The State Bank of Pakistan (SBP) recently announced its financial results for FY20. Amidst much fanfare, the SBP posted its highest ever profit of Rs1.16 trillion, against a loss of Rs1.04 billion in the same period last year. Before partisan politics blows the numbers out of proportion, it is essential to understand how profitability of central banks works.

The primary function of a central bank is to issue currency notes, regulate and supervise the financial system, be the banker for the government, and the lender of last resort. Revenue for a central bank essentially stems from issuance of currency notes, and by being a lender to the government. As of 30th June 2020, banknotes in circulation amounted to Rs6.458 trillion. Essentially, SBP can and will honor any of these banknotes that are presented to it, unless they are discontinued. These banknotes, which are a liability for SBP are backed by its assets, which primarily include investments in Pakistan Investment Bonds (PIB), gold, investments and foreign currency accounts.

At the same time, SBP held more than Rs7.2 trillion in PIBs, as well as gold valued at Rs617.4 billion. The mark-up accrued on the PIBs makes up major chunk of revenue for the central bank, amounting to more than Rs1 trillion. The mark-up accrued is largely a function of interest rates prevailing in the market which is in turn dependent on the monetary policy. The mark-up is paid by the Government of Pakistan.

During most part of the last fiscal year, yields on PIBs were well in excess of 12 percent which allowed SBP to accrue a significant increase in revenue. A sharp decline in interest rates following pandemic-driven change in monetary stance may be more apparent in subsequent periods. Similarly, during the period under consideration, the central bank also realized an exchange gain of Rs66 million, against an exchange loss of Rs506 million during the previous year. Higher international gold prices helped SBP accrue an unrealised appreciation of Rs613 million on gold reserves. Following such gains, SBP transferred Rs935 billion to the federal government, enabling it to plug its deficits.

The growth in the profitability of the central bank is largely a function of double-digit interest rates which enabled accrual of relatively higher interest income, as well as an improvement in the price of gold, and a nominal exchange gain, compared to the massive exchange loss in the previous year. The magnitude of profitability and its direction is largely a consequence of monetary policy, and sovereign debt. This was a very simplified primer on the central bank’s accounting – the underlying transactions and nuances are much more complex, and can fill up reams of paper.