Central banking has become a global growth industry. But it isn't just the size of balance sheets that has changed: so too have their composition. With rates close to zero, the U.S., U.K., Japanese and European central banks have pumped cash into the financial system. But each has chosen a different method—and will face different challenges when they try to shrink again.
The growth in balance sheets has been startling: The combined assets of the four central banks will top $9 trillion by the end of March, compared with $3.5 trillion five years ago, Deutsche Bank says. The European Central Bank's €3 trillion ($3.93 trillion) balance sheet is the biggest relative to the economy, at 32% of nominal euro-zone GDP, followed by the Bank of Japan with 24%, the Bank of England with 21% and the Federal Reserve with 19%. The BOE's balance sheet has expanded fastest in the crisis, more than tripling to £321 billion ($504.6 billion).
But the change in composition and maturity profile of the balance sheets has been equally noteworthy. In January 2007, the Fed held $779 billion of U.S. Treasurys, of which 52% matured in under a year and only 19% in more than five years. Now, it holds $1.65 trillion of Treasurys, of which 57% mature in more than five years. Of the BOE's £255 billion face value of gilts, 72% mature in more than five years, with 26% maturing in more than 20 years.
The ECB has focused on loans to banks. From €450 billion of mostly one-week loans in January 2007, its exposure has risen to €1.1 trillion of mostly three-year loans. So while it has bought €284 billion of government and covered bonds, the overall maturity of its assets is weighted toward shorter-maturity bank loans. But the ECB is taking higher credit risk than the BOE or Fed because of the loan collateral it is accepting, even after hefty haircuts.
The BOJ is both offering loans and buying Japanese government bonds and other assets under its latest ¥65 trillion ($803.5 billion) program but has focused purchases on two-year bonds so far.
To tighten policy, central banks could raise rates, sell assets or mop up liquidity through market operations. Because of the long-maturity bonds the Fed and BOE hold, even by 2015 they will still face a tricky task in selling assets without disrupting markets. So they are more likely to raise rates first but might take years to run down their holdings. The ECB is relying on a full recovery in private funding markets to exit from its loans—which is far from guaranteed. Meanwhile, the BOJ has been stuck with ultra-loose policy for years.
The exit for all of them is likely to be a long and gradual process.