Central banking has changed into a worldwide expansion industry. However it is not just the dimensions of balance sheets that are changed: so too have their composition. With rates close to nil, the U.S, U.K, Japanese and EU central banking institutions have pumped money into the monetary system. But each has selected a different method and will face different challenges when they try and shrink again. The expansion in balance sheets has been alarming: The mixed assets of the 4 central banking institutions will top $9 trillion by the end of March, compared to $3.5 trillion 5 years back, Deutsche Bank says. The European Central Bank’s three trillion ( $3.93 trillion ) balance sheet is the most important relative to the economy, at 32% of nominal euro-zone GDP, followed by the Bank of Japan with thirty percent, the UK Central Bank with 21% and the Fed Reserve with 19%. The BOE’s balance sheet has expanded quickest in the emergency, more than tripling to £321 bln ($504.6 bln).
But the change in composition and maturity profile of the balance sheets has been similarly notable. In Jan 2007, the Federal Reserve held $779 billion of U.S. Treasury’s, of which 52% matured in under a year and only 19% in more than 5 years. Now, it holds $1.65 trillion of Treasury’s, of which 57% mature in more than 5 years.
Of the BOE’s £255 bln face price of gilts, 72% mature in more than 5 years, with 26% maturing in more than twenty years.
The ECB has concentrated on loans to banks. From 450 bln of usually one-week loans in Jan 2007, its exposure has risen to 1.1 trillion of usually three-year loans. So although it has acquired 284 bill of government and covered bonds, the maturity of its assets is weighted towards shorter-maturity bank loans.
But the ECB is taking higher credit risk than the BOE or Fed thanks to the loan collateral it is accepting, even after big haircuts.
The BOJ is both offering loans and purchasing Japanese govt. bonds and other assets under its latest sixty five trillion ($803.5 bill) program but has centered purchases on 2 year bonds so far.
To tighten policy, central banking organizations could raise rates, sell assets or mop up liquidity thru market operations. Due to the long-maturity bonds the Federal Reserve and BOE hold, even by 2015 they may still face a troublesome task in selling assets without interrupting markets. So they are likely to raise rates first but might take forever to run down their holdings.
The ECB is counting on a total recovery in private funding markets to exit from its loans which is a long way from guaranteed.
In the meantime, the BOJ has been clung to an ultra-loose policy for some time.
The exit for every one of them is probably going to be a long and steady process.