Central Bank Insolvency: Causes, Effects and Remedies

This article analyzes the possibility and consequences of central bank insolvency. Sovereign insolvency may indirectly cause or aggravate problems leading to central bank insolvency. Sovereigns have a bailout guarantee, either implicitly via loans from major central banks or the IMF, or explicitly, as is the case in the Eurozone via the European Stability Mechanism. Exchange rate stability through these bail-out guarantees allows for a greater amount of foreign-denominated debt accumulation than otherwise would prove prudent, or profitable. In the event of a crisis, the currency mismatch may be problematic for a central bank trying to support its banking system. Lacking the ability to supply foreign currency in the absence of an international bailout, central banks may face insolvency as they try to support an economy indebted in foreign currency