175 years of financial risks and returns in central banking

Central banks around the world have substantial domestic and foreign financial assets and liabilities on their balance sheets reflecting their role as monetary authorities. This paper explores the long-term trends in risk and return in central banking using the central bank of Denmark, Danmarks Nationalbank, as a case study. The paper presents new annual time series data on Danmarks Nationalbank's balance sheets and profit from financial items 1839-2014 and analyses developments in core earnings and earnings from assuming additional risks within a simple asset/liability framework. During the past 175 years or so core earnings associated with the basic functions and the risks that unavoidable follow from being a central bank have on average accounted for the main part of the Nationalbank's financial return. There has, however, been a downward trend in core earnings since the early 1980s in step with the general decline in the interest-rate level. During this period earnings from additional risks taken as a financial institution by evaluating the expected risk-return trade-off have contributed significantly to the financial return. The paper adds to the literature by taking a long-term historical perspective that makes it possible to trace potential links between the macro economic environment, the monetary-policy strategy and financial risks and returns in central banking.