The Perspective
Atlanta, Georgia
February 25, 2020

Paul Collins

The Central Bank of Liberia (CBL) has always been an exceptional animal- a rare species. It is one of a kind in the country. Just like for every country, there is just one central bank. CBL is also very different from banks, except for its ancillary legal mandate of the fiscal agency, where it performs banking services for GoL (and for banks). 

CBL’s core objective is to maintain price stability and to ensure a sound banking and financial system.  In order to achieve this objective, it performs several functions which include issuing banknotes for transaction purposes, as the most common form of the LRD currency. The LRD currency is represented by both banknotes and LRD account balances. 

Banknotes have to be printed.  Some countries have internal arrangements to print their own banknotes.  Others, like Liberia, have no such capacity and therefore must print their banknotes externally.

Printing money to an economist and from the perspective of central banks usually refers to the expansion of money supply or creation of additional credit whereby for expansionary monetary policy purposes the central bank (lender of last resort) makes more money available to its customers (banks or Government).  This credit to central banks’ customers allows them to put more money into the economy when there appears to be a need to encourage more spending, and also gives the central banks some leverage in influencing the direction of both interest and inflation rates. 

But printing money also means the production of physical banknotes, as in this case regarding CBL printing money.  It is important to note that the printing of banknotes for the purpose of meeting the demand for physical cash where there is no expansion of credit or account balances at the CBL may not result in an expansion of the money supply.  For instance, if a commercial bank has an LRD 1bn credit balance at the CBL, and decides to withdraw all of this money in cash for whatever agreed purpose, the CBL needs to be able to meet this demand for cash.  If all of this cash is not available, the CBL may print and issue the required quantity of banknotes to meet this cash demand. 

The need to print banknotes must be evaluated, based on the monetary policy direction of the bank, the growth of the economy, and as already stated the operational need for cash transaction purposes. Central banks around the world aim to have enough banknotes available to meet the cash demand of the economy. Developed economies with less cash-based transactions have banknotes in the circulation of around 4 to 5 percent of their GDP.  For cash-intensive economies, this average can be within the range of 10 to 15 percent of their GDP.  The global market average cost of printing each leaf of the banknote is US$0.06 (six cents USD).
The National Legislature, which has the authority to issue currencies, had previously delegated to the CBL the right to print LRD banknotes as it saw fit without seeking authorization from anybody.  That independence was however curtailed a little over 4 years ago when the CBL Act was amended in March 2014 to require that the CBL seek the approval of the National Legislature before printing banknotes. 

The National Legislature in the Public Procurement and Concessions Act (PPCA) has also given the CBL exemptions from following a competitive procurement process when undertaking procurements of a monetary policy nature; hence the CBL can argue that procurement activities related to printing banknotes are of a monetary policy nature.

But it could be argued also that going through a competitive procurement process offers economic benefits which could include a below-average cost, better security features and high service quality.   However, once a printer is contracted, only that printer can continue printing that particular family of banknotes as the production plates are expensive to produce and normally the exclusive property of the printer.  A new printer would have to develop its own production plates which would change the features of the family of banknotes.  That’s like printing new banknotes different from the previous ones.  So for instance, the CBL can only contract Crane Currency to print the additional LR$ 4bn as only Crane has the production plates of the existing family of banknotes.  Contracting a different printer would result in a different family of banknotes. That’s the reason we currently have different families of banknotes on the market- because each type was printed by a different printer.

When the CBL awards a banknotes printing contract to a company, it must account for the cost of printing the banknotes.  Upfront (which is usual) or installment payments result as normal in credit entries to the bank ledger and debit entries to prepayments on the balance sheet.   When the banknotes are delivered to the CBL the prepayments are canceled and printed material inventories replace the prepayments on the balance sheet. 

These accounting posting entries would be supported by the procurement package which would include the currency printing contract and CBL Governance Board resolution; copies of communication exchanges between the printer and CBL; the shipping documentation which specifies exactly what has been shipped; delivery and receiving documentation which confirm what has been received; physical inventory report at CBL which confirms the exact quality, quantity and other specifications of the shipment received;  reconciliation reports of the physical inventory details, shipping details, and contract requirements; the storage vault detailed report confirming what has been placed in the vault and the updated vault contents; and an internal audit report confirming that all of these details are correct as stated.    

These newly delivered banknotes are not considered monies yet but are called printed material inventories, and the storage vaults in which they are stored are referred to as reserve vaults; not operational vaults.  They are not money as far as the CBL is concerned, but simple pieces of paper whose monetary value is the cost incurred by CBL to print and bring them into storage (just like any stationery item).  That is why they are treated in the accounting system as printed material inventories.  They become money when they are brought into use by the CBL; that is when the printed material inventories are transferred from the reserve (storage) vaults into the operational vaults.

The accounting posting entries to transfer the printed materials from the reserve vaults to the operational vaults, where the printed materials now become money, would be supported by a detailed inventory of what has been transferred; ie., quantity of bills in their respective denominations, along with their associated cost of production and shipment as was booked in the printed materials inventory account on the balance sheet. Also included would be an updated reserve vault report detailing exactly what was in the vault, what has left the vault, and the balance of what is in the vault.  Additionally, the authorization to make the transfer along with Internal Audit’s report would be attached.

Remember that banknotes are really promissory notes issued by the CBL, to holders of the banknotes. These promissory notes are negotiable (transferable) because the holders are authorized to treat them as legal tender for the value indicated on the face of the notes. Simply put, the CBL owes all the holders of its promissory notes (banknotes).  This, therefore, is a liability of the CBL to the holders of the banknotes.  Hence, the CBL credits a liability account on the balance sheet to account for all promissory notes (banknotes), and calls them, LRD currency in circulation (CIC).

Those banknotes in the operations vault at the CBL, however, are not considered currency in circulation, as they are not actually in circulation.  Additionally, because currency in circulation is a liability of the CBL, the CBL cannot conceivably have a liability to itself (one cannot owe themself).  But transfers from the reserve vaults to the operations vault as previously stated are credited to the CIC account.  In effect, the credits to the CIC liability account are effectively netted off or offset by the debits to the operations vault.  Hence, the actual currency in circulation balance is the balance sheet amount less than the operations vault amount on the same balance sheet.

CIC is money in circulation and a component of the money supply (M0), whereas printed material inventory is not money.  The value of the printed material on the balance sheet will not be the same as the value of the CIC.  This is because the printed material inventory is valued as normal inventory or stock under IAS 2 (International Financial Reporting Standards).  Unfortunately, there is really no IFRS that deals with CIC (and other peculiar accounting issues of central banks).  However, central banks around the world value CIC using the face value of the banknotes put into circulation.  This amount is always going to be different from the cost of the banknotes.  So even though we are talking about the same pieces of papers (banknotes), they carry different values depending on where they are. 

For instance, if it costs CBL 6 cents USD to print one LRD100 banknote, the cost is going to be USD 6 cents, but the value of the (monetized) banknote in circulation is going to be LRD 100. Using today’s rate of US$1/LRD200, the LRD 100 is going to be treated as USD 50 cents. In order to make the values balance out, the printed material inventory cost is written off to the Profit and Loss as they are put into circulation, so that you have a debit to the P/L and a credit to the balance sheet (to reduce printed material inventory), of the same value.  As for the CIC that is now a credit on the balance sheet, its corresponding debit entry is posted to the operations cash vault, also on the balance sheet.  This creates an asset to offset the CIC liability.  Payments from this operations cash vault lead to reductions of the operations cash vault holdings (credit entries) and debits to the accounts of the payee- a reduction in the account balance of the payee.

Printing money invariably leads to profit, whether it is the expansion of credit or the production of banknotes.  When credit is created, the interest on the credit is a profit to the central bank.  When banknotes are produced, the difference between the cost of production and the face value of the banknotes is the profit.  This profit has to be calculated and accounted for. How central banks account for such profits, however, is not standardized because of the absence of generally accepted accounting standards such as IFRS on how to deal with that kind of profit. 

Economists call this profit seigniorage. However, modern-day central banks don’t like to define seigniorage as the difference between the cost and face value of printed banknotes, because they claim the definition dates back to the era of coins which were basically in circulation forever, had intrinsic value of their own, and so were often not recorded as liabilities, but as assets. Instead, central banks prefer to define seigniorage as the income earned on the assets financed by the banknotes. So for example, if the interest rate is 10% an LRD100 note will earn LRD10 a year. If it lasts 2 years in circulation, the total seigniorage income will be LRD 20.  From this one needs to deduct the cost to give the net seigniorage.  Thus for many small notes, the seigniorage may be negative. 

The Economists’ view of seigniorage, however, fits the Liberian scenario, particularly because the Liberian economy is highly dollarized (about 70%), the US dollar is legal tender, and in practice those banknotes could be printed and issued in exchange for USD, thus accruing realized profit to the CBL.

For instance, if the difference between printing cost and face value of LRD 100 banknote is 44 cents USD (50 cents USD minus 6 cents USD) immediately post-issuance, one would need to reduce this difference by the future replacement cost of the banknote (another 6 cents USD) to arrive at a profit of 38 cents USD.  However, if the value of the LRD 100 depreciates by 50% as a result of the excess printing of LRD, then the profit of 38 cents would need to be reduced by the loss in value as a result of the depreciation, which is a further 25 cents USD deduction.  Final seigniorage would, therefore, be 13 cents. 

The problem is, knowing how much the loss would be, and how long it would take to eventually realize the total loss over time, wouldn’t be immediately known to the CBL at the year-end when the financial statements relevant to the printing and issuance of the currency in question are published.   So the external auditors normally agree with the CBL not to do anything about seigniorage.  That is why there has been no qualification of the financial statements of the CBL with regards to seigniorage by any of their big four auditors over the last 15 years. And this is common to central banks around the world.

So CBL says nothing about seigniorage in its financial statements, even though it is there somewhere, hidden in the numbers, and below the lines as a financing income.  This is one-way CBL finances its operations and grows its reserves.  Maybe the CBL does not calculate let alone disclose its seigniorage income because it doesn’t want to be asked for dividends out of such profits, as these profits could be eroded by the depreciation of the currency in the future periods. 

To conclude, therefore, our folks at the CBL knew how to account for LRD banknotes.  The CBL could forecast their cash needs correctly, perform the procurement activities legally and efficiently, account for the exact number (and value) of banknotes accurately, and keep the economy running without any missing billions or cash crisis. 

The system of accountability surrounding the printing of banknotes has always proven adequate to safeguard the banknotes and provide detailed information on their movements and storage.  This is a system that has involved several different departments and external parties, with both Internal Audit and the external auditor providing assurance on the resilience and effectiveness of the integrity of the system on a regular basis.
It is instructive to note that in order to effectively audit or review a central bank, one must have been a central banker in order to understand how the system works and know how to walk through it. Otherwise, there would certainly be a scope limitation, as any such audit or review would fail to successfully achieve its objectives. That is one reason why central banks normally only hire international audit firms that have ex-central bankers that have audited central banks in other jurisdictions.

Now, however, USAID is paying Kroll, a US firm, several million dollars to assist the CBL to do what the CBL has been doing for many years, even though Kroll’s understanding of the CBL is doubtful, considering its last engagement that produced more questions than answers, and whose findings were unreconciliable and inconclusive. Interesting.

---