Monday, February 4, 2013

Central banks that trade on the stock market

Most people don't realize that the central banks of Belgium, Japan, Greece, Switzerland, and South Africa are all publicly-traded. In times past, central clearinghouses were typically privately-owned while the issuance of bank-notes was the domain of competing banks. The fact that a few central banks still retain traces of their former private nature is a good reminder that centralized banking isn't necessarily the domain of the public sector.

The Swiss National Bank, for instance, was founded in 1907 to take upon itself the issuance of national bank notes, hitherto provided by private banks. According to Hübscher and Kuhn (pdf), efforts to establish a wholly government-owned central bank were defeated in an 1897 national referendum. Opponents of the plan drew up an alternative proposal for a privately owned bank the structure of which would, according to Bordo, "not allow for state socialism or the public control of credit policy." One fifth of the new bank's capital would be given to the private banks to compensate them for the loss of their power to issue notes.

Nowadays, SNB shares trade on the SIX Swiss Exchange. The original 100,000 shares are still outstanding, with 2,185 private shareholders owning about 37% of the float. Another 53% is owned by the cantonal governments and cantonal banks and the last 10% by other public institutions. The Swiss Federal council (Switzerland's federal government) doesn't own a single share, a contrast to most central banks which are 100% owned by their federal government. The largest private investor is Theo Siegert, who owns 5.95% of the float. The SNB provides all breakdowns here.

Though the shareholders of the five central banks may to some extent "own" their nation's central bank, they don't exercise the same degree of control over their company that regular shareholders do. Here are some of the drawbacks to owning central bank shares:

1. Capped dividends: The SNB's dividend is capped at 6% of the company's paid-up share capital. Because the SNB was originally capitalized with CHF 25 million, a large amount a hundred years ago but today a minuscule slice, aggregate dividend payments to all shareholders are limited to a mere CHF 1.5 million a year (around US$1.6 million), or CHF 10.50 per share. At today's stock price of CHF 1115, the shares yield just 1% or so.

This is a stable dividend. The SNB has paid it going back to at least 1996 (the last annual report I could get my hands on). But unlike the typical common share, there is no chance of this dividend growing.

2. Profits siphoned away: Nor will the profits that are not distributed to shareholders stay with the Bank. The lion's share of the SNB's remaining profits go to the state. Specifically, two-thirds of earnings are paid to the cantonal governments, and another third to the Federal council. In 2011, for instance, the SNB earned CHF 4.9 billion. A tiny CHF 1.5 million sliver was paid to shareholders while the various governments received CHF 1 billion (the balance was held over as reserve for the next year).

Much like the SNB, the Bank of Japan (BOJ) pays a fixed dividend. The BOJ, established in 1882, trades on the JASDAQ for around ¥46,500 a share. The Bank is not permitted to pay more than 5% of its  ¥100 million in paid-up capital to shareholders. As is the case with the SNB, this was a large amount back in 1942, the last time the BoJ was capitalized, but today its amounts to just ~$10 million. The upshot is that the BOJ can only provide shareholders a piddling ¥5 million in aggregate dividends a year, or  ¥5 a share. This equates to just US$50,000 in aggregate dividend payments, or around 5 cents a share. Considering that total profits earned by the BOJ in 2011 amounted to  ¥503 billion (around $5 billion), the shareholders are getting peanuts.

3. Minority position: Unlike the SNB, the Japanese federal government owns 55% of the Bank's shares. This puts private shareholders at an even larger disadvantage since they must play second fiddle to a dominant shareholder at all shareholder meetings.

4. No residual claim: The Bank of Japan Act stipulates that should the Bank be dissolved, shareholders only get a return of initial paid-up capital. All residual assets belong to the national treasury. Thus shareholders get a mere  ¥100 million (around $1 million) back in case of dissolution, or around  ¥100 per share -- far less than the current  ¥46,500 a share. Genuine common shares would allow shareholders to get all residual assets.

According the the National Bank Act, SNB shareholders are also restricted in their ability to claim residual assets:
In case of a liquidation of the National Bank, the shareholders shall receive in cash the nominal value of their shares as well as reasonable interest for the period of time since the decision to liquidate the National Bank became effective. The shareholders shall not have any additional rights to the assets of the National Bank. Any remaining assets shall become the property of the new central bank.
This means that each SNB shareholder is entitled to CHF 250 a share upon dissolution, far less than the current CHF 1150 per share price.

4. Inability to select management. Even with their voting power, SNB shareholders have little influence over the composition of bank management. The supreme managing and executive body of the Bank is the three-member Governing Board. All three members are appointed by the Federal Council upon recommendation of the SNB's Bank Council. Here shareholders do exercise some power. They have the ability to vote 5 members of the Bank Council. But the remaining 6 are appointed by the Federal Council, which means that the Federal Council can always stack the deck to ensure that its people get appointed to the Governing Board.

In the BOJ's case, it appears that shareholders have no ability whatsoever to select BOJ officials.

5. Voting limitations: The SNB limits non-public shareholders to a maximum of 100 votes. Even though Theo Siegert owns 5,950 shares, he only gets 100 votes. Most common shares carry the privilege of one share, one vote.

The South African Reserve Bank (SARB) also imposes artificial limitations on shareholders. No single shareholder is allowed to hold more than 10,000 of the 2 million shares outstanding. This limits the ability of individuals shareholders or blocks of shareholders to exercise voting control, a key element of modern shareholder activism.

The SARB was established in 1921 and, much like the SNB, replaced the existing network of private bank-note issuers then operating in South Africa. Its shares currently trade for about R7.00 on a SARB-hosted OTC market rather than the local Johannesburg Stock Exchange from which the shares were delisted a few years ago. The market is thin, although according to the bank's records there are over 600 shareholders. Like the SNB, the federal government does not own a single share of the Bank.

Similar to the SNB and BOJ, the SARB can only pay a fixed dividend of 10% on paid-up capital. With just R2 million in paid-up capital outstanding (about $225,000), the Bank only distributes R200,000 a year, or R0.10 a share. Compared to the R53 million in central bank profits paid to the government in 2011, shareholders get next to nothing.

Because the return on all three central bank shares so far discussed is calculated on a nominally fixed amount of paid-up capital from a bygone era when a few million dollars was still a large amount of money, they trade more like perpetual bonds than stocks. But this isn't the case for our fourth publicly-traded central bank -- the Bank of Greece (BoG). In 1927, the private National Bank of Greece waived its right to issue bank-notes in return for handling the IPO of the new Greek central bank. The BoG currently has some 19,000 shareholders and trades on the Athens Exchange for around €16.

What makes the Bank of Greece unique is that it pays a fixed 12% dividend on paid-up capital and an additional dividend based on remaining profits. Whereas the first payment is fixed relative to paid-up capital, the second is floating, thereby allowing shareholders to get exposure to continued growth in the Bank's business. The floating dividend also exposes shareholders to declines in the Bank's business, which is what has happened over the last few years:

Due to the euro crisis, the floating portion of the dividend has collapsed from over €40 million to zero. The upshot is that BoG shares are much more volatile than the shares of their fixed-rate cousins the BOJ, SNB, and SARB. Below is the share price of the BoG, which seems to trade much like a regular bank common share:

The National Bank of Belgium (NBB) falls in the same mold as the BoG. The NBB was founded in 1850 as a limited liability company, with shares distributed to private banks who in exchange agreed to forgo the privilege of issuing bank-notes. The Belgian government subscribed to 50% of the shares in 1948. The Bank's constituting articles specify a minimum 6% dividend on paid-up capital and an additional dividend to be paid after the reserve fund has been topped up:
Article 32. - The annual profits shall be distributed as follows:
1. a first dividend of 6% of the capital shall be allocated to the shareholders;
2. from the excess, an amount proposed by the Board of Directors and established by the Council of Regency shall be  independently allocated to the reserve fund or to the available reserves; 
3. from the second excess, a second dividend, established by the Council of Regency, forming a minimum of 50% of the net proceeds from the assets forming the counterpart to the reserve fund and available reserves shall be allocated to the shareholders;
4. the balance shall be allocated to the State; it shall be exempt from company tax.
In 2011, the bank earned €900 million. Of this, a healthy  €61.6 was paid out to shareholders, with €225 and €618 allocated to the reserve fund and government respectively. The first dividend, it should be noted, amounts to a mere €600,000 a year, since it is based on a percentage of legacy paid-up capital from the 1800s. The second dividend provides pretty much all of the returns. Thanks to the floating nature of the second dividend, the NBB's dividends have appreciated nicely over the last decade:

Despite this stability, its shares, which trade on Euronext Brussels, have been volatile, falling from over  €4,000 per share in 2010 to under €2,000 last year:

Compare the NBB and BoG variability to the relative stability of the SNB, with its fixed coupon:

According to the SNB's 1997 Annual Report, the massive 1997 price spike was anomalous and due entirely to speculation surrounding the effects of the Bank's planned marking-to-market of their gold holdings:
The rise was apparently due to recommendations made in various broker reports, which were based on hopes that the planned revaluation of the gold reserves would generate additional earnings for the National Bank’s shareholders. However, the authors of these recommendations failed to note that the law earmarks for public use any profits in excess of the maximum dividend of 6%.
A sure example of the EMH not working.

It mystifies me why BOJ shares are so volatile. They promise a fixed and stable dividend, yet have collapsed from over ¥170,000 a share to ¥30,500 over the last few years. What happened in September 2005 that caused the shares to almost triple in value? Shares have recently rallied on the news that the BOJ will target 2% inflation, which is odd, since as a bond-like investment, the shares should fall with the promise of more inflation, not rise:

Below are the five central banks with their respective dividends and market capitalizations:

The NBB has the largest market cap, and justifiably so since it pays an attractive floating second dividend and, unlike the BoG, is a relatively stable institution. I find it amusing that the entire SARB can be bought for a mere $1.5 million. You can own a nation's central bank for the price of a large house!

What is even more odd is the terrific valuation being put on BOJ shares. In aggregate, BOJ shareholders earn a miserable $53,763 a year in dividends, only twice what SARB shareholders earn in aggregate. Yet the Japanese market is putting a value of $500 million on that cash flow, or 500x more than the value that shareholders put on SARB cash flows. BOJ shareholders have absolutely no claim on residual assets. What are they thinking?

Which one would I buy? Gun to my head, I'll take BoG shares. When things get back to normal they'll be paying a  €3 dividend which you can buy now for  €16 or so. But if you're going to take any profit from this post, hopefully its because it gives you another perspective from which to view centralized banking.


  1. A thought experiment: imagine the Fed were publicly traded and distributed all profits to shareholders. How would the shares have reacted to the announcement of QE3?

    1. That's a pretty good question. Is this the same as asking: how would Microsoft shares react if it announced it was going to increase its balance sheet by 25%?

      My gut reactions is that Fed shares would fall on QE3. It seems that most large corporate acquisitions cause the acquirer's price to fall. Would be curious to hear what others have to say.

  2. From a shareholder's perspective, the "core strategy" of the Fed is to earn seigniorage profits (on riskless s.t. bills). With QE and IOR, the Fed has diversified into outright maturity transformation: i.e. earning a spread between long-duration assets and short-duration liabilities. In this regard, the Fed is just another "shadow bank".

    Like any shadow bank, the Fed would add value to the extent it has proprietary information about the future path of interest rates. That is, if the Fed knows inflation will be lower than the market perceives, it can buy long duration assets at a discount to their true value. Shareholders would therefore reward any expansion of the Fed's balance sheet.

    Does the Fed have such proprietary information? I would argue no: the Fed has no demonstrated advantage over the market in predicting inflation. That leaves two cases: 1) shareholders should be indifferent to balance sheet expansion since any higher returns are offset by higher duration risk. 2) shareholders should punish balance sheet expansion if the Fed is overpaying for long duration assets for policy reasons, as the extra return will be more than offset by added duration risk.

    I think its 2): the Fed's share price would have fallen on the QE3 announcement.

  3. The BoJ basically did the exact same thing, and their share price exploded. We don't really need to do a thought experiment.

  4. Like any shadow bank, the Fed would add value to the extent it has proprietary information about the future path of interest rates. That is, if the Fed knows inflation will be lower than the market perceives, it can buy long duration assets at a discount to their true value. Shareholders would therefore reward any expansion of the Fed's balance sheet.