In other words, a central bank can run the risk of being insolvent, even when it has been successful in maintaining the stability in the value of its currency. The insolvency risk of a central bank is less obvious, because of the very nature of a central bank. A central bank, even if its capital is negative and its currency liability is not matched by an equivalent value of foreign assets or valuable domestic assets, could still continue to be in business unlike a private organisation. In the case of a private organisation, if the net-worth is negative, it has to be re-capitalised as an urgent need. If it does not happen, it cannot operate as a going concern and has to be liquidated on the ground of insolvency. However, a central bank can still operate with a negative net-worth, by continuing to issue currency as long as the members of the public are willing to accept such currency in exchange for the assets held by them. It could, in these circumstances, defer and hide the need for recapitalising itself and continue to be in operation. The fact that the insolvency of a central bank is not known to the outside world does not mean that a central bank is without problems. A central bank’s operations are smooth and faultless, if its expenses are funded out of net interest income it earns on its foreign reserves or its domestic asset portfolio.
Though this provided a temporary relief to CBP in the form of an augmentation of gross foreign reserves and a higher import cover adequacy, it forced CBP to take a huge loss amounting to 31 billion Pesos during 1983-90 on account of exchange rate risks. At the same time, the use of the foreign exchange balances so acquired for defending the currency led to an undue reserve risk by converting the foreign assets to a net negative position and forcing CBP to borrow abroad to settle its liabilities. The forward cover was provided by CBP to local corporations, especially the oil corporation, by guaranteeing the exchange rate when they borrowed abroad in the wake of the balance of payments crisis. When CBP had to relax its grip on the exchange rate from time to time due to the non-availability of reserves, the forward covers given by CBP resulted in massive losses. The total of such losses for the period 1983-90 amounted to 20 billion Pesos. 4  There have been a number of central banks which had become insolvent due to the erosion of capital. For a survey, see, Kazuo Ueda, “The role of Capital for Central Banks”, The text of Speech delivered at Japan Society of Monetary Economics on 25 Oct 2003. www.boj.or.jp. 5  A lucid description of the events that led to CBP’s insolvency is given by Mario B Lamberte in Central Banking in the Philippines: Then, Now and the Future Discussion Paper Series 2002-10, Philippine Institute of Development Studies.