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Practice paper

Central bank capital management

Paul Wessels and Dirk Broeders
Journal of Risk Management in Financial Institutions, 16 (3), 304-315 (2023)
https://doi.org/10.69554/FGHW8156

Abstract

This paper offers general guidelines for central bank capital management. Capital adequacy is important to be a credible, independent monetary authority over a medium-term horizon. Central banks, however, face several challenges in determining their capital adequacy. Firstly, the amount of capital only plays an auxiliary role in central banks' effectiveness given that they cannot default as long as they have the right to issue legal tender. Secondly, central banks face two types of financial risks: calculable risks from current exposures and latent risks from future exposures. These latent risks, in particular, are difficult to quantify because they stem from contingent policy measures such as quantitative easing and lending of last resort. It is argued that a central bank's target level of capital (1) can be calibrated with a confidence level that is lower than that used for commercial banks and (2) takes latent risks into account that are related to GDP or the size of the financial sector in the economy.

Keywords: capital; capital management; central banks; latent risks; risk management

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Author's Biography

Paul Wessels is currently Head of Payment and Collateral Operations at De Nederlandsche Bank (DNB) and was formerly Head of Risk Management at DNB.

Dirk Broeders is a senior financial risk manager for the Financial Markets Division of DNB and a Professor of Finance at the School of Business and Economics of Maastricht University.

Citation

Wessels, Paul and Broeders, Dirk (2023, June 1). Central bank capital management. In the Journal of Risk Management in Financial Institutions, Volume 16, Issue 3. https://doi.org/10.69554/FGHW8156.

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cover image, Journal of Risk Management in Financial Institutions
Journal of Risk Management in Financial Institutions
Volume 16 / Issue 3
© Henry Stewart
Publications LLP

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