Federal Reserve posted its largest operating loss on record last year — here’s what the central bank’s shrinking balance sheet actually means

To account for inflation and the Federal Reserve’s increases to the key rate, the bank had to shell out $60 billion more in interest on depository institutions' reserve balances compared to the year before. And in the same period, it incurred an additional $62.4 billion in interest on securities sold under agreements to repurchase.

Here’s why it could now take years for the Fed to return to profitability.

Why the Fed is dealing with higher operating costs

After covering day-to-day operating costs, the central bank usually sends off any profits from services it provides to the financial system or on its securities portfolio to the Treasury, which uses the revenue to offset federal deficits.

Since 2022, the Fed has lifted its target rate from near-zero levels to the current 5.25% to 5.5% range with an aim of cooling inflation. As a result, its expenses surpassed its earnings last year.

The audited financial statements revealed interest payments to banks on excess reserves parked at the Fed hit a record $176.8 billion last year, almost triple the amount paid in 2022.

Interest payouts from the reverse repo facility also swelled from $41.9 billion to $104.3 billion last year.

What this means for the economy

Despite the sizable loss, the Fed has often emphasized that net negative income does not impact the central bank’s operations or its ability to control monetary policy.

When there’s a shortfall in earnings, the Fed uses a deferred asset, which essentially works as an IOU by the Fed to itself, to fund operations. So, when the central bank becomes profitable once more, it can divert the excess earnings to pay down the deferred asset until it reaches zero.

Once the deferred asset is fully paid off, the Fed can continue to hand excess profits over to the Treasury again.

However, a November report from the St. Louis Fed estimates the central bank will carry this deferred asset until mid-2027, which means it’ll be a few years before it can return profits to the government.