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Danmarks Nationalbank Pays Interest on Deposits and Seeks to Balance Risk
Overview
Danmarks Nationalbank, Denmark’s central bank, generates interest income from deposits made by monetary policy counterparties into their current accounts with the bank. The government also has an account with the bank, earning interest at the transaction-based reference rate, DESTR.
Structural Earnings
The bank’s structural earnings come from the interest rate differential between its assets and liabilities. This is similar to a commercial bank making money from the difference between deposit and lending rates, but unlike a commercial bank, Danmarks Nationalbank’s interest rate is reserved exclusively for managing the fixed exchange rate policy.
Seigniorage Gains and Losses
Banknotes and coins in circulation account for a substantial share of Danmarks Nationalbank’s liabilities. When banks withdraw cash from the central bank, they borrow money or transfer assets to do so. The central bank charges interest on these loans or receives returns on the acquired assets, known as seigniorage. When interest rates are positive, the bank makes a profit from seigniorage gains, while losses occur when interest rates are negative.
Foreign Exchange Reserve Risk
The foreign exchange reserve, which consists mainly of euro-denominated assets, exposes Danmarks Nationalbank to losses due to changes in exchange rates against the Danish krone. The bank’s gold fund, valued at 66.5 tonnes, also carries risk from fluctuations in gold prices.
Investment Strategy
To spread risk and increase earnings, the foreign exchange reserve includes a range of assets, such as:
- Equities
- Bonds with longer maturities
- Lower credit ratings
By taking on more risk, the bank can potentially generate higher long-term earnings, but this also increases the likelihood of large capital losses.
Danmarks Nationalbank’s investment and asset allocation processes involve weighing expected earnings against the risk of capital losses. The bank uses a proprietary risk model to calculate its market risk and sets simpler limits on:
- Equity exposure
- Interest rate sensitivity
- Currency exposure
Recent Performance
In recent years, Danmarks Nationalbank’s earnings have been impacted by structural pressures in the form of low interest rates. However, the bank’s investment assets have contributed positively to earnings, generating higher returns than would have been possible from gold and short-term deposits with central banks.
Profit Transfer
As a self-governing institution, Danmarks Nationalbank transfers a share of its profit to the central government each year. The amount transferred depends on the size of the profit and the need for continuous consolidation of equity. Due to the structural pressure on earnings, no profit has been transferred in recent years.
For more information on Danmarks Nationalbank’s financial results and investment strategy, please visit our website.