ECB reports record loss for 2023 as rate hikes bite

FRANKFURT (Reuters) - The European Central Bank on Thursday reported a record annual loss for 2023 and said further losses were likely as its aggressive interest rate hikes force it to pay out billions of euros to banks.

The ECB, which has raised rates at an unprecedented pace over the past two years, has a bloated balance sheet after a decade of financial stimulus and commercial banks now earn hefty interest on the trillions of euros it printed during the era of anaemic inflation.

"The loss... reflects the role and necessary policy actions of the Eurosystem in fulfilling its primary mandate of maintaining price stability and has no impact on its ability to conduct effective monetary policy," the ECB said.

The ECB, the central bank for the 20-nation euro area said its loss before the release of provisions was 7.9 billion euros after a loss of 1.6 billion euros in 2022.

Once all risk provisions are wiped out, a loss of 1.3 billion euros will be carried forward, to be offset against future profits, its financial accounts showed.

The bank said it was still well-capitalised and could operative effectively regardless of any losses.

"The ECB is likely to incur further losses over the next few years as a result of the materialisation of interest rate risk, before returning to making sustained profits," the bank said.

Unlike commercial banks, a central bank can operate with depleted provisions and even negative equity. However, these losses can raise credibility concerns, deprive governments of dividend earnings and could influence a looming debate over a new operational framework.

For an explainer on why central bank losses matter, click here.

The core of the problem is the ECB's large scale money printing operation, the hallmark of its stimulus efforts under former President Mario Draghi.

The ECB printed cash to buy government bonds in the hope that abundant and cheap credit would rekindle economic growth and push inflation back up to 2%. When interest rates were negative, this had little cost to the ECB but it must now pay a 4% interest rate on the funds it handed to lenders.

Commercial banks still sit on 3.5 trillion euros worth of excess liquidity across the euro zone and it could even take a decade to extract this cash from the financial system without causing instability.

Meanwhile the ECB earns only a modest interest income on the bonds it bought during the stimulus scheme.

The ECB's balance sheet holds some potential risk, too, because the value of these very bonds has dropped sharply since their purchase. But the ECB has again decided against writing down their value because they are held until maturity, mostly with fixed coupons and tend to have long durations.

"The ECB can operate effectively and fulfil its primary mandate of maintaining price stability regardless of any losses," it said.

(Reporting by Balazs Koranyi; editing by Christina Fincher)