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Central Banks Need to Be Honest About Their Losses

By fudging their balance sheets to recategorize losses as "deferred assets," the European Central Bank and the US Federal Reserve are venturing into the unknown. Both would do well to abandon the financial nonsense, work out recapitalization agreements with their beneficial owners, and prepare for large realized losses.

NEW YORK – The European Central Bank recently reported its first annual operating loss since 2004. Its losses for 2023 amounted to €1.3 billion ($1.41 billion), following the release of €6.6 billion from its provision for financial risks. In its accounting treatment of this loss, the ECB is relying on the same misleading fudge as the US Federal Reserve Board, which has conjured up a “deferred asset” category to deal with excessive losses.

As the ECB press release explains, this loss “will be carried forward on the ECB’s balance sheet to be offset against future profits.” This means that a loss was entered as a positive asset, even though the sensible alternative would have been to enter it as negative retained earnings in the shareholders’ equity section on the liabilities side of the balance sheet. Total net equity – the sum of paid-up capital, any amounts held in the financial-risks and general-reserve funds, the revaluation accounts, any accumulated losses from previous years, and any profit/(loss) for the year – should be on the liabilities side of the balance sheet.

The Fed, too, enters losses that would take its net equity below a threshold value either as a positive asset (the “deferred asset”) or as a negative liability on its balance sheet. In its own words: