driven. There are no economic incentives for profit-oriented firms to provide such services (goods), which by implications, are public goods. Second, unlike governments’ financing of public goods via taxation, central banks, do not have such privilege to finance the public goods they provide. However, central banks do have the authority to issue currency.

That said, central banks’ capital adequacy requirement is not necessary for the achievement of central bank roles or mandates. Put differently, technically, central banks do not require (the accounting measure of) capital to conduct their mandates. However, they do need to generate enough revenue to cover their operational costs. Note that it is important for central banks to have operational profits to cover for the operational costs.

That being the case, the accounting measure of capital adequacy in the central bank balance sheet is immaterial to determining the central bank financial strength. Rather, the financial strength of the central bank should be determined based on the success of their policy objectives. In other words, central banks can still have the financial strength once their policy objectives are achieved despite the negative accounting measure of capital.

Notwithstanding the above, the reputational risk or credibility of central banks may emerge as a result. Reputation is a socially constructed phenomenon and is embedded within the central bank governor’s character.  A central bank governor may promote him/herself to the public either as dovish or bullish or remain silent for the public to guess. Either way, reputational risk comes with it. To minimize this risk, central banks (or governors for that matter) need to be transparent in terms of governing, policy making and policy outcomes, and internal operations.

Moreover, reputation is a function of expectations that central bank conducts public policy from an economic perspective instead of being limited by balance sheet considerations. That is to say, reputation should be charged against the achievement of the policy target instead of the negative capital and/or losses incurred. Evidence has showed central banks having negative capital but have not suffered from reputational risk.

With the uncertainty presented by the COVID-19 pandemic or for any other future severe economic crisis for that matter, it is in such times that the public looks at the central bank (and the Ministry of Finance and Economy) for solutions and direction to mitigate the negative economic impacts. For the central bank, an operational loss may become inevitable given low interest rates. In such situations, central banks should aim at minimizing the operational loss, but not to lose foresight of its roles or mandates. Importantly, it is also at such moments the reputation of central bank governors is put to the test.


Dr Luke Forau, Governor, Central Bank of Solomon Islands.  The views expressed in this article are that of the author and do not necessarily represent the position of the Central Bank of Solomon Islands. For more articles on PIC economies, see Pacific Forum.